52374 Federal Register / Vol. 74, No. 195 / Friday, October 9, 2009 / Proposed Rules 

1See References to Ratings of Nationally 

Recognized Statistical Rating Organizations, 

Exchange Act Release No. 58070 (July 1, 2008) [73 

FR 40088 (July 11, 2008)] (proposing amendments 

to rules and forms under the Securities Exchange 

Act) (‘‘Exchange Act Proposing Release’’); 

References to Ratings of Nationally Recognized 

Statistical Ratings Organizations, Investment 

Company Act Release No. 28327 (July 1, 2008) [73 

FR 40124 (July 11, 2008)] (proposing amendments 

to rules under the Investment Company Act and the 

Investment Advisers Act) (‘‘Investment Company 

Act Proposing Release’’); Security Ratings, 

Securities Act Release No. 8940 (July 1, 2008) [73 

FR 40106 (July 11, 2008)] (proposing amendments 

to rules and forms under the Securities Act and the 

Securities Exchange Act) (‘‘Securities Act Proposing 

Release’’). 2See Exchange Act Proposing Release, supra note 

1, at Section I; Investment Company Act Proposing 

Release, supra note 1, at Section I; and Securities 

Act Proposing Release, supra note 1. 3See References to Ratings of Nationally 

Recognized Statistical Rating Organizations, 

Exchange Act Release No. 34–60789 (October 5, 

2009) (‘‘NRSRO References Adopting Release’’). 4See, e.g., Money Market Fund Reform, 

Investment Company Act Release No. 28807 (June 

30, 2009) [74 FR 32688 (July 8, 2009)] (‘‘Money 

Market Fund Proposing Release’’) (proposing 

amendments designed to improve the regulatory 

framework governing money market funds and 

requesting comment on, among other things, 

whether the Commission should eliminate Rule 

2a–7’s use of ratings by NRSROs, or whether the 

Commission should adopt other alternatives to 

encourage more independent credit risk analysis, 

including whether the Commission should 

reformulate the rule’s use of ratings by requiring the 

fund’s directors to designate specific NRSROs that 

the board of directors determines issue credit 

ratings that are sufficiently reliable.). 

5For a detailed discussion of each of these 

proposals, see Exchange Act Proposing Release, 

supra note 1. 

SECURITIES AND EXCHANGE 

COMMISSION 

17 CFR Parts 229, 230, 239, 240, 242, 

249, 270 and 275 

[Release Nos. 33–9069; 34–60790; IA–2932; 

IC–28940; File Nos. S7–17–08, S7–18–08, 

S7–19–08] 

RIN 3235–AK17, 3235–AK18, 3235–AK19 

References to Ratings of Nationally 

Recognized Statistical Rating 

Organizations 

AGENCY: Securities and Exchange 

Commission (‘‘Commission’’). 

ACTION: Proposed rule; re-opening of 

comment period; request for additional 

comments. 

SUMMARY: The Securities and Exchange 

Commission is re-opening the comment 

period on certain of the proposed rule 

amendments to remove references to 

ratings of Nationally Recognized 

Statistical Rating Organizations 

proposed in Release Nos. 33–8940 [73 

FR 40106 (July 11, 2008)], 34–58070 [73 

FR 40088 (July 11, 2008)], and IC–28327 

[73 FR 40124 (July 11, 2008)] 

‘‘Proposing Releases’’). Today, in a 

companion release, the Commission is 

taking action on some of the 

amendments in the Proposing Releases. 

In view of the continuing public interest 

in the Proposing Releases and the 

Commission’s desire to receive 

additional comment, we believe that it 

is appropriate to re-open the comment 

period before we take further action on 

certain proposals made in the Proposing 

Releases. 

DATES: Comments should be received on 

or before December 8, 2009. 

ADDRESSES: Comments may be 

submitted by any of the following 

methods: 

Electronic Comments 

• Use the Commission’s Internet 

comment form (http://www.sec.gov/ 

rules/proposed.shtml); or 

• Send an e-mail to rulecomments@sec.gov. Please include File 

Number S7–17–08, S7–18–08, and/or 

S7–19–08 on the subject line; or 

• Use the Federal eRulemaking Portal 

(http://www.regulations.gov). Follow the 

instructions for submitting comments. 

Paper Comments 

• Send paper comments in triplicate 

to Elizabeth M. Murphy, Secretary, 

Securities and Exchange Commission, 

100 F Street, NE., Washington, DC 

20549–1090. 

All submissions should refer to File 

Number S7–17–08, S7–18–08, and/or 

S7–19–08. The file number(s) should be 

included on the subject line if e-mail is 

used. To help us process and review 

your comments more efficiently, please 

use only one method. The Commission 

will post all comments on the 

Commission’s Internet Web site (http:// 

www.sec.gov/rules/proposed.shtml). 

Comments are also available for public 

inspection and copying in the 

Commission’s Public Reference Room, 

100 F Street, NE., Washington, DC 

20549 on official business days between 

the hours of 10 a.m. and 3 p.m. All 

comments received will be posted 

without change; we do not edit personal 

identifying information from 

submissions. You should submit only 

information that you wish to make 

publicly available. 

FOR FURTHER INFORMATION CONTACT: 

Michael A. Macchiaroli, Associate 

Director, Thomas K. McGowan, Deputy 

Associate Director, Randall W. Roy, 

Assistant Director, Joseph I. Levinson, 

Special Counsel (Net Capital 

Requirements and Customer Protection) 

at (202) 551–5510; Paula Jenson, Deputy 

Chief Counsel, Ignacio Sandoval, 

Special Counsel (Confirmation of 

Transactions) at (202) 551–5550; 

Josephine J. Tao, Assistant Director, 

Elizabeth A. Sandoe, Branch Chief, and 

Bradley Gude, Special Counsel 

(Regulation M) at (202) 551–5720; 

Marlon Quintanilla Paz, Senior Counsel 

to the Director at (202) 551–5756, in the 

Division of Trading and Markets; Hunter 

Jones, Assistant Director, Penelope W. 

Saltzman, Assistant Director, or Daniel 

K. Chang, Attorney at (202) 551–6792, 

in the Division of Investment 

Management; or Katherine Hsu, Special 

Counsel (Asset-Backed Securities), Blair 

Petrillo, Special Counsel at (202) 551– 

3430, in the Division of Corporation 

Finance, U.S. Securities and Exchange 

Commission, 100 F Street, NE., 

Washington, DC 20549. 

SUPPLEMENTARY INFORMATION: 

I. Introduction 

On July 1, 2008, the Commission 

proposed to eliminate references to 

ratings issued by nationally recognized 

statistical rating organizations 

(‘‘NRSROs’’) in certain rules and forms 

under the Securities Exchange Act of 

1934 (‘‘Exchange Act’’), the Investment 

Company Act of 1940 (‘‘Investment 

Company Act’’), the Investment 

Advisers Act of 1940 (‘‘Investment 

Advisers Act’’), and the Securities Act 

of 1933 (‘‘Securities Act’’).1 The 

Commission proposed these 

amendments, among other reasons, to 

address the risk that the reference to and 

use of NRSRO ratings in Commission 

rules could be interpreted by investors 

as an endorsement of the quality of the 

credit ratings issued by NRSROs, and 

may encourage investors to place undue 

reliance on NRSRO ratings.2 The 

comment period for the Proposing 

Releases ended on September 5, 2008. 

