18312 Federal Register / Vol. 87, No. 61 / Wednesday, March 30, 2022 / Proposed Rules 

TABLE 14 TO § 431.97—UPDATED MINIMUM EFFICIENCY STANDARDS FOR AIR-COOLED, THREE-PHASE, SMALL COMMERCIAL PACKAGE AIR CONDITIONING AND HEATING EQUIPMENT WITH A COOLING CAPACITY OF LESS THAN—Continued 

65,000 BTU/H AND AIR-COOLED, THREE-PHASE, SMALL VARIABLE REFRIGERANT FLOW MULTI-SPLIT AIR CONDITIONING

AND HEATING EQUIPMENT WITH A COOLING CAPACITY OF LESS THAN 65,000 BTU/H

Equipment type Size category 

(cooling) Subcategory Minimum efficiency 

VRF Heat Pumps ...................................................................... <65,000 Btu/h .......................... .................................................. 13.0 SEER2. 

6.5 HSPF2. 

[FR Doc. 2022–06450 Filed 3–29–22; 8:45 am] 

BILLING CODE 6450–01–P 

SECURITIES AND EXCHANGE 

COMMISSION 

17 CFR Parts 240 and 242 

[Release No. 34–94499; File No. S7–11–22] 

RIN 3235–AL14 

Removal of References to Credit 

Ratings From Regulation M 

AGENCY: Securities and Exchange 

Commission. 

ACTION: Proposed rule. 

SUMMARY: The Securities and Exchange 

Commission (‘‘Commission’’) is reproposing amendments to remove the 

references to credit ratings included in 

certain Commission rules. The DoddFrank Wall Street Reform and Consumer 

Protection Act (‘‘Dodd-Frank Act’’), 

among other things, requires the 

Commission to remove any references to 

credit ratings from its regulations. In 

one rule governing the activity of 

distribution participants, the 

Commission is proposing to remove the 

reference to credit ratings, substitute 

alternative measures of creditworthiness, and impose related 

recordkeeping obligations in certain 

instances. In another rule governing the 

activity of issuers and selling security 

holders during a distribution, the 

Commission is proposing to eliminate 

the exception for investment-grade 

nonconvertible debt, nonconvertible 

preferred securities, and asset-backed 

securities. 

DATES: Comments should be received on 

or before May 23, 2022. 

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/submitcomments.htm); or 

• Send an email to rule-comments@

sec.gov. Please include File Number S7– 

11–22 on the subject line; or 

Paper Comments 

• Send paper comments to Secretary, 

Securities and Exchange Commission, 

100 F Street NE, Washington, DC 

20549–1090. 

All submissions should refer to File 

Number S7–11–22. This file number 

should be included on the subject line 

if email is used. To help us process and 

review your comments more efficiently, 

please use only one method of 

submission. The Commission will post 

all comments on the Commission’s 

website (http://www.sec.gov/rules/ 

proposed.shtml). Comments are also 

available for website viewing and 

printing 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. Operating conditions 

may limit access to the Commission’s 

Public Reference Room. All comments 

received will be posted without change; 

we do not edit personal identifying 

information from comment submissions. 

You should submit only information 

that you wish to make publicly 

available. 

Studies, memoranda, or other 

substantive items may be added by the 

Commission or staff to the comment file 

during this rulemaking. A notification of 

the inclusion in the comment file of any 

such materials will be made available 

on the Commission’s website. To ensure 

direct electronic receipt of such 

notifications, sign up through the ‘‘Stay 

Connected’’ option at www.sec.gov to 

receive notifications by email. 

FOR FURTHER INFORMATION CONTACT: John 

Guidroz, Branch Chief, Laura Gold, 

Special Counsel, Jessica Kloss, 

Attorney-Adviser, or Josephine Tao, 

Assistant Director, in the Office of 

Trading Practices, at (202) 551–5777, 

Division of Trading and Markets, U.S. 

Securities and Exchange Commission, 

100 F Street NE, Washington, DC 20549. 

SUPPLEMENTARY INFORMATION: The 

Commission is proposing to amend the 

existing exceptions found in 17 CFR 

242.101 (‘‘Rule 101’’) and 17 CFR 

242.102 (‘‘Rule 102’’) for investmentgrade nonconvertible debt securities, 

nonconvertible preferred securities, and 

asset-backed securities. Specifically, the 

Commission is proposing to remove the 

requirement to qualify for the exception 

in each of these rules that these 

securities be rated investment grade by 

at least one nationally recognized 

statistical rating organization 

(‘‘NRSRO’’). In its place, in Rule 101, 

the Commission proposes to except (1) 

nonconvertible debt securities and 

nonconvertible preferred securities 

(collectively, ‘‘Nonconvertible 

Securities’’) that meet a specified 

probability of default threshold, and (2) 

asset-backed securities that are offered 

pursuant to an effective shelf 

registration statement filed on the 

Commission’s Form SF–3. In addition, 

the Commission is proposing to 

eliminate the existing exception in Rule 

102 for investment-grade 

Nonconvertible Securities, and assetbacked securities. The Commission is 

also proposing amendments to 17 CFR 

240.17a–4(b) (‘‘Rule 17a–4(b)’’) under 

the Securities Exchange Act of 1934 

(‘‘Exchange Act’’) to require brokerdealers to maintain the written 

probability of default determination. 

