52358 Federal Register / Vol. 74, No. 195 / Friday, October 9, 2009 / Rules and Regulations 

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]. 

9Public 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)]. 

10See 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). 

11See 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). 

12The 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’’). 

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. 

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. 

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– 11 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–R4 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

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

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. 

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 PILOT16 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 

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Federal Register / Vol. 74, No. 195 / Friday, October 9, 2009 / Rules and Regulations 52359 

17See Exchange Act Release No. 40760 (Dec. 8, 

1998) [63 FR 70844 (Dec. 22, 1998)] (‘‘Regulation 

ATS Adopting Release’’). 

18See 17 CFR 240.3a1–1(a)(2). 

19See 17 CFR 240.3a1–1(b); Regulation ATS 

Adopting Release, 63 FR at 70857. 

20Specifically, 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). 

21See 17 CFR 240.3a1–1(b)(3). 

22Compare 17 CFR 240.3a1–1(b)(3)(v) with 17 

CFR 240.3a1–1(b)(3)(vi). 

23See 17 CFR 240.3a1–1(b)(3)(v). 

24See 17 CFR 240.3a1–1(b)(3)(vi). 

25Existing paragraphs (b)(3)(vii) and (b)(3)(viii) 

are unchanged but redesignated as paragraphs 

(b)(3)(vi) and (b)(3)(vii), respectively. 

26See 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%. 

27The 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. 

28See 17 CFR 242.300(i) and (j). 

29See 17 CFR 242.301(b)(5). 

30See 17 CFR 240.600(a)(47) (defining ‘‘NMS 

stock’’). 

31 17 CFR 242.301(b)(6). 

32 17 CFR 242.301(b)(6)(i). 

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. 

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

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) noninvestment 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

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 noninvestment 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

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

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) noninvestment grade corporate debt 

securities. 

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) noninvestment grade corporate debt 

securities.32

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) 

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52360 Federal Register / Vol. 74, No. 195 / Friday, October 9, 2009 / Rules and Regulations 

33 15 U.S.C. 78c(a)(12). 34When 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)]. 

35Each 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). 

36 15 U.S.C. 78s. 

37 17 CFR 240.19b–4. 

38 17 CFR 240.19b–5. 

39The 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 NRSROratings 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 

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. 

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 noninvestment grade corporate debt 

securities, and instead creating a single 

category for ‘‘corporate debt securities.’’ 

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. 

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 

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Federal Register / Vol. 74, No. 195 / Friday, October 9, 2009 / Rules and Regulations 52361 

is deferring action and seeking additional 

comments on those other proposed amendments. 

See NRSRO Comment Re-Opening Release, supra 

note 12. 

40See 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). 

41See Comment Letter of DBRS (Sept. 8, 2008) 

(‘‘DBRS Comment Letter’’); Comment Letter of 

Multiple-Markets (Sept. 5, 2008) (‘‘MultipleMarkets Comment Letter’’). 

42See DBRS Comment Letter. 

43See 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. 

44See 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.’’ 

46The Commission retains the authority to 

request more specific information regarding the 

securities traded by ATSs. See 17 CFR 242.302–303. 

47 15 U.S.C. 80b. 

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

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

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 noninvestment 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 noninvestment 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

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. 

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 

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52362 Federal Register / Vol. 74, No. 195 / Friday, October 9, 2009 / Rules and Regulations 

48See Investment Company Act Proposing 

Release, supra note 10, at Section III. 

49The 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). 

50Comment 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). 

51See, 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. 

52As 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). 

53See Section 6(c) of the Investment Company 

Act. 

54See Section 10(f) of the Investment Company 

Act. 

55Rule 5b–3(c)(4). 

56Rule 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’’). 

57Rule 5b–3(c)(4)(iii). 

58See 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. 

contexts, and for different purposes, to 

distinguish among various grades of 

debt and other rated securities. 

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. 