Today, in a companion release, the 

Commission is adopting proposed 

amendments to remove references to 

ratings issued by NRSROs in certain 

rules.3 Given regulatory developments,4

comments received on the proposals, 

and the continuing public interest in the 

Proposing Releases, particularly in light 

of recent economic events, the 

Commission is requesting additional 

public comment on certain proposed 

rule changes relating to the use of 

references to ratings issued by NRSROs, 

as detailed below. 

II. References to Ratings of NRSROs in 

Exchange Act Rules 

As discussed below, the Commission 

is deferring consideration of action and 

soliciting comment on certain of its 

proposals relating to the use of NRSRO 

credit ratings in the rules and forms 

proposed in the Exchange Act Proposing 

Release.5 The Commission is seeking 

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Federal Register / Vol. 74, No. 195 / Friday, October 9, 2009 / Proposed Rules 52375 

6See Exchange Act Proposing Release, supra 

note 1. 

7 Id. 

8 Id. 

9We received five comment letters that 

specifically addressed the Regulation M proposals 

and each opposed the proposals. Letter from Keith 

F. Higgins, Chair, Committee on Federal Regulation 

of Securities, American Bar Association (‘‘ABA’’), to 

Florence E. Harmon, Acting Secretary, dated 

October 10, 2008 (‘‘ABA Letter 1’’); Letter from 

Robert Dobilas, CEO and President, Realpoint LLC, 

to Secretary, dated September 8, 2008; Letter from 

Jeremy Reifsnyder and Richard Johns, Co-chairs, 

ASF Credit Rating Agency Task Force, to Florence 

E. Harmon, Acting Secretary, dated September 5, 

2008 (‘‘ASF Letter’’); Letter from Deborah A. 

Cunningham and Boyce I. Greer, Co-chairs, SIFMA 

Credit Rating Agency Task Force, to Florence E. 

Harmon, Acting Secretary, dated September 4, 2008 

(‘‘SIFMA Letter’’); and Letter from Mayer Brown 

LLP, to Florence E. Harmon, Acting Secretary, dated 

September 4, 2008 (‘‘Mayer Brown Letter’’). There 

were comment letters supportive of the 

Commission’s effort to minimize undue reliance on 

NRSRO ratings by market participants, however, 

these commenters did not discuss Regulation M. 

See, e.g., Letter from Suzanne C. Hutchinson, 

Executive Vice President, Mortgage Insurance 

Companies of America, to Florence E. Harmon, 

Acting Secretary, dated September 5, 2008. 

10See, e.g., SIFMA Letter (‘‘Regulation M is 

primarily directed at the actions of the issuers of 

securities and the investment banks who 

underwrite them; in contrast, the investors that the 

Commission is concerned with are not users of 

Regulation M’’). 

11ABA Letter 1, SIFMA Letter. 

12ABA Letter 1, SIFMA Letter. 

13The ABA did, however, suggest that should the 

Commission insist on using the WKSI standard for 

investment-grade non-convertible debt and 

investment-grade non-convertible preferred 

securities, it do so only as an alternative to the 

current exceptions at Rules 101(c)(2) and 102(d)(2). 

ABA Letter 1. However, the ABA expressed its 

‘‘strong[] belie[f] that the Commission should retain 

the current exceptions.’’ Id. 

14The Commission specifically invited 

commenters to suggest alternatives to the 

Regulation M Proposals in the Proposing Release, 

see Exchange Act Proposing Release, supra note 1, 

at 40096, but none were received at that time. 

15While the Commission asked similar questions 

in the Exchange Act Proposing Release relating to 

the specific Regulation M Proposals, the 

Commission will consider these factors in 

connection with any alternative proposal suggested 

by commenters. 

additional comment on specific issues 

as well as general comments on the 

proposals. 

A. Regulation M 

Regulation M is intended to preclude 

manipulative conduct by persons with 

an interest in the outcome of an offering. 

It governs the activities of underwriters, 

issuers, selling security holders, and 

others in connection with offerings of 

securities. In particular, Rules 101 and 

102 of Regulation M prohibit, in 

connection with a distribution of 

securities, issuers, selling shareholders, 

distribution participants, or any 

affiliated persons of such persons from 

directly or indirectly bidding for, 

purchasing, or attempting to induce a 

person to bid for or purchase a covered 

security during certain defined periods. 

Certain securities are excepted from 

Rules 101 and 102, including 

investment grade non-convertible debt 

securities, investment grade nonconvertible preferred securities, and 

investment grade asset-backed 

securities. 

In the Exchange Act Proposing 

Release, the Commission proposed to 

change the exceptions in Rules 101(c)(2) 

and 102(d)(2) of Regulation M for 

investment-grade non-convertible debt 

securities, investment grade nonconvertible preferred securities, and 

investment grade asset-backed securities 

(‘‘Regulation M Proposals’’).6 The 

Regulation M Proposals would have 

removed references to NRSRO ratings 

from the determination of whether such 

securities would be eligible for the 

exceptions, and instead would have 

excepted non-convertible debt securities 

and non-convertible preferred securities 

based on the ‘‘well-known seasoned 

issuer’’ (‘‘WKSI’’) concept of Securities 

Act Rule 405.7 The Regulation M 

Proposals would have also excepted 

asset-backed securities that are 

registered on Form S–3.8

Commenters that specifically 

addressed the Regulation M Proposals 

expressed uniform opposition.9 Many of 

these commenters stated their view that 

the proposal would fail to address the 

issue of investors’ undue reliance on 

NRSRO ratings.10 Commenters that 

specifically addressed the Regulation M 

Proposal also stated that, because the 

Regulation M Proposals would have 

altered the scope of the exception for 

investment-grade non-convertible debt 

securities, investment-grade nonconvertible preferred securities, and 

asset-backed securities, the Regulation 

M Proposals would have placed new 

burdens on issuers and underwriters by 

imposing the restrictions of Regulation 

M on currently excepted investmentgrade securities.11 Additionally, 

commenters that specifically addressed 

the Regulation M Proposal expressed 

the view that certain issuers of high 

yield securities that are currently 

subject to Regulation M, but are 

arguably more vulnerable to 

manipulation than securities currently 

excepted from Regulation M, would 

have been excepted from Rules 101 and 

102 of Regulation M by the Regulation 

M Proposals.12 These commenters 

suggested retaining the NRSRO 

references in Regulation M and did not 

generally suggest alternatives to the 

Regulation M Proposals that would 

achieve our goals while addressing 

these concerns.13

The Commission is deferring 

consideration of action on the 

Regulation M Proposals. In light of the 

uniform opposition in the comment 

letters and the Commission’s remaining 

concern regarding the undue influence 

of NRSRO ratings, the Commission is 

seeking additional comment. The 

Commission is continuing to consider 

its proposed amendments as well as 

other changes to Rules 101(c)(2) and 

102(d)(2) of Regulation M to address 

concerns with regard to references to 

NRSRO ratings, and it continues to 

invite comments suggesting alternative 

proposals to achieve the Commission’s 

goals, as well as comments on the 

Regulation M Proposals generally.14 In 

assessing the Commission’s proposals 

and alternatives to these proposals, the 

Commission would consider a number 

of factors, including: 15

• Is the alternative comparable in 

scope to the existing exceptions? Does 

the alternative except roughly the same 

type and quantity of securities as the 

current exceptions for non-convertible 

debt, non-convertible preferred, and 

asset-backed securities? 

• Does the alternative capture 

securities that are traded on basis of 

their yields, are largely fungible and less 

likely to be subject to manipulation? Are 

there factors in addition to yield and 

fungible nature that effect the trading of 

nonconvertible and asset backed 

securities? 