Table of Contents 

I. Background 

II. Prior Proposals To Remove References to 

Credit Ratings in Regulation M 

A. 2008 Proposal 

B. 2011 Proposal 

III. Application of Regulation M to 

Distributions of Nonconvertible 

Securities and Asset-Backed Securities 

IV. Proposed Amendments to Rules 101 and 

102 To Remove References to Credit 

Ratings 

A. Rule 101 

B. Rule 102 

V. Recordkeeping Requirement: Rule 17a– 

4(b)(17) 

A. Proposed Recordkeeping Requirement 

B. Request for Comment 

VI. General Request for Comment 

VII. Paperwork Reduction Act Analysis 

A. Background 

B. Proposed Use of Information 

C. Information Collections 

D. Collection of Information Is Mandatory 

E. Confidentiality 

F. Retention Period of Recordkeeping 

Requirement 

G. Request for Comment 


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Federal Register / Vol. 87, No. 61 / Wednesday, March 30, 2022 / Proposed Rules 18313 

1See Public Law 111–203 secs. 931–939H, 124 

Stat. 1376, 1872–90 (2010). These provisions are 

designed ‘‘[t]o reduce the reliance on ratings.’’ Joint 

Explanatory Statement of the Committee of 

Conference, Conference Committee Report No. 111– 

517, to accompany H.R. 4173, 864–79, 870 (June 29, 

2010). 

2Public Law 111–203 sec. 939A(a); see infra note 

4. 

3See id. at sec. 939A(b). 

4 Id. at sec. 939A(c); see U.S. Securities and 

Exchange Commission Staff, Report on Review of 

Reliance on Credit Ratings: As Required by Section 

939A(c) of the Dodd-Frank Wall Street Reform and 

Consumer Protection Act (2011), available at 

https://www.sec.gov/news/studies/2011/ 

939astudy.pdf. Staff reports, Investor Bulletins, and 

other staff documents (including those cited herein) 

represent the views of Commission staff and are not 

a rule, regulation, or statement of the Commission. 

The Commission has neither approved nor 

disapproved the content of these documents and, 

like all staff statements, they have no legal force or 

effect, do not alter or amend applicable law, and 

create no new or additional obligations for any 

person. 

5 17 CFR 240.15c3–1. In 1975, the Commission 

adopted the term NRSRO as part of its amendments 

to Exchange Act Rule 15c3–1. In 2013, pursuant to 

Section 939A of the Dodd-Frank Act, the 

Commission adopted amendments to Rule 15c3–1 

to remove the reference to NRSROs. See Removal 

of Certain References to Credit Ratings Under the 

Securities Exchange Act of 1934, Release No. 34– 

71194 (Dec. 27, 2013) [79 FR 1522, 1527–28 (Jan. 

8, 2014)]. 

6See 17 CFR 242.101(c)(2), 17 CFR 242.102(d)(2). 

7To assist the Commission in conducting 

effective examinations and oversight of distribution 

participants and their affiliated purchasers, the 

Commission is also requiring the maintenance and 

preservation of the written probability of default 

determination. See infra Part V. 

8See 17 CFR 242.100 (‘‘Rule 100’’) (defining 

‘‘distribution participant’’ as any ‘‘underwriter, 

prospective underwriter, broker, dealer, or other 

person who has agreed to participate or is 

participating in a distribution’’). 

9Specifically, Rule 101 governs the activities of 

‘‘distribution participants,’’ while Rule 102 governs 

the activities of the issuer and selling security 

holders. Rules 101 and 102 also apply to the 

affiliated purchasers of underwriters and issuers or 

selling security holders, respectively. 

10See 17 CFR 242.100 (defining ‘‘covered 

security’’ as any security that is the subject of a 

distribution or any reference security, and 

‘‘reference security’’ as a security into which a 

security that is the subject of a distribution may be 

converted, exchanged, or exercised or which, under 

the terms of the subject security, may in whole or 

in significant part determine the value of the subject 

security). 

11The restricted period for any particular 

distribution commences one or five business days 

before the day of the pricing of the offered security 

and continues until the distribution is complete. 

The restricted period that applies to a particular 

offering is determined based on the trading volume 

value of the offered security and the public float 

value of the issuer. See Rule 100. A person 

determines when it completes its participation in 

the distribution based on its role. See Rule 100; 

Anti-Manipulation Rules Concerning Securities 

Offerings, Release No. 34–38067 (Dec. 20, 1996) [62 

FR 520, 522 (Jan. 3 1997)] (‘‘Regulation M Adopting 

Release’’). In addition, securities acquired in the 

distribution for investment purposes by any person 

participating in a distribution, or any affiliated 

purchaser of such person, are deemed to be 

distributed. Rule 100; Regulation M Adopting 

Release, 62 FR 523. 

12See Trading Practices Rules Concerning 

Securities Offerings, Release No. 33–7282 (Apr. 11, 

1996) [61 FR 17108, 17111, 17120 (Apr. 18, 1996)] 

(‘‘Regulation M Proposing Release’’). 

13Regulation M Adopting Release, 62 FR 528. The 

Commission also stated more generally that 

Regulation M applies where there is a ‘‘readily 

identifiable incentive to manipulate the price of an 

offered security.’’ Id. at 540. 

VIII. Economic Analysis 

A. Baseline 

B. Benefits of the Proposed Amendment 

C. Costs of the Proposed Amendment 

D. Efficiency, Competition, and Capital 

Formation 

E. Reasonable Alternatives 

F. Request for Comment 

IX. Regulatory Flexibility Act Certification 

X. Consideration of Impact on the Economy 

Statutory Basis and Text of Proposed 

Amendments 

List of Subjects in 17 CFR Part 240 and 242 

I. Background 

Title IX, Subtitle C, of the Dodd-Frank 

Act includes provisions regarding 

statutory and regulatory references to 

credit ratings in the Exchange Act and 

the rules promulgated thereunder.1 One 

such provision, Section 939A, requires 

the Commission to ‘‘review any 

regulation issued by [the Commission] 