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

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

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 prerefunded securities would not affect 

payments on the securities from the 

escrow account.58 This condition is not 

required, however, if the refunded 

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Federal Register / Vol. 74, No. 195 / Friday, October 9, 2009 / Rules and Regulations 52363 

59Rule 5b–3(c)(4)(iii). 

60See 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. 

61Amended Rule 5b–3(c)(4)(iii). 

62 Id. 

63See Calvert Comment Letter (Sept. 5, 2008); 

Letter of Connecticut Treasurer (Sept. 4, 2008) 

(‘‘Connecticut Treasurer’s Comment Letter’’); 

Oppenheimer Comment Letter (Sept. 4, 2008). 

64Although 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. 65See 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/creditdesk

reports/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. 

66The 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). 

67Section 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). 

68See 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). 

69Exemption 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. 

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

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. 

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. 

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

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

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 

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52364 Federal Register / Vol. 74, No. 195 / Friday, October 9, 2009 / Rules and Regulations 

70See Rule 10f–3(c)(2) (also providing an 

exception from the pricing provision for rights 

offerings required by law in certain foreign 

offerings). 

71See Rule 10f–3(c)(6). 

72See Rule 10f–3(c)(9). 

73Rule 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’’). 

74Rule 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. 

75See 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. 

76See Investment Company Act Proposing 

Release, supra note 10, at Section III.D. 

77See id. at Section III. 

78See supra note 50 and accompanying text; 

Schwab Comment Letter; Calvert Comment Letter; 

SIFMA Comment Letter. 

79See CFA Institute Comment Letter. 

80 Id. 

81See, 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). 

82See 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.’’ 

83For a discussion of the proposed amendments 

to Rule 10f–3, see Investment Company Act 

Proposing Release, supra note 10, at Section III.D. 

84The 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). 

85As 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. 

86A 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). 

87See M. David Gelfand, State and Local 

Government Debt Financing § 8:72 (2nd. ed. 2007) 

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

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

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

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

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

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

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(noting that municipal securities trade largely on 

the basis of creditworthiness). 

88See 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.’’). 

89Rule 10f–3(c)(10); Investment Company Act 

Proposing Release, supra note 10, at n.69 and 

accompanying text. 

90See amended Rule 10f–3(a)(3), (c)(10)(i). 

91See Investment Company Act Proposing 

Release, supra note 10, at Section VI.A. 92When 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. 93See 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). 

94 44 U.S.C. 3501 et seq. 

95 5 CFR 1320.5(g). 

96See Exchange Act Proposing Release, 73 FR at 

40097. 

97 5 CFR 1320.5(g). 

98 44 U.S.C. 3501 et seq. 

99 44 U.S.C. 3501–3520. 

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

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. 

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

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

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 information97 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. 

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 

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100See supra notes 83–84 and accompanying text. 

101Rule 10f–3(c)(10). 

102See Submission for OMB Review, Comment 

Request, Rule 10f–3 [73 FR 13263 (Mar. 12, 2008)]. 

103See Investment Company Act Proposing 

Release, supra note 10, at Section V.B. 

104See supra note 82 and accompanying text. 

105See supra text accompanying note 85. 

106See 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. 

107We 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. 

108These estimates are based on the following 

calculations: 350 fund boards × 2 hours = 700 

hours; 700 hours × $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. 

109This estimate is based on the following 

calculation: 350 fund boards × 0.67 hours = 234.5 

hours. 

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. 

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. 

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. 

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

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

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 noninvestment 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 noninvestment grade debt securities and 

replace them with a single category, 

‘‘corporate debt securities.’’ We believe 

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Federal Register / Vol. 74, No. 195 / Friday, October 9, 2009 / Rules and Regulations 52367 

110See Investment Company Act Proposing 

Release, supra note 10, at Section VII. 

111See, e.g., Oppenheimer Comment Letter (‘‘a 

subjective standard is difficult to apply, difficult to 

test for compliance, and causes uncertainty 

regarding enforcement’’). 