• What effect(s) of the alternative, if 

any, would you anticipate in the 

investment-grade debt market and highyield debt market? 

• To the extent the alternative excepts 

non-convertible debt, non-convertible 

preferred, and asset-backed securities 

that are not currently excepted, how are 

those newly excepted securities less 

likely to be subject to manipulation? 

• Will the alternative remove the 

exception for certain non-convertible 

debt, non-convertible preferred, and 

asset-backed securities that fall within 

the current exceptions? 

• Does the alternative provide an 

equally bright-line demarcation that is 

not unduly reliant on NRSRO ratings? 

• Is the alternative easy for all 

persons subject to Rules 101 and 102 of 

Regulation M to determine (i.e., can it be 

determined by publicly available 

sources of information)? 

Please provide empirical data, when 

possible, and cite to economic studies to 

support alternative approaches. Please 

suggest additional factors that you 

believe should be considered in 

assessing alternatives. Please discuss 

whether and to what extent investors 

rely upon the current Rule 101 and 102 

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52376 Federal Register / Vol. 74, No. 195 / Friday, October 9, 2009 / Proposed Rules 

16 17 CFR 240.10b–10. 

17Municipal securities are covered by Municipal 

Securities Rulemaking Board rule G–15, which 

applies to all municipal securities brokers and 

dealers. 

18See Exchange Act Release No. 34962 

(November 10, 1994) [59 FR 59612 (November 17, 

1994)] (File No. S7–6–94) (‘‘1994 Adopting 

Release’’). 

19 Id. The Commission stated in the 1994 

Adopting Release that ‘‘[i]n most cases, this 

disclosure should verify information that was 

disclosed to the investor prior to the transaction. If 

a customer was not previously informed of the 

security’s unrated status, the confirmation 

disclosure may prompt a dialogue between the 

customer and the broker-dealer.’’ 

20Exchange Act Proposing Release, supra note 1, 

73 FR at 40092. 

21 Id. 

22See Realpoint Letter; SIFMA Letter; Letter from 

Cate Long, Multiple-Markets to Secretary, Securities 

and Exchange Commission, dated September 5, 

2008 (‘‘Multiple-Markets Letter’’); Tom McNerney, 

Managing Director, Data and Analytics and Marcus 

Schuler, Managing Director, Regulatory Affairs, 

Markit to Securities and Exchange Commission, 

dated September 5, 2008 (‘‘Markit Letter’’). 

23See SIFMA Letter. 

24 Id. 

25See Realpoint Letter. This commenter also 

urged the Commission to ‘‘at a minimum, retain the 

existing requirement * * * [and] strongly consider 

requiring that the confirmation disclose whether the 

security is rated by an NRSRO who was not and is 

not being compensated’’ directly or indirectly by 

the issuer. Id. 

26See Multiple-Markets Letter. This commenter 

stated that a proposed FINRA rule ‘‘serves to protect 

investors but could be enhanced by the addition of 

an alternative method of showing credit quality’’ by 

requiring broker-dealers to ‘‘provide the investor 

with the ‘average’ rating across NRSROs.’’ Id. The 

Commission is considering the FINRA proposed 

rule change separately. See Exchange Act Release 

No. 56661 (October 15, 2007) [72 FR 59321 (October 

19, 2007)] (File No. SR–NASD–2005–100). 

27See Markit Letter. ‘‘The usage of credit spreads 

for this purpose would be much more accurate, and 

would be capable of revealing that many unrated 

securities are actually less risky than rated ones.’’ 

Id. 

exceptions for investment-grade nonconvertible and asset-backed securities 

when making a decision to invest in 

such securities. Please also discuss 

whether, given that Rules 101 and 102 

of Regulation M are directed at 

distribution participants, issuers and 

selling security holders, Rules 101 and 

102 of Regulation M pose any danger of 

undue reliance on NRSRO ratings by 

investors. 

B. Rule 10b–10 

Exchange Act Rule 10b–10,16 the 

Commission’s transaction confirmation 

rule for broker-dealers, generally 

requires broker-dealers that effect 

transactions for customers in securities, 

other than U.S. savings bonds or 

municipal securities,17 to provide those 

customers with written notification, at 

or before completion of a securities 

transaction, disclosing certain 

information about the terms of the 

transaction. Specifically, Rule 10b–10 

requires the disclosure of the date, time, 

identity, and number of securities 

bought or sold; the capacity in which 

the broker-dealer acted (e.g., as agent or 

principal); yields on debt securities; and 

under specified circumstances, the 

amount of compensation the brokerdealer will receive from the customer 

and any other parties. In doing so, the 

rule serves a basic investor protection 

function by conveying information that: 

(1) Allows customers to verify the terms 

of their transactions; (2) alerts customers 

to potential conflicts of interest; (3) acts 

as a safeguard against fraud; and (4) 

allows customers a means of evaluating 

the costs of their transactions and the 

quality of the broker-dealer’s execution 

and order-handling. 

Paragraph (a)(8) of Rule 10b–10, 

which the Commission adopted in 1994, 

requires a broker-dealer to inform the 

customer in the transaction 

confirmation if a debt security, other 

than a government security, is unrated 

by an NRSRO.18 While paragraph (a)(8) 

was intended to alert customers to the 

potential need to obtain more 

information about a security from a 

broker-dealer, it was not intended to 

suggest that an unrated security is 

inherently riskier than a rated 

security.19 The Commission proposed to 

delete paragraph (a)(8) of the Rule in 

light of present concerns regarding 

undue reliance on NRSRO ratings and 

confusion about the significance of 

those ratings.20 The Commission also 

stated that, in the absence of this 

requirement, broker-dealers could 

voluntarily include this information in 

confirmations they send to customers.21

Four commenters expressed views 

regarding the proposed deletion of 

paragraph (a)(8) from Rule 10b–10.22

One commenter maintained that 

deleting the requirement could be 

confusing and misleading to customers, 

who might presume that the security 

was rated because the non-rated status 

would no longer appear on the 

confirmation.23 This commenter also 

noted that customers could be confused 

by a lack of uniformity in confirmations, 

if some broker-dealers chose to continue 

including the non-rated status on 

confirmations while others did not.24

Another commenter stated that 

investors benefit from, and brokerdealers are not materially burdened by, 

the disclosure requirement in paragraph 

(a)(8).25 One commenter expressed the 

view that deleting paragraph (a)(8) 

would be appropriate, and noted that a 

proposed FINRA rule would, among 

other things, require brokers-dealers to 

provide investors with the lowest credit 

rating on a security.26 Finally, one 

commenter suggested that if paragraph 

(a)(8) were deleted, it could be replaced 

with the use of a credit spread as a 

credit risk measure.27

After considering the comments, the 

Commission has determined to seek 

further comment on this proposal before 

considering action. The Commission is 

continuing to consider the relative 

benefits of retaining this information in 

the transaction confirmation against the 

benefits of removing the reference to 

whether a security is unrated. The 

Commission notes in this regard that the 

current requirement to disclose when a 

debt security is unrated by an NRSRO 

provides investors with an item of 

factual information that is conveyed 

together with additional factual 

information about the terms of the trade. 

Moreover, we are still evaluating the 

impact that eliminating this disclosure 

requirement would have against the 

possibility of permitting broker-dealers 

to continue providing, on a voluntary 

basis, information on the confirmation 

that a debt security is not rated. In 

addition, we are concerned that 

customers may potentially be confused 

by the lack of a disclosure that they may 

be accustomed to receiving. 

At the same time, the Commission 

remains concerned that customers may 

place undue reliance on NRSRO ratings 

and that there may continue to be 

confusion about the significance of 

those ratings. Therefore, the 

Commission will continue to consider 

whether to delete paragraph (a)(8) of 

Rule 10b–10, particularly in light of 

comments received to date, and invites 

further comment on the proposed 

deletion of Rule 10b–10(a)(8), including 

comments that suggest alternative 

proposals to achieve the Commission’s 

stated goals. In continuing to assess 

these issues, the Commission requests 

comments on the following: 

• Would the investor protection 

function of Rule 10b–10 be, in any way, 

undercut by deleting paragraph (a)(8) 

from the Rule? Are there any other 

alternatives for providing customers 

with this information? 

• What types of securities would 

typically be unrated by an NRSRO? 

What types of issuers would typically 

not have their securities rated by an 

NRSRO? 

• Could the disclosure that a security 

is unrated be removed from the 

confirmation without creating customer 

confusion? If so, given the historical use 

and investor expectations related to this 

disclosure, could it be removed without 

implying that a security is in fact rated? 

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Federal Register / Vol. 74, No. 195 / Friday, October 9, 2009 / Proposed Rules 52377 

28 ‘‘Credit spread’’ has been defined to mean the 

‘‘differences in yield resulting from different levels 

of credit risk.’’ See Oxford Dictionary of Finance 

and Banking 100 (3rd ed. 2005). See also Barron’s 

Dictionary of Finance and Investment Terms 152 

(6th ed. 2003) (defining ‘‘credit spread’’ as the 

‘‘difference in value of two options, when the value 

of the one sold exceeds the value of the one bought. 

The opposite of a debt spread.’’). 

29 17 CFR 240.15c3–1; see Exchange Act 

Proposing Release, supra note 1, 73 FR at 40092. 

30See Exchange Act Proposing Release, supra 

note 1, 73 FR at 40092. 

31 Id. 

32 Id. 

33See Exchange Act Proposing Release, supra 

note 1, 73 FR at 40093. 

34See Exchange Act Proposing Release, supra 

note 1, 73 FR at 40092. 

35See, e.g., SIFMA Letter; Markit Letter; Letter 

from Jeffrey T. Brown, Senior Vice President, 

Charles Schwab Co., Inc., Washington, District of 

Columbia to Florence E. Harmon, Acting Secretary, 

Commission dated September 5, 2008 (‘‘Schwab 

Letter’’); Letter from Kent Wideman, Group 

Managing Director, Policy and Rating Committee, 

DBRS and Mary Keogh, Managing Director, Policy 

and Regulatory Affairs, DBRS dated September 8, 

2008; Letter from Robert Dobilas, CEO and 

President, Realpoint LLC dated Sept. 8, 2008; 

Gregory W. Smith, General Counsel, Colorado 

Public Employees’ Retirement Association to Nancy 

Continued 

Would the suggested approach vary if 

certain broker-dealers continued to 

voluntarily disclose that securities were 

unrated? Should broker-dealers be 

required to alert customers that the 

unrated status of a security is no longer 

being disclosed? If so, for how long? 

• The preliminary note to Rule 10b– 

10 provides: ‘‘This section requires 

broker-dealers to disclose specified 

information in writing to customers at 

or before completion of a transaction. 

The requirements under this section 

that particular information be disclosed 

is not determinative of a broker-dealer’s 

obligation under the general antifraud 

provisions of the federal securities laws 

to disclose additional information to a 

customer at the time of the customer’s 

investment decision.’’ If paragraph (a)(8) 

were deleted, would the preliminary 

note to Rule 10b–10 affect a brokerdealer’s decision to nonetheless 

continue to voluntarily disclose whether 

a security is unrated? 

• One approach for addressing 

possible customer confusion if some 

broker-dealers continue to disclose that 

a security is unrated, while others do 

not, could be to prohibit broker-dealers 

from making this disclosure on the 

confirmation. Such an approach, 

however, could be viewed as 

inconsistent with broker-dealers’ 

obligations under the general antifraud 

provisions of the federal securities laws, 

as highlighted in the preliminary note to 

Rule 10b–10, to disclose material 

information to their customers. We 

invite comment on this approach, and 

particularly on how a broker-dealer, if it 

considered the fact that a security was 

unrated to be material, could disclose 

this information to customers other than 

on the confirmation. 

• If paragraph (a)(8) were deleted, is 

there a disclosure that should be 

required in the confirmation on a 

transitional or permanent basis that 

would help prevent customer 

confusion? For example, should the 

Commission require broker-dealers, 

either permanently or temporarily for a 

transition period, to disclose that 

broker-dealers are no longer required to 

include on the confirmation the fact that 

a security is unrated? Should such a 

disclosure be made on the confirmation, 

the account statement, or in a separate 

document accompanying the 

confirmation or account statement? 

What are the costs associated with 

providing this disclosure on the 

confirmation, the account statement or 

in a separate document? 

• If the requirement to disclose that a 

security is unrated were deleted from 

Rule 10b–10, would broker-dealers 

nevertheless feel compelled to include 

the disclosure in order to satisfy their 

suitability or other sales practice 

obligations? 

• Should the requirement to disclose 

that a security is unrated be replaced by 

a requirement to provide a general 

statement regarding the importance of 

considering an issuer’s 

creditworthiness? 

• If the requirement to disclose that a 

security is unrated were deleted from 

the rule, are there alternative external or 

objective measures of credit risk that 

could be substituted for ratings by an 

NRSRO? Is it practicable to replace it 

with a requirement to disclose specific 

information regarding an issuer’s 

creditworthiness? If so, what specific 

information should the Commission 

consider including? 

• Are credit spreads 28 a viable 

method of addressing an issuer’s 

creditworthiness? For example, is there 

a consistent, reliable, and generally 

agreed upon method for determining 

credit spread? How could information 

about credit spread be presented so that 

it could be readily understood by 

customers, particularly retail customers? 

C. Net Capital Rule 

The Commission proposed to remove, 

with limited exceptions, all references 

to NRSROs from the net capital rule for 

broker-dealers, Rule 15c3–1 under the 

Exchange Act (‘‘Net Capital Rule’’).29

Under the Net Capital Rule, brokerdealers are required to maintain, at all 

times, a minimum amount of net 

capital, generally defined as a brokerdealer’s net worth (assets minus 

liabilities), plus certain subordinated 

liabilities, less certain assets that are not 

readily convertible into cash (e.g., fixed 

assets), and less a percentage of certain 

other liquid assets (e.g., securities). 

When calculating net capital, brokerdealers are permitted to take a lower 

capital charge, called a ‘‘haircut,’’ for 

certain types of securities that are rated 

investment grade by an NRSRO. 

As the Commission stated in 

proposing to remove references to 

NRSROs from the Net Capital Rule, 

broker-dealers are sophisticated market 

participants regulated by at least one 

self-regulatory organization. 

Accordingly, the Commission expressed 

its preliminary belief that broker-dealers 

would be able to assess the 

creditworthiness of the securities they 

own without undue hardship.30 In lieu 

of the references to NRSROs in the Net 

Capital Rule, the Commission proposed 

substituting two subjective standards for 

credit risk and liquidity risk. For the 

purposes of determining haircuts on 

commercial paper, the Commission 

proposed to replace the current NRSRO 

ratings-based criterion with a 

requirement that the instrument be 

subject to a minimal amount of credit 

risk and have sufficient liquidity such 

that it can be sold at or near its carrying 

value almost immediately.31 For the 

purposes of determining haircuts on 

nonconvertible debt securities as well as 

on preferred stock, the Commission 

proposed to replace the current NRSRO 

ratings-based criterion with a 

requirement that the instrument be 

subject to no greater than moderate 

credit risk and have sufficient liquidity 

such that it can be sold at or near its 

carrying value within a reasonably short 

period of time.32 The proposed 

standards were intended to advance the 

purpose the NRSRO ratings-based 

standards were designed to advance, 

which is to enable broker-dealers to 

make net capital computations that 

reflect the market risk inherent in the 

positioning of those particular types of 

securities. Notwithstanding the 

Commission’s belief that broker-dealers 

have the financial sophistication and 

resources to make these 

determinations,33 the Commission 

stated that it would be appropriate, as 

one means of complying with the 

proposed amendments, for brokerdealers that wished to continue to rely 

on credit ratings of NRSROs to do so.34

The majority of the commenters to the 

Commission’s proposal to remove 

references to NRSROs from the Net 

Capital Rule were opposed to the 

change.35 Generally, commenters stated 

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M. Morris, Secretary, Commission dated September 

5, 2008. 

36See, e.g., SIFMA Letter. 

37Letter from Keith F. Higgins, Chair, Committee 

on Federal Regulation of Securities, and Vicki O. 

Tucker, Chair, Committee on Securitization and 

Structured Finance, Business Law Section, 

American Bar Association to Florence E. Harmon, 

Acting Secretary, Commission dated September 12, 

2008 (‘‘ABA Letter 2’’); SIFMA letter. 

38ABA Letter 2. 

39Schwab Letter. 

40Schwab Letter. 

41ABA Letter 2; Schwab Letter. 

42See Letter from Suzanne C. Hutchinson, 

Executive Vice President, Mortgage Insurance 

Companies of America; Letter from Lawrence J. 

White, Professor of Economics, Stern School of 

Business, New York University, New York, New 

York to Commission dated September 5, 2008 

(‘‘White Letter’’). 

43White Letter. 

44 17 CFR 230.415. 45 17 CFR 239.13 and 17 CFR 239.33. 46For a more detailed discussion of each of these 

proposals, see Securities Act Proposing Release, 

supra note 1. 47 17 CFR 230.436(g). 

that they preferred the existing rule 

because it is a bright line objective test 

that is relatively inexpensive to 

utilize.36 Commenters asserted that the 

new subjective standards that rely on 

the discretion of an interested decisionmaker (i.e., the broker-dealer itself) 

would increase uncertainty, decrease 

transparency, and decrease market 

confidence in the financial strength of 

broker-dealers.37 Commenters expressed 

their belief that the direct conflict of 

interest that would exist for brokerdealers to overestimate the 

creditworthiness of a security to 

minimize the amount of required net 

capital would lead broker-dealers to 

maintain too little net capital and would 

have the effect of increasing systemic 

risk.38 Commenters also stated that the 

proposed changes would require 

increased oversight by Commission staff 

to enforce the use of internal processes 

in capital charge calculations.39 In this 

regard, commenters noted that 

Commission staff would need to review 

procedures at each broker-dealer, and 

each review would need to include the 

algorithms of broker-dealer internal 

processes, requiring intensive scrutiny 

at both large and small broker-dealers.40

Further, commenters argued that not all 

broker-dealers are ‘‘sophisticated’’ and 

have sufficient resources or expertise to 

develop their own internal processes for 

rating securities.41 A minority of 

commenters supported the proposal to 

remove references to NRSROs from the 

net capital rule.42 One commenter 

argued that NRSROs have too much 

influence on the ‘‘quality assessments of 

securities that the SEC’s regulated 

financial institutions have been required 

to make.’’ 43

After considering these comments, the 

Commission has determined to solicit 

further comment before considering 

action on the proposed rule 

amendments to remove references to 

NRSROs from the Net Capital Rule. In 

evaluating whether to take action in the 

future, the Commission would consider, 

among other things, whether the haircut 

for the position would be appropriate 

given the risks inherent in the position. 

The relevant risks would include the 

price volatility, creditworthiness, and 

liquidity of the position. Additionally, 

in evaluating whether to adopt any 

amendments, the Commission would 

consider, among other things, the costs 

of an objective approach versus a 

subjective test; whether any alternative 

objective approaches exist; whether the 

proposed rule would create conflicts of 

interest that may result in undesirable 

consequences, such as increasing 

systemic risk; and whether brokerdealers have sufficient resources and 

expertise to implement the proposed 

rule. 

The Commission generally requests 

comments on whether it should retain 

the NRSRO reference in the Net Capital 

Rule, as well as all aspects of the 

proposed rule and reiterates its request 

for comment in the Exchange Act 

Proposing Release. Further, the 

Commission seeks comments on the 

factors it would consider in determining 

whether to amend the requirements for 

determining haircuts for proprietary 

securities positions. The Commission 

also requests comments on the 

following specific questions: 

• Are there factors other than 

creditworthiness and liquidity that 

should be required to be considered in 

determining the appropriate haircut for 

a proprietary securities position? 

• What would be the cost to brokerdealers to develop, document, and 

enforce internal procedures to 

evaluating the creditworthiness and 

liquidity of proprietary securities 

positions? 

• Do certain broker-dealers lack 

sufficient resources or expertise to 

independently assess the 

creditworthiness of securities? 

• How could the concern that a 

broker-dealer would have an incentive 

to downplay the credit risk associated 

with a particular security to minimize 

capital charges be addressed? Would 

reviews of internal procedures by 

examiners be sufficient to address this 

concern? Are there other methods, such 

as reviews by internal or external 

auditors, that could effectively address 

this concern? Do other objective 

measures of credit risk exist, and could 

they be used in place of NRSRO ratings 

to address this concern? 

• If the Commission decides to adopt 

the proposal to replace the current 

NRSRO ratings-based criterion with a 

requirement that the instrument be 

subject to a minimal amount of credit 

risk and have sufficient liquidity, and 

permits broker-dealers to continue to 

rely on credit ratings of NRSROs as one 

mean of complying with the proposed 

amendments, should the Commission 

nevertheless require that the standard 

that results in a higher determination of 

credit risk be used for each individual 

instrument? 

• If the Commission replaces the 

current NRSRO ratings-based criterion 

with a requirement that the instrument 

be subject to a minimal amount of credit 

risk and have sufficient liquidity such 

that it can be sold at or near its carrying 

value within a reasonably short period 

of time, should the Commission also 

require that broker-dealers consult 

credit ratings of NRSROs for that 

instrument, comparing which method 

requires the higher capital charge, and 

require that the broker-dealer take the 

higher capital charge? 

• Conversely, if broker-dealers 

continue to rely on credit ratings of 

NRSROs, either because the 

Commission does not remove the 

reference to NRSROs from the Net 

Capital Rule or as one means of 

complying with the proposed 

amendments, should the Commission 

require an analysis of the debt 

instrument that is independent of the 

NRSRO credit rating (e.g., an internal 

risk assessment or one performed by a 

third-party vendor) to support the use of 

the credit rating of NRSROs, and if the 

analysis does not support the credit 

rating, require that the broker-dealer 

take the higher capital charge? 

III. References to Ratings of NRSROs in 

Securities Act Rules 

In the Securities Act Proposing 

release, the Commission proposed 

changes to certain eligibility criteria for 

issuers to conduct primary offerings ‘‘off 

the shelf’’ under Securities Act Rule 

415 44 and Forms S–3 and F–3 45 and 

changes to other rules that refer to that 

eligibility.46 In addition, the 

Commission proposed changes to Rule 

436(g) under the Securities Act.47

Today, in a companion release, the 

Commission is proposing amendments 

to our rules to require disclosure of 

information regarding credit ratings 

used by registrants in connection with 

a registered offering of securities so that 

investors will better understand the 

credit rating and its limitations and, in 

another companion release, the 

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48See the releases considered by the Commission 

on September 17, 2009 regarding proposed 

amendments to require disclosure of information 

about credit ratings used by registrants in 

connection with registered offerings, and soliciting 

comment on whether the Commission should 

propose to rescind Rule 436(g) under the Securities 

Act. 49See General Instruction I.B.2 of Form S–3 and 

General Instruction I.B.2 of Form F–3. 50See 17 CFR 230.415(a)(1)(x). 51See General Instruction I.B.5. of Form S–3. 52The term ‘‘mortgage related securities’’ is 

defined by Section 3(a)(41) of the Exchange Act [15 

U.S.C. 78c(a)(41)]. 

53See 17 CFR 230.415(a)(1)(vii). 

54See Securities Act Proposing Release, supra 

note 1. 

55 17 CFR 230.144A. 56See ABA Letter 1; ABA Letter 2; SIFMA Letter; 

Letter from Thomas G. Berkmeyer, Associate 

General Counsel, American Electric Power Service 

Corporation to Secretary, Commission dated 

September 4, 2008; ASF Letter; Letter from Shirley 

Baum, Senior Attorney, Pinnacle West Capital 

Corporation to Secretary, Commission dated 

September 5, 2008; Letter from Walter E. 

Skrowronski, President, Boeing Capital Corporation 

to Secretary, Commission dated September 26, 

2008; Schwab Letter; Letter from Constance Curnow 

to Christopher Cox, Chairman, Commission dated 

August 28, 2008; Letter from Davis Polk & Wardwell 

to Florence E. Harmon, Acting Secretary, 

Commission dated September 4, 2008; Letter from 

Debevoise & Plimpton LLP to Florence E. Harmon, 

Acting Secretary, Commission dated September 3, 

2008 (‘‘Debevoise Letter’’); Letter from Dewey & 

LeBoeuf LLP to Florence Harmon, Acting Secretary, 

Commission dated September 5, 2008; Letter from 

James P. Carney, Vice President and Assistant 

Treasurer, Dominion Resources, Inc. to Florence E. 

Harmon, Acting Secretary, Commission dated 

September 5, 2008; Letter from David K. Owens, 

Executive Vice President, Business Operations 

Group, Edison Electric Institute to Commission 

dated September 5, 2008; Letter from Joseph J. 

Novak, General Counsel, Incapital, LLC to Florence 

E. Harmon, Acting Secretary, Commission dated 

September 5, 2008; Letter from Richard A. Lococo, 

Senior Vice President & Deputy General Counsel, 

Manulife Financial Corporation to Commission 

dated September 5, 2008; Mayer Brown Letter; 

Letter from John A. Courson, Chief Operating 

Officer, Mortgage Bankers Association to Jill M. 

Peterson, Assistant Secretary, Commission dated 

September 5, 2008; Letter from Michael W. Rico, 

Assistant Treasurer, PNM Resources, Inc. to Office 

of the Secretary, Commission dated September 5, 

2008; Letter from W. Paul Bowers, Executive Vice 

President and Chief Financial Officer, Southern 

Company to Florence Harmon, Acting Secretary, 

Commission dated September 5, 2008; Letter from 

Vincent L. Ammann, Jr., Vice President and Chief 

Financial Officer, WGL Holdings, Inc. and 

Washington Gas Light Company to Florence 

Harmon, Acting Secretary, Commission dated 

September 10, 2008; Letter from James C. Fleming, 

Wisconsin Energy Corporation to Secretary, 

Commission, dated September 5, 2008. 

57 15 U.S.C. 80a. Unless otherwise noted, all 

references to rules under the Investment Company 

Act will be to Title 17, Part 270 of the Code of 

Federal Regulations [17 CFR 270]. 

58 15 U.S.C. 80b. Unless otherwise noted, all 

references to rules under the Investment Advisers 

Act will be to Title 17, Part 275 of the Code of 

Federal Regulations [17 CFR 275]. 

59 Investment Company Act Proposing Release, 

supra note 1. 

60See Investment Company Act Proposing 

Release, supra note 1, at Section III. As discussed 

in the Investment Company Act Proposing Release, 

we did not propose an alternative provision for one 

of the NRSRO references in Rule 3a–7, which 

excludes structured finance vehicles from the 

definition of ‘‘investment company’’ subject to 

certain conditions. We did not provide an 

alternative for the requirement that structured 

financings offered to the general public have an 

investment grade rating because we believed that 

Continued 

Commission is soliciting comment on 

whether it should propose rescinding 

Rule 436(g) under the Securities Act.48

The Commission is deferring 

consideration of action at this time on 

the other proposals in the Securities Act 

Proposing Release. However, in view of 

the continuing public interest in the 

Proposing Releases and the 

Commission’s desire to receive 

additional comment, the Commission is 

re-opening the comment period for the 

Securities Act Proposing Release. As the 

Commission continues to evaluate and 

consider the proposed rule revisions 

outlined in this section, the Commission 

will review whether there are 

appropriate alternatives to references to 

credit ratings by NRSROs in those rules 

and forms. 

Under existing requirements, an 

issuer’s ability to conduct shelf offerings 

of non-convertible debt or asset-backed 

securities (ABS) may depend on, among 

other things, the securities’ credit 

ratings. In particular, a primary offering 

of non-convertible debt securities is 

eligible for registration on Form S–3 or 

Form F–3, regardless of the issuer’s 

public float or reporting history, if the 

securities are investment grade rated.49

Securities registered on Form S–3 or 

Form F–3 may be offered on a delayed, 

or ‘‘shelf,’’ basis.50 An offering of assetbacked securities is eligible for shelf 

registration on Form S–3 or Form F–3 if 

the securities are investment grade rated 

and the offering meets certain other 

conditions.51 In addition, a subset of 

asset-backed securities, ‘‘mortgagerelated securities,’’ that, among other 

things, are rated in one of the two 

highest rating categories by an 

NRSRO,52 may be offered on a delayed 

basis, regardless of the form on which 

the offering is registered.53

In the Securities Act Proposing 

Release, the Commission proposed to 

replace the shelf eligibility requirements 

that rely on investment grade ratings 

with alternate requirements.54 For the 

registration of a non-convertible debt 

offering on Form S–3 or Form F–3, the 

Commission proposed to require that, 

instead of having investment grade rated 

securities, a registrant must have issued 

$1 billion of non-convertible securities 

in registered primary offerings over the 

prior three years. For shelf eligibility of 

ABS offerings, including offerings of 

mortgage related securities, the 

Commission proposed to replace the 

investment grade ratings requirement 

with requirements that initial and 

subsequent resales of ABS offerings be 

made in minimum denominations of 

$250,000 and that initial sales of the 

securities be made only to ‘‘qualified 

institutional buyers,’’ as that term is 

defined in Securities Act Rule 144A.55

We also proposed revisions to related 

rules and form requirements. We 

received letters from 35 commenters on 

these proposals. Most commenters 

opposed the proposed amendments that 

would replace the investment grade 

ratings component of the shelf eligibility 

requirements.56

At this time, the Commission is 

deferring consideration of action on the 

proposals to amend the investment 

grade ratings component of the Form 

S–3 or Form F–3 eligibility 

requirements and, as noted above, we 

are soliciting further comment on the 

proposals. With respect to the ABS shelf 

eligibility requirements, the staff of the 

Division of Corporation Finance is 

currently engaged in a broad review of 

the Commission’s regulation of assetbacked securities including disclosure, 

offering process, and reporting of assetbacked issuers. In connection with that 

review, the staff is evaluating 

alternatives to the investment grade 

rating requirements, including 

alternatives other than the type of 

purchaser or the denomination of the 

security. The Commission believes that 

any proposal for an alternative to 

investment grade ratings for the purpose 

of ABS shelf eligibility will be better 

considered together with other possible 

proposals to the regulations governing 

the offer and sale of asset-backed 

securities. 

IV. References to Ratings of NRSROs in 

Investment Company Act and 

Investment Advisers Act Rules 

In the Investment Company Act 

Proposing Release, the Commission 

proposed to amend four of the 

Commission’s rules under the 

Investment Company Act 57 (Rules 2a–7, 

3a–7, 5b–3, and 10f–3) and one rule 

under the Investment Advisers Act 58

(Rule 206(3)–3T) that refer to credit 

ratings by NRSROs.59 These rules use 

the credit ratings issued by NRSROs in 

different contexts, and for different 

purposes, to distinguish among various 

grades of debt and other rated securities. 

The Commission proposed to amend 

each rule to omit references to NRSRO 

ratings and, except with respect to one 

of the rules, substitute alternative 

provisions that were designed to 

achieve the same purpose as the 

ratings.60 The Commission received 66 

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these offerings generally were not made to retail 

investors. See id. 73 FR at nn. 41–42 and 

accompanying and following text. 

61See, e.g., Letter from Ronald W. Forbes and 

Rodney D. Johnson, Independent Directors of the 

Blackrock money market funds to Florence Harmon, 

Acting Secretary, dated September 10, 2008; Letter 

from Robert G. Zack, Executive Vice President and 

General Counsel, OppenheimerFunds, Inc. to 

Florence Harmon, Acting Secretary, dated 

September 4, 2008. The comment letters are 

available for public inspection and copying in the 

Commission’s Public Reference Room, 100 F Street, 

NE, Washington, DC 20549 on official business days 

between the hours of 10 am and 3 pm (File No. S7– 

19–08), and also are available on the Commission’s 

Internet Web site (http://www.sec.gov/comments/ 

s7-19-08/s71908.shtml). 

62See, e.g., Letter from David Oestreicher, Chief 

Legal Counsel, T. Rowe Price Associates, Inc. to 

Florence Harmon, Acting Secretary, dated 

September 5, 2008. 

63See, e.g., ABA Letter 2; SIFMA Letter. A few 

commenters also stated that removing the 

references may lead to a significant risk of 

unintended adverse consequences to capital 

markets, regulatory community and other industries 

that have regulatory requirements involving NRSRO 

ratings and may not address concerns about undue 

investor reliance on NRSRO ratings. See, e.g., 

SIFMA Letter; Debevoise Letter; Letter from Nathan 

Douglas, Secretariat, Institutional Money Market 

Funds Association to Florence Harmon, Acting 

Secretary, dated September 5, 2008). 

64See NRSRO References Adopting Release, 

supra note 3. 

65For example, Rule 2a–7 limits a money market 

fund’s portfolio investments to securities that have 

received credit ratings from at least one NRSRO in 

one of the two highest short-term rating categories 

or, if unrated, be of comparable quality. Rule 2a– 

7(a)(10) (definition of ‘‘Eligible Security’’). 

66See Money Market Fund Reform, Investment 

Company Act Release No. 28807 (June 30, 2009) [74 

FR 32688 (July 8, 2009)]. 

67See id. at Section II.A.2.a. 

68Structured financings meet the definition of 

investment company under Section 3(a) of the Act 

because they issue securities and invest in, own, 

hold, or trade securities. Almost none of the 

structured financings, however, are able to operate 

under the Act’s requirements. See Exclusion from 

the Definition of Investment Company for 

Structured Financings, Investment Company Act 

Release No. 19105 (Nov. 19, 1992) [57 FR 56248 

(Nov. 27, 1992)]. 

69Rule 3a–7(a)(2). 

70See supra Section III. 

71Section 5(b)(1) of the Act limits the amount that 

a fund that holds itself out as being a diversified 

investment company may invest in the securities of 

any one issuer (other than the U.S. Government). 

Section 12(d)(3) of the Investment Company Act 

generally prohibits a fund from acquiring an 

interest in a broker, dealer, or underwriter. Because 

a repurchase agreement may be considered to be the 

acquisition of an interest in the counterparty, 

Section 12(d)(3) may limit a fund’s ability to enter 

into repurchase agreements with many of the firms 

that act as repurchase agreement counterparties. 

72See Rule 5b–3(c)(1)(iv). 

73See Rule 5b–3(c)(1)(iv)(C)–(D). 

74A ‘‘refunded security’’ is a debt security whose 

principal and interest are to be paid by U.S. 

government securities that have been irrevocably 

placed in an escrow account and pledged only to 

payment of the principal and interest on the debt 

security. See Rule 5b–3(c)(4). 

75See Rule 5b–3(c)(4)(iii) (requiring at the time 

the deposited securities are placed in the escrow 

account that an independent accountant has 

certified to the escrow agent that the deposited 

securities will satisfy all scheduled payments of 

principal, interest, and applicable premiums in the 

refunded securities). 

comment letters on the proposal, most 

of which opposed the proposals.61

Commenters expressed a variety of 

concerns regarding the proposed 

amendments. For example, some 

commenters expressed concern that the 

proposed amendments would replace an 

objective standard of an NRSRO rating 

with a riskier, subjective determination 

by the board of directors, which would 

be difficult to apply and would increase 

the burden on the fund’s board.62

Several commenters also asserted it was 

premature for the Commission to 

consider eliminating NRSRO ratings 

from Commission rules given the 

Commission’s ongoing initiatives to 

address issues such as improving the 

accuracy of NRSRO ratings and 

eliminating NRSRO conflicts of 

interest.63

In a companion release the 

Commission is issuing today, the 

Commission is adopting certain of the 

proposed amendments to Rules 5b–3 

and 10f–3 under the Investment 

Company Act.64 The Commission is 

deferring consideration of action on the 

remaining proposed amendments to 

Rules 2a–7, 3a–7, and 5b–3 under the 

Investment Company Act and Rule 

206(3)–3T under the Investment 

Advisers Act in light of the comments 

received on the proposed amendments 

and further actions the Commission is 

considering in separate rulemakings. 

Rule 2a–7 under the Investment 

Company Act governs the operation of 

money market funds, which rely on the 

rule to use different valuation and 

pricing methods than other investment 

companies (‘‘funds’’) are permitted to 

use, to help maintain a stable share 

price. The rule contains conditions that 

restrict money market funds’ portfolio 

investments to securities that have 

received certain minimum credit ratings 

from NRSROs or comparable unrated 

securities.65 This past June, the 

Commission proposed amendments to 

Rule 2a–7 and related rules designed to 

improve the regulatory framework 

governing money market funds.66 In 

that release, the Commission requested 

further comment on whether we should 

eliminate the use of NRSRO ratings in 

Rule 2a–7, including whether we should 

consider establishing a roadmap for 

phasing in the eventual removal of 

NRSRO references from the rule. We 

also asked whether we should adopt 

other alternatives to encourage more 

independent credit risk analysis, 

including whether we should 

reformulate the rule’s use of ratings by 

requiring a money market fund’s 

directors to designate specific NRSROs 

that the board determines issue ratings 

that are sufficiently reliable.67

Rule 3a–7 under the Investment 

Company Act excludes structured 

finance vehicles from the Act’s 

definition of ‘‘investment company’’ 

subject to certain conditions.68 The 

conditions include the requirement that 

structured financings offered to the 

general public be rated by at least one 

NRSRO in one of the four highest 

ratings categories, with certain 

exceptions.69 As discussed above, 

Commission staff is developing 

proposals regarding the offer and sale of 

asset-backed securities, which may 

affect the exemptive relief provided by 

Rule 3a–7.70 In considering those 

changes, the Commission may revisit 

the use of NRSRO ratings in the offer 

and sale of asset-backed securities. 

Rule 5b–3 under the Investment 

Company Act permits a fund, subject to 

certain conditions, to treat a repurchase 

agreement as an acquisition of the 

securities collateralizing the repurchase 

agreement in determining whether the 

fund is in compliance with two 

provisions of the Act that may affect a 

fund’s ability to invest in repurchase 

agreements.71 The rule permits a fund to 

treat a repurchase agreement as an 

investment in the underlying collateral 

if the agreement is ‘‘collateralized 

fully,’’ and some types of collateral must 

have received certain credit ratings in 

order to meet this standard.72 This 

reference to credit ratings is used to 

determine credit risk and liquidity of 

collateral securities that the fund may 

look to in meeting the diversification 

requirements of the Investment 

Company Act.73 Fourteen commenters 

opposed the proposed amendment to 

eliminate NRSRO ratings references 

from this definition because, among 

other reasons, it would replace an 

objective standard with a subjective 

standard that would be difficult to 

apply. 

Rule 5b–3 includes a second reference 

to NRSRO ratings, in the definition of 

‘‘refunded security.’’ 74 The rule allows 

a fund for purposes of the Investment 

Company Act’s diversification 

requirements to treat the acquisition of 

a refunded security as the acquisition of 

U.S. government securities that are 

pledged to make payments to investors 

if, among other conditions, an 

independent certified public accountant 

has certified to the escrow agent that the 

government securities will satisfy all 

scheduled payments on the refunded 

security.75 Three commenters opposed 

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76See NRSRO References Adopting Release, 

supra note 3, at Section II.B.1. 77Rule 206(3)–3T [17 CFR 275.206(3)–3T]. See 

also Temporary Rule Regarding Principal Trades 

with Certain Advisory Clients, Investment Advisers 

Act Release No. 2653 (September 24, 2007) [72 FR 

55022 (September 28, 2007)] (‘‘Principal Trade Rule 

Release’’). Section 206(3) of the Investment 

Advisers Act makes it unlawful for any investment 

adviser, directly or indirectly ‘‘acting as principal 

for his own account, knowingly to sell any security 

to or purchase any security from a client * * * 

without disclosing to such client in writing before 

the completion of such transaction the capacity in 

which he is acting and obtaining the consent of the 

client to such transaction.’’ 15 U.S.C. 80b–6(3). 78Rule 206(3)–3T(c). 

79See Principal Trade Rule Release, supra note 

77. 80Rule 2a–7(c)(3)(i). 

eliminating this NRSRO reference on 

the grounds it could increase fund 

expenses and decrease liquidity if funds 

chose not to bid on refunded securities 

for which certifications are not 

available. As discussed in the NRSRO 

References Adopting Release, because 

we understand that bond indentures or 

resolutions authorizing the issuance of 

the refunded bonds typically require 

that the escrow agent receive the 

requisite certification, we do not share 

these commenters’ concerns and are 

amending Rule 5b–3 to eliminate this 

reference to NRSRO ratings.76

Finally, Rule 206(3)–3T under the 

Investment Advisers Act establishes a 

temporary alternative means for 

investment advisers who are registered 

with the Commission as broker-dealers 

to meet the requirements of Section 

206(3) of the Advisers Act when they 

act in a principal capacity in 

transactions with certain of their 

advisory clients.77 The rule contains a 

condition that excludes securities from 

coverage under the rule if the adviser or 

its close affiliate is the issuer or an 

underwriter of the security, unless it is 

an underwriter of non-convertible debt 

securities rated in one of the four 

highest rating categories of at least two 

NRSROs.78 The Commission intends to 

consider taking separate, broader, action 

on Rule 206(3)–3T, which is set to 

expire at the end of this year.79

As previously mentioned, the 

Commission is deferring consideration 

of action on the proposals to remove 

NRSRO references from the rules 

described above under the Investment 

Company Act and Investment Advisers 

Act. Our broader consideration of each 

of these rules will afford us the 

opportunity to re-evaluate credit rating 

references in those rules. 

The Commission generally requests 

further comment on the proposed 

amendments described above to Rules 

3a–7 and 5b–3 under the Investment 

Company Act and Rule 206(3)–3T under 

the Investment Advisers Act. We also 

request specific comment on whether 

the rules should require, in place of 

existing references to credit ratings, 

alternate standards that would use (i) 

credit ratings as a minimum standard, 

and (ii) additional criteria that must be 

met with regard to evaluating the 

securities, such as determinations of 

credit quality, liquidity, or 

appropriateness of the security as an 

investment for the particular purchaser. 

This approach, if applied to Rules 

3a–7 and 5b–3 under the Investment 

Company Act and Rule 206(3)–3T under 

the Investment Advisers Act, would be 

designed to help reduce undue reliance 

on ratings by requiring an additional 

evaluation of credit quality, while 

retaining the external or objective 

measure of the NRSRO rating. Under 

Rule 2a–7 in its current form, for 

example, a determination that a security 

is an ‘‘eligible security’’ as a result of its 

NRSRO ratings is a necessary but not 

sufficient finding in order for a money 

market fund to acquire the security. The 

rule also currently requires a 

determination that the security presents 

minimal credit risks, and specifically 

requires that the determination ‘‘be 

based on factors pertaining to credit 

quality in addition to any ratings 

assigned to such securities by an 

NRSRO.’’ 80 Although the Commission, 

as noted above, is continuing to 

consider whether to remove references 

to credit ratings from Rule 2a–7 

altogether, we request comment on 

whether we should consider the twostep approach of existing Rule 2a–7 for 

the other rules (i.e., Rules 3a–7, 5b–3, 

and 206(3)–3T) that contain references 

to NRSRO credit ratings. Alternatively, 

are there other objective measures of 

credit risk, and should they be used in 

place of NRSRO ratings to address the 

concerns addressed by the rules? 

V. Request for Comment 

The Commission generally requests 

comment on the Proposing Releases as 

indicated above, including whether the 

Commission should remove references 

to credit ratings by NRSROs in 

Commission rules and the appropriate 

factors to consider in making this 

determination. The Commission asks 

that commenters provide specific 

reasons and information to support 

alternative recommendations. Please 

provide empirical data, when possible, 

and cite to economic studies, if any, to 

support alternative approaches. 

By the Commission. 

Dated: October 5, 2009. 

Elizabeth M. Murphy, 

Secretary. 

[FR Doc. E9–24365 Filed 10–8–09; 8:45 am] 

BILLING CODE 8011–01–P 

mstockstill on DSKH9S0YB1PROD with PROPOSALS3