that requires the use of an assessment of 

the credit-worthiness of a security or 

money market instrument and any 

references to or requirements in such 

regulations regarding credit ratings.’’ 2

Upon completion of this review, the 

Commission must ‘‘remove any 

reference to or requirement of reliance 

on credit ratings’’ and ‘‘substitute in 

such regulations such standard of 

credit-worthiness’’ as the Commission 

determines to be appropriate for such 

regulations. In making such a 

determination, the Commission shall 

seek to establish, to the extent feasible, 

uniform standards of credit-worthiness 

for use by the Commission, taking into 

account the entities it regulates and the 

purposes for which such entities would 

rely on such standards of creditworthiness.3 The statute also requires 

the Commission to transmit a report to 

Congress upon the conclusion of the 

review required in Section 939A(a).4

In reference to the requirements in 

Section 939A, the Commission is 

proposing amendments to Rule 101 and 

Rule 102 to remove the existing 

exceptions for nonconvertible debt 

securities, nonconvertible preferred 

securities, and asset-backed securities, 

that are rated by at least one NRSRO, as 

that term is used in Rule 15c3–1 under 

the Exchange Act,5 in one of its generic 

rating categories that signifies 

investment grade.6 Throughout this 

release, this exception referencing an 

investment grade rating is referred to as 

the ‘‘Investment Grade Exception,’’ or 

the ‘‘Investment Grade Exceptions’’ 

when referencing the exception 

provided in Rule 101 and Rule 102 or 

the rules collectively, as applicable. In 

place of the Investment Grade Exception 

in Rule 101, the Commission proposes 

to substitute alternative standards of 

credit-worthiness with respect to the 

type of security that is the subject of a 

distribution. First, for distributions of 

Nonconvertible Securities, the 

Commission is proposing a standard 

that is based on the probability of 

default of the issuer.7 Second, for 

distributions of asset-backed securities, 

the Commission is proposing to except 

asset-backed securities that are offered 

pursuant to an effective shelf 

registration statement filed on Form SF– 

3. Finally, the Commission is proposing 

to eliminate the Investment Grade 

Exception in Rule 102 and not replace 

it with an alternative standard. 

As a set of prophylactic antimanipulation rules, Regulation M is 

designed to preserve the integrity of the 

securities trading markets as 

independent pricing mechanisms by 

prohibiting activities that could 

artificially influence the market for an 

offered security. Subject to exceptions, 

Rules 101 and 102 prohibit issuers, 

selling security holders, distribution 

participants,8 and any of their affiliated 

purchasers 9 from, directly or indirectly, 

bidding for, purchasing, or attempting to 

induce another person to bid for or 

purchase a covered security 10 during a 

specified period referred to as the 

‘‘restricted period.’’ 11

The Investment Grade Exceptions are 

two of several exceptions to the general 

prohibitions of Rules 101 and 102. The 

Commission expressed its belief that 

certain securities and activities should 

be excepted from the prohibitions in 

order to allow for activities necessary 

for the distribution to occur; to limit 

adverse effects to the trading market that 

could result from these prohibitions 

absent such exceptions; and to allow 

conduct that is not likely to have a 

manipulative impact.12 The 

Commission did not except other 

securities and activities, however, 

expressing a belief that the application 

of Regulation M is appropriate ‘‘where 

the incentive to manipulate can 

escalate.’’ 13 The securities and 

activities exceptions provided in 

Regulation M take into account the 

different types of interests that 

distribution participants, issuers, and 

selling security holders have regarding 

the outcome of a distribution by 

providing different and limited 

exceptions in Rule 102 to issuers and 


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14See Regulation M Adopting Release, 62 FR 530. 

15 Id. 

16References to Ratings of Nationally Recognized 

Statistical Rating Organizations, Release No. 34– 

58070 (July 1, 2008) [73 FR 40088, 40095–97 (July 

11, 2008)] (‘‘2008 Proposing Release’’). 

17Removal of Certain References to Credit 

Ratings Under the Securities Exchange Act of 1934, 

Release No. 34–64352 (Apr. 27, 2011) [76 FR 26550 

(May 6, 2011)] (‘‘2011 Proposing Release’’). 

18See Removal of Certain References to Credit 

Ratings Under the Securities Exchange Act of 1934, 

Release No. 34–71194 (Dec. 27, 2013) [79 FR 1522 

(Jan. 8, 2014)]. 

19 2008 Proposing Release, 73 FR 40095–97. More 

specifically, the 2008 Proposal—consistent with the 

definition of WKSI in Securities Act Rule 405— 

would have excepted Nonconvertible Securities of 

issuers who have issued at least $1 billion aggregate 

principal amount of nonconvertible securities, other 

than common equity, in primary offerings for cash, 

not exchange, registered under the Securities Act. 

See 17 CFR 230.405, paragraph (1)(i)(B)(1) of the 

definition of WKSI; see also 2008 Proposing 

Release, 73 FR 40096. 

20See 2011 Proposing Release at 26559 

(discussing commenter views about the 2008 

Proposal). Comments received in response to the 

2008 Proposal are contained in File No. S7–17–08, 

available at https://www.sec.gov/comments/s7-17- 

08/s71708.shtml. Comments that were received in 

response to the 2008 Proposal that are relevant to 

the substance or scope of the amendments being 

proposed in this release and are discussed below in 

Part IV. Comments that were received in response 

to the 2008 Proposal that are relevant to the 

economic effects of the amendments being 

proposed in this release and are discussed below in 

Part VIII. 

21See, e.g., Letter from Deborah A. Cunningham 

and Boyce I. Greer, Co-chairs, Securities Industry 

and Financial Markets Association (‘‘SIFMA’’) 

Credit Rating Agency Task Force, to Florence E. 

Harmon, Acting Secretary (Sep. 4, 2008) (‘‘SIFMA 

Letter 1’’) at 14 (‘‘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.’’). 

22Letter from Keith F. Higgins, Chair, Committee 

on Federal Regulation of Securities, American Bar 

Association (‘‘ABA’’), to Florence E. Harmon, 

Acting Secretary (Oct. 10, 2008) (‘‘ABA Letter’’) and 

SIFMA Letter 1 at 13. 23ABA Letter at 16 and SIFMA Letter 1 at 13. 

24The ABA did, however, suggest that should the 

Commission insist on using the WKSI standard for 

investment grade Nonconvertible Securities, it do 

so only as an alternative to the current exceptions 

in Rules 101(c)(2) and 102(d)(2). ABA Letter at 17. 

However, the ABA expressed its ‘‘strong[ ] belie[f] 

that the Commission should retain the current 

exceptions.’’ Id. at 16. 

25References to Ratings of Nationally Recognized 

Statistical Rating Organizations, Release No. 34– 

60790 (Oct. 5, 2009) [74 FR 52374, 52375 (Oct. 9, 

2009)]. 

26Letter from Mary Keogh, Managing Director, 

Regulatory Affairs and Daniel Curry, President, 

DBRS, Inc., to Elizabeth M. Murphy, Secretary 

(Nov. 13, 2009); Letter from Sean C. Davy, 

Managing Director, Corporate Credit Markets 

Division, SIFMA, to Elizabeth M. Murphy, 

Secretary (Dec. 8, 2009). 

27Letter from Steven G. Tepper, Arnold & Porter 

LLP, to the Honorable Mary L. Schapiro, Chairman 

(Dec. 8, 2009) (‘‘Arnold & Porter Letter’’). 

28See 2011 Proposing Release, 76 FR 26559. 

29 2011 Proposing Release, 76 FR 26559. 

30 Id. at 26560. 

31Comments received in response to the 2011 

Proposal are contained in File No. S7–15–11, 

available at https://www.sec.gov/comments/s7-15- 

11/s71511.shtml. Comments that were received in 

response to the 2011 Proposal that are relevant to 

the substance or scope of the amendments being 

proposed in this release are discussed below, in 

Part IV. Comments that were received in response 

to the 2011 Proposal that are relevant to the 

economic effects of the amendments being 

proposed in this release are discussed below, in 

Part VIII. One commenter expressed complete 

support for the 2011 Proposal. See Letter from Kurt 

N. Schacht, Managing Director, Standards and 

Financial Markets Integrity, and Linda L. 

Rittenhouse, Director, Capital Markets Policy, CFA 

Institute to Elizabeth M. Murphy, Secretary (Dec. 

20, 2011) (‘‘CFA Letter’’). 

32Letter from Sullivan & Cromwell LLP to 

Elizabeth M. Murphy, Secretary (July 5, 2011) 

selling security holders.14 Rule 102 

contains fewer exceptions than Rule 101 

because issuers and selling security 

holders have the greatest interest in an 

offering’s outcome and generally do not 

have the same market access needs as 

underwriters.15

II. Prior Proposals To Remove 

References to Credit Ratings in 

Regulation M 

The Commission has previously 

proposed two alternatives with respect 

to the Investment Grade Exceptions, 

once in 2008 (‘‘2008 Proposal’’) 16 and 

once in 2011 (‘‘2011 Proposal’’).17 The 

Commission did not adopt any rules 

based on the 2008 Proposal or the 2011 

Proposal.18

A. 2008 Proposal 

In 2008, prior to the enactment of the 

Dodd-Frank Act, the Commission 

proposed to substitute the Investment 

Grade Exceptions with a standard for 

Nonconvertible Securities based 

primarily on the well-known seasoned 

issuers (‘‘WKSI’’) concept from Rule 405 

of the Securities Act of 1933 

(‘‘Securities Act’’), as well as a standard 

for asset-backed securities that were 

registered on Form S–3.19 Commenters 

expressed uniform opposition to the 

2008 Proposal.20 Many of these 

commenters stated their view that 

changes to the Regulation M exceptions, 

such as those in the 2008 Proposal, were 

not necessary as the Regulation M 

exceptions did not raise the same 

concerns about investors’ undue 

reliance on credit ratings as other rules 

could.21 Commenters also stated that a 

result of the 2008 Proposal would be 

new burdens on issuers and 

underwriters from imposing the 

restrictions of Regulation M on 

currently excepted investment grade 

securities.22 Additionally, commenters 

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 

102.23 These commenters generally did 

not suggest specific alternatives to the 

proposed rule changes.24

In 2009, in light of the uniform 

opposition by commenters and 

continuing concern regarding the undue 

influence of credit ratings, the 

Commission reopened the comment 

period for the 2008 Proposal and invited 

comments suggesting alternative 

proposals to achieve the Commission’s 

goals.25 The Commission received three 

additional comment letters. Of these, 

two reiterated earlier objections,26 and 

the third stated that the 2008 Proposal 

would have resulted in adverse effects 

on foreign sovereign issuers of debt 

securities.27 Although the Commission 

invited commenters to suggest 

alternative proposals, no new 

alternatives were suggested.28 As noted 

above, the Commission did not adopt 

any rules based on the 2008 Proposal. 

B. 2011 Proposal 

In 2011, after the Dodd-Frank Act was 

signed into law, the Commission issued 

a different proposal, which would have 

replaced the Investment Grade 

Exceptions with a standard based on the 

trading characteristics that the 

Commission believed made the 

exceptions apply to securities that were 

less prone to the type of manipulation 

that Regulation M seeks to prevent. The 

2011 Proposal would have replaced the 

Investment Grade Exceptions with an 

exception for Nonconvertible Securities 

and asset-backed securities that (1) were 

liquid relative to the market for that 

asset class, (2) traded in relation to 

general market interest rates and yield 

spreads, and (3) were relatively fungible 

with securities of similar characteristics 

and interest rate yield spreads.29 The 

2011 Proposal would have required the 

person seeking to rely on the exception 

to make the determination that the 

security in question met these standards 

utilizing reasonable factors of 

evaluation. Further, this determination 

would have been required to be 

subsequently verified by an 

independent third party.30

Almost all commenters expressed 

concerns about aspects of the 2011 

Proposal.31 For example, commenters 

generally had concerns regarding the 

practicality of the 2011 Proposal. More 

specifically, there were concerns that, 

because of the forward-looking and 

subjective nature of the proposed 

standards in this release, it would be 

impractical to make consistent 

determinations among market 

participants, even in the same 

distributions.32 Many commenters 


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Federal Register / Vol. 87, No. 61 / Wednesday, March 30, 2022 / Proposed Rules 18315 

(‘‘Sullivan & Cromwell Letter’’) at 3; see also Letter 

from Suzanne Rothwell, Managing Member, 

Rothwell Consulting LLC to Elizabeth M. Murphy, 

Secretary (July 5, 2011) (‘‘Rothwell Letter’’) at 6–7 

and Letter from Kenneth E. Bensten, Jr., Executive 

Vice President, Public Policy and Advocacy, SIFMA 

to Elizabeth M. Murphy, Secretary (July 5, 2011) 

(‘‘SIFMA Letter 3’’) at 3–10. SIFMA Letter 3 stated 

that this could lead to market participants being 

overly conservative in their analysis in fear of other 

distribution participants taking more negative views 

of the security or being overly optimistic regarding 

the security in order to gain a competitive 

advantage, leaving the application of the exceptions 

to something other than whether the security is less 

susceptible to manipulation. See SIFMA Letter 3 at 

7. 

33Letter from Davis Polk & Wardwell LLP to 

Elizabeth M. Murphy, Secretary (July 5, 2011) 

(‘‘Davis Polk Letter’’) at 2; Rothwell Letter at 7; 

Sullivan & Cromwell Letter at 3; SIFMA Letter 3 at 

3; see also Letter from Dennis M. Kelleher, 

President & CEO, and Stephen W. Hall, Securities 

Specialist, Better Markets, Inc., to Elizabeth M. 

Murphy, Secretary (July 5, 2011) (‘‘Better Markets 

Letter’’) at 5 (arguing for bright-line standards to 

ensure that manipulation does not occur). Some 

commenters also pointed to the success of the 

references to credit ratings in the current exceptions 

at creating workable exceptions to Regulation M. 

See Rothwell Letter at 2; Sullivan & Cromwell 

Letter at 3. 

34 Davis Polk Letter at 3; Rothwell Letter at 7; 

Sullivan & Cromwell Letter at 4; SIFMA Letter 3 at 

7. 

35 Davis Polk Letter at 1. 

36 Davis Polk Letter at 1; SIFMA Letter 3. 

37Sullivan & Cromwell Letter at 2 (stating that 

‘‘[a]s a purely conceptual matter, we think the new 

standard is logical and consistent with the 

principles underlying Regulation M, as they have 

been developed over time’’); CFA Letter at 6–7 

(stating that ‘‘the exemptions . . . appear to be 

reasonably focused at preventing the types of 

manipulation that the regulation seeks to deter’’). 

38This commenter said that the rationale for the 

exceptions for investment grade fixed income 

securities applies equally to non-investment grade 

fixed income securities. SIFMA Letter 3 at 14. 

39 Davis Polk Letter at 4. 

40See, e.g., 17 CFR 242.101(b)(10). 

41Sullivan & Cromwell Letter at 4–5; SIFMA 

Letter 3 at 4. 

42Sullivan & Cromwell Letter at 2. However, this 

commenter also stated that it did not ‘‘perceive any 

real purpose being served by this proposed change’’ 

and while the change would not be substantial, 

‘‘that is not a good reason to make it.’’ Id. It also 

described the potential impact of the proposal on 

distributions that are not completed immediately 

after pricing. Id. at 3–5. 

43For example, commenters who questioned the 

need for the changes pointed out that the 

underlying concern with Section 939A, that market 

participants had become overly reliant on credit 

ratings as a substitute for their own credit analysis, 

was not present in the Regulation M exceptions at 

issue because Regulation M regulates trading 

practices. See Rothwell Letter at 4; Sullivan & 

Cromwell Letter at 3. One of these commenters also 

stated that, because the credit rating process has 

been improved by regulatory changes in recent 

years, including the Credit Rating Agency Reform 

Act of 2006, the Commission did not need the 2011 

Proposal. See Rothwell Letter at 4. 

44See SIFMA Letter 3 at 4 (suggesting adopting 

a modified version of the 2008 Proposal ‘‘now that 

the Dodd-Frank Act requires removal of references 

to credit ratings’’) (emphasis added); see also Letter 

from Chris Barnard to Elizabeth M. Murphy, 

Secretary (June 6, 2011); Better Markets Letter at 13 

(questioning whether the 2011 Proposal offered a 

sufficient ‘‘standard of credit-worthiness’’ as 

required in Section 939A). 

45SIFMA Letter 3 at 7–8. 

46SIFMA Letter 3 at 9; Letter from Sean C. Davy, 

Managing Director, Corporate Credit Markets 

Division, SIFMA, to Elizabeth M. Murphy, 

Secretary (Jan. 24, 2014) at 3. 

47Regulation M Adopting Release, 62 FR 524. 

48To illustrate with a simple example, absent an 

exception, a broker-dealer who is participating in a 

distribution of XYZ Corp.’s 3% bonds maturing 12/ 

31/2029 would be prohibited from making a market 

in bonds with those terms prior to completing the 

distribution. The broker-dealer would not, however, 

be prohibited from making a market in XYZ Corp.’s 

3% bonds maturing 12/31/2030 because the date of 

maturity, a term of the bond, is different from the 

security in distribution. 

49For a discussion of why the Commission 

considered replacing former Exchange Act Rule 

10b–6 (and other predecessor trading practices 

rules) with Regulation M, see Review of 

Antimanipulation Regulation of Securities 

Offerings, Release No. 34–33924 (Apr. 19, 1994) [59 

FR 21681 (Apr. 26, 1994)]. 

50Letter from Robert C. Lewis, Associate Director, 

Division of Market Regulation, to Donald M. 

Feuerstein, General Partner and Counsel, Salomon 

Brothers (Mar. 4, 1975). The request letter to the 

staff states that debt securities ‘‘are merely a right 

to receive a fixed amount of money no later than 

a specified future date, and the issuer’s prospects 

are relevant only insofar as they reflect on its ability 

to meet its obligations to the debtholders. Thus, 

nonconvertible debt securities with similar 

economic terms and similar degrees of assurance of 

payment are substantially fungible even though 

their issuers may be different. The economic terms 

of particular debt issues are susceptible to precise 

comparison, particularly when mathematically 

translated into yield to maturity, average life or call. 

Although the degree of assurance of payment 

cannot be precisely quantified, debt investors are 

not influenced by many developments in the 

issuer’s affairs that are material to equity 

investors. . . . Thus the identity of the issuers of 

corporate bonds with similar risk factors is not 

important in the analysis of fixed income 

securities.’’ 

contrasted these issues with the fact that 

using credit ratings under the existing 

standard establishes a bright-line for 

market participants.33 Many 

commenters also stated that the 2011 

Proposal would have added costs and 

delays to the offering process.34

One commenter suggested that the 

risk of manipulation is low for the 

securities at issue.35 Another said that 

the 2011 Proposal was contrary to the 

approach in Regulation M in general 

and the exceptions specifically, which 

was to focus the restrictions of the 

regulation on those circumstances 

where the chance for manipulation was 

heightened,36 though others disagreed.37

One commenter suggested that all fixed 

income securities be excepted from 

Rules 101 and 102.38 One commenter 

believed that the 2011 Proposal would 

have excluded some investment grade 

securities, changing the scope of the 

exception.39

Commenters also suggested that 

unintended consequences could have 

resulted from the 2011 Proposal. Some 

suggested that, in light of the fact that 

transactions in Rule 144A securities are 

generally excepted from Rules 101 and 

102,40 the lack of a bright-line could 

have reduced the attractiveness of 

registered offerings because of the 

complications in using the exceptions 

from Regulation M as changed by the 

2011 Proposal.41 However, one of these 

commenters agreed with the 

Commission’s assessment that the 

‘‘impact of the change should not be 

substantial.’’ 42

Some commenters questioned 

whether Section 939A of the DoddFrank Act requires that the Commission 

change Regulation M at all,43 whereas 

others suggested that the proposal did 

not go far enough to comply with that 

section.44 One commenter suggested 

that the Commission adopt amendments 

similar to those included in the 2008 

Proposal in response to the 2011 

Proposal in light of the apparent 

mandate of 939A to not retain the 

status-quo.45 This commenter noted that 

it preferred a proposal that utilized an 

objective, bright-line standard.46 As 

noted above, the Commission did not 

adopt any rules based on the 2011 

Proposal. 

III. Application of Regulation M to 

Distributions of Nonconvertible 

Securities and Asset-Backed Securities 

The application of Regulation M’s 

prohibitions to distributions of 

Nonconvertible Securities and assetbacked securities generally is limited 

because distribution participants and 

affiliated purchasers are restricted only 

from bidding for or purchasing 

securities that are identical in all of 

their terms to the security being 

distributed.47 In other words, the 

restrictions do not apply for a security 

if there is a single basis point difference 

in coupon rates or a single day’s 

difference in maturity dates from the 

security in distribution.48

The Investment Grade Exceptions 

trace back to a 1975 no-action position 

taken by Commission staff regarding 

former Exchange Act Rule 10b–6, the 

predecessor to Rules 101 and 102.49

This no-action letter was premised on 

the principle that investment grade 

Nonconvertible Securities and assetbacked securities are less likely to be 

subject to manipulation because they 

are traded on the basis of their yields 

and credit ratings rather than the 

identity of the particular issuer.50 This 

reasoning served as the basis for the 

Commission’s adoption of the 


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51See Regulation M Adopting Release, 62 FR 527. 

52Former Exchange Act Rule 10b–6(a)(3). 

53See Review of Antimanipulation Regulation of 

Securities Offerings, Release No. 34–33924 (Apr. 19, 

1994) [59 FR 21681, 21688 (Apr. 26, 1994)]; see also 

Gamble Skogmo, Inc., SEC No-Action Letter, (Jan. 

11, 1974), in which the staff took a no-action 

position to permit bids for or purchases of the 

issuer’s outstanding debt securities that varied by 

at least 1% in coupon interest rate and by at least 

ten years in maturity from those of the debt 

securities being distributed. 

54See SIFMA Letter 3 at 6. 

55 Id. 

56See Arnold & Porter Letter at 2–3. 

57Sullivan & Cromwell Letter at 4. The 

Commission also indicated that a sticky offering 

could be a circumstance in which Regulation M 

would impact debt securities, stating its belief that 

‘‘as a practical matter, Rule 101 and Rule 102 will 

have very limited impact on debt securities, except 

for the rare situations where selling efforts continue 

over a period of time.’’ Regulation M Adopting 

Release, 62 FR 528. 

58Sullivan & Cromwell Letter at 4. 

59Rothwell Letter at 9. In a best-efforts offering, 

the underwriters are not required to sell any 

specific number or dollar amount of securities but 

will use their best efforts to sell the securities 

offered. See Plain English Disclosure, Release No. 

34–38164, (Jan. 14, 1997) [62 FR 3152 (Jan. 21, 

1997)]. 

60Sullivan and Cromwell Letter at 4. 

61 Id. (discussing the alternative to following the 

steps required for an underwriter to determine the 

availability of the exception from Regulation M 

under the 2011 Proposal). 

62Arnold & Porter Letter at 3. 

63As discussed below, the term ‘‘structural credit 

risk model’’ for purposes of the proposed exception 

in Rule 101(c)(2)(i) shall mean any commercially or 

publicly available model that calculates the 

probability that the value of the issuer may fall 

below a threshold based on an issuer’s balance 

sheet. 

64Regulation M Adopting Release, 62 FR 527. 

65Fischer Black & Myron Scholes, The Pricing of 

Options and Corporate Liabilities, 81 J. Pol. Econ. 

637, 637–54 (1973). The Black-Scholes option 

pricing model is used to determine the fair price or 

theoretical value for a call or put option based on 

a number of variables, including the volatility and 

price of the underlying stock, the type of option, 

time, the option’s strike price, and the risk-free rate. 

66Robert C. Merton, On the Pricing of Corporate 

Debt: The Risk Structure of Interest Rates, 29 J. Fin. 

449, 449–70 (1974). The Merton (1974) Model has 

been expanded upon and used to develop new 

Structural Credit Risk Models that rely on its 

principles (‘‘Successor Models’’), such as the BlackCox (1976) model and the Leland (1994) model. 

See, e.g., Suresh Sundaresan, A Review of Merton’s 

Model of the Firm’s Capital Structure with its Wide 

Applications, 5 Ann. Rev. Fin. Econ. 21, 21–41 

(2013); Fischer Black & John C. Cox, Valuing 

Corporate Securities: Some Effects of Bond 

Indenture Provisions, 31 J. Fin. 351, 351–67 (1976); 

see also Hayne E. Leland, Corporate Debt Value, 

Bond Covenants, and Optimal Capital Structure, 49 

J. Fin. 1213, 1213–52 (1994). 

Investment Grade Exceptions in 

Regulation M 51 and continues to serve 

in part as the basis for the proposed 

amendments to Rule 101. 

While the Commission carried over its 

reasoning from former Exchange Act 

Rule 10b–6 to serve as the premise of 

the Investment Grade Exceptions, it did 

not adopt the former rule’s broad 

application. In contrast to Regulation 

M’s limited applicability only to 

distributions of securities that have 

identical terms, former Exchange Act 

Rule 10b–6 applied to distributions of 

‘‘any security of the same class and 

series.’’ 52 The phrase ‘‘same class and 

series’’ was construed broadly to 

encompass securities that were 

sufficiently similar in their terms to the 

security in a distribution to raise the 

possibility that bids for or purchases of 

the outstanding security might facilitate 

the distribution, even in the absence of 

an inherent mathematical relationship 

between the prices of the two 

securities.53

Accordingly, some commenters 

responding to the 2008 Proposal and the 

2011 Proposal stated that reliance on the 

Investment Grade Exceptions largely is 

limited to two situations. The first 

situation is a so-called ‘‘reopening,’’ 

which is an offering of an additional 

principal amount of fixed-income 

securities that are identical to, and 

fungible with, the securities that are 

already outstanding.54 One commenter 

stated that an issuer may want to make 

a series of offerings of its fixed-income 

securities via a reopening to match its 

funding needs or the desires of its target 

investor class.55 Further, some foreign 

sovereign issuers may conduct a 

reopening for public finance purposes.56

The second situation identified by 

commenters is a so-called ‘‘sticky 

offering,’’ which is an offering where a 

lack of demand results in an 

underwriter being unable to sell all of 

the securities in a distribution.57 One 

commenter stated that an investor 

failing to honor a previously given 

indication of interest is an example of 

a situation that can cause a sticky 

offering.58 Another example provided 

by a commenter is a ‘‘best-efforts’’ 

offering.59

One commenter noted that, absent the 

Investment Grade Exceptions, 

underwriters would be prohibited from 

making a market in the distribution 

securities while the distribution 

continued.60 The implication of this is 

that underwriters would have to ‘‘weigh 

(a) the risk of . . . a continuing 

distribution occurring, against (b) the 

possible disruptive effect of having no 

underwriters making a market in the 

immediate post-pricing period.’’ 61

Another commenter identified that the 

absence of an Investment Grade 

Exception from Rule 102 would disrupt 

the ability of foreign sovereign issuers 

and their affiliates to purchase any of 

the issuer’s securities in connection 

with the sovereign issuer’s own general 

trading and investment activities, or for 

other public purposes, during the 

applicable restricted period.62

IV. Proposed Amendments to Rules 101 

and 102 To Remove References to 

Credit Ratings 

As discussed below, the Commission 

is proposing to eliminate the Investment 

Grade Exceptions from both Rules 101 

and 102. The Commission is proposing 

to replace the Investment Grade 

Exception in Rule 101 with two separate 

exceptions based on different standards: 

(1) With respect to Nonconvertible 

Securities, an exception that is based on 

a probability of default standard as an 

indicator of credit-worthiness, and (2) 

an exception for asset-backed securities 

that are offered pursuant to an effective 

shelf registration statement filed on 

Form SF–3. 

A. Rule 101 

1. Excepted Securities: Nonconvertible 

Securities 

With respect to Nonconvertible 

Securities, the Commission is proposing 

to replace the NRSRO reference 

currently included in Rule 101(c)(2) 

with a standard utilizing a specified 

probability of default threshold based 

on certain structural credit risk models 

(‘‘Structural Credit Risk Models’’).63

(a) Existing Exception for Investment 

Grade Nonconvertible Securities 

As discussed above, Rule 101(c)(2) 

currently provides an exception for 

Nonconvertible Securities that are rated 

by at least one NRSRO in one of its 

generic rating categories that signifies 

investment grade. The Commission 

excepted investment grade 

Nonconvertible Securities from Rule 

101 ‘‘based on the premise that these 

securities traded on the basis of their 

yield and credit ratings, are largely 

fungible and, therefore, are less likely to 

be subject to manipulation.’’ 64

(b) Overview of Structural Credit Risk 

Models 

In 1974, Robert C. Merton published 

a paper that provided a method, based 

on the Black-Scholes option pricing 

model,65 of analyzing a company’s 

credit risk by modeling a company’s 

equity as a call option on the company’s 

assets (‘‘Merton (1974) Model’’), which 

is generally regarded as the first 

Structural Credit Risk Model.66 Since 

1974, Structural Credit Risk Models, 

such as the Merton (1974) Model and 


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67See infra Part VIII.B. For example, the Merton 

(1974) Model and the Successor Models are 

included in the curriculum for such credentials as 

the Chartered Financial Analyst. See, e.g., Credit 

Analysis Models, CFA Inst. (2022), available at 

https://www.cfainstitute.org/en/membership/ 

professional-development/refresher-readings/creditanalysis-models. 68See infra note 84. 69The Default Point is frequently calculated as all 

short-term liabilities plus half of the long-term 

liabilities. See Mario Bondioli, Martin Goldberg, 

Nan Hu, Chengrui Li, Olfa Maalaoui, and Harvey J, 

Stein, The Bloomberg Corporate Default Risk Model 

(DRSK) for Public Firms (2021), available at https:// 

ssrn.com/abstract=3911300. 

70Structural Credit Risk Models calculate the 

probability of default based on inputs from an 

issuer’s balance sheet. Transactions in equity 

securities are frequently used as a proxy to 

determine the value of the firm and the overall 

volatility of the issuer’s assets in Structural Credit 

Risk Models. Even though a market for an issuer’s 

equities may not exist, this alone does not preclude 

the ability for a distribution participant to use a 

Structural Credit Risk Model. Specifically, the 

issuer’s balance sheet will include the liabilities, 

assets, and equity, which, with further analysis, can 

be used to determine the inputs for the models. 

Distribution participants, based on their activities 

as an underwriter, broker-dealer, or other person 

who has agreed to participate in a distribution, 

would have access to an issuer’s balance sheet to 

calculate the probability of default. 

71Although two commenters to the 2011 Proposal 

believed that Section 939A of the Dodd-Frank Act 

did not mandate the removal of credit rating 

references from Regulation M, the Commission 

believes that Section 939A of the Dodd-Frank Act 

requires the Commission to remove such references 

from Regulation M, without flexibility to retain the 

references, contrary to the suggestion made by these 

commenters. See supra note 43. Specifically, 

Section 939A of the Dodd-Frank Act requires the 

Commission to review ‘‘any references to or 

requirements in such regulations regarding credit 

ratings’’ and issue a report upon conclusion of the 

review. See Public Law 111–203 sec. 939A(a) and 

(c); see supra note 4. It then requires the 

Commission to ‘‘remove any reference to or 

requirement of reliance on credit ratings, and to 

substitute in such regulations such standard of 

credit-worthiness’’ as the Commission determines 

to be appropriate for such regulations. See Public 

Law 111–203 sec. 939A(b) (emphasis added). 

Accordingly, the Commission believes that it does 

not have discretion to retain the Investment Grade 

Exceptions provided in Rules 101 and 102. 

72See supra note 50 and accompanying text. 

Sticky offerings of Nonconvertible Securities issued 

by credit-worthy issuers might indicate that a 

security is not trading based upon its yield or credit 

quality, due to some reason, despite the perceived 

credit-worthy nature of the issuer (based on a 

probability of default calculation or otherwise). As 

discussed below, a distribution participant should 

be able to find someone willing to purchase the 

Nonconvertible Securities of credit-worthy issuers 

because the securities would be trading based on 

their yield and price in relation to securities of 

similar credit-worthiness. The inability to sell 

securities of credit-worthy issuers could reflect, for 

example, a lag between the trading in the market 

for such Nonconvertible Securities and the credit 

rating, or more recent concerns related to the issuer 

of the securities reflected in the market but not yet 

absorbed in credit-worthiness assessments or inputs 

for such assessments. The Commission solicits 

comments below regarding this particular issue. 

73Bonds trade among investors and dealers in 

secondary markets at prices that depend on 

economy-wide interest rates, as well as on market 

perceptions regarding the likelihood that the 

issuing company will make the promised payments. 

Hendrik Bessembinder & William Maxwell, 

Markets: Transparency and the Corporate Bond 

Market, 22 J. Econ. Persp. 217, 220 (2008). 

74Some commenters to the 2008 Proposal, which 

would have replaced a credit-worthiness standard 

with a WKSI standard, believed that the 2008 

Proposal would place burdens related to complying 

with Regulation M on issuers and underwriters who 

are currently able to rely on the Investment Grade 

Exceptions. The proposed exception using 

Structural Credit Risk Models, in contrast to the 

2008 Proposal, continues to rely on the premise 

underlying the Investment Grade Exception—that 

certain Nonconvertible Securities trade based on 

their yield and credit-worthiness. Accordingly, 

similar to how the prohibitions related to 

Regulation M do not exist for securities that 

currently meet the Investment Grade Exception