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 noninvestment 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 noninvestment 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. 

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 judgmentbased 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 

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112See, e.g., SIFMA Comment Letter; Comment 

Letter of Institutional Money Market Funds Ass’n 

(Sept. 5, 2008). 

113See supra Section II.A.2. 

114Amended Rule 5b–3(c)(4). 

115See, e.g., Calvert Comment Letter. 

116See, e.g., Connecticut Treasurer’s Comment 

Letter. 

117See supra text preceding note 64. 

118See supra note 64 and accompanying text. 

119See supra note 65 and accompanying text. 

120See Investment Company Act Proposing 

Release, supra note 10, at text preceding n.107. 

121See, 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.’’). 

122Rule 10f–3(c)(10)(i), (iii). 

123See supra text following note 102. 

124See supra text accompanying note 106. These 

commenters did not provide any estimates of the 

increased burden that boards might incur under the 

proposed amendments. 

125This is based on the following calculation: 350 

funds × 2 hours × $4,000 per hour of board time 

= $2,800,000. 

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. 

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. 

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. 

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. 

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

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 

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Federal Register / Vol. 74, No. 195 / Friday, October 9, 2009 / Rules and Regulations 52369 

126As 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. 

127See 1997 Rule 10f–3 Adopting Release, supra 

note 88, at text following n.51. 

128 15 U.S.C. 78c(f). 

129 15 U.S.C. 78w(a)(2). 130See supra Section II.A.4. 

131 15 U.S.C. 80a–2(c). 

132See Investment Company Act Proposing 

Release, supra note 10, at Section VII. 

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. 

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. 

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 noninvestment 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. 

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 ‘‘noninvestment 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

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. 

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 

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52370 Federal Register / Vol. 74, No. 195 / Friday, October 9, 2009 / Rules and Regulations 

133 5 U.S.C. 603(a). 

134 5 U.S.C. 605(b). 

135 17 CFR 240.17a–5(d). 

136See 17 CFR 240.0–10(c). 

137See 17 CFR 242.301(b)(1). 138 5 U.S.C. 605(b). 

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. 

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

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 brokerdealers 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. 

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. 

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 

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Federal Register / Vol. 74, No. 195 / Friday, October 9, 2009 / Rules and Regulations 52371 

139 17 CFR 270.0–10. 

140See supra Section II.A.1. 

141Amended Rule 5b–3(c)(4)(iii). 

142Amended Rule 10f–3(a)(3). 

143See supra note 64 and accompanying text. 

144See supra note 65 and accompanying text. 

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. 

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. 

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

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. 

(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)]. 

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52372 Federal Register / Vol. 74, No. 195 / Friday, October 9, 2009 / Rules and Regulations 

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 

■ 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 

■ 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. 

* * * * * 

■ 2. Amend § 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: 

§ 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 

■ 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. 

■ 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: 

§ 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: 

§ 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 

■ 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. 

* * * * * 

■ 7. Form ATS–R (referenced in 

§ 249.638) is amended by: 

■ 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 

■ 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)). 

* * * * * 

■ 8. Form PILOT (referenced in 

§ 249.821) is amended by: 

■ 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 

■ 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. 

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Federal Register / Vol. 74, No. 195 / Friday, October 9, 2009 / Rules and Regulations 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 

■ 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. 

* * * * * 

■ 10. Section 270.5b–3 is amended by 

revising paragraph (c)(4)(iii) to read as 

follows: 

§ 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. 

* * * * * 

■ 11. Section 270.10f–3 is amended by: 

■ a. Revising paragraph (a)(3); 

■ b. Removing paragraph (a)(5); and 

■ c. Redesignating paragraphs (a)(6), 

(a)(7) and (a)(8) as paragraphs (a)(5), 

(a)(6) and (a)(7). 

The revision reads as follows: 

§ 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 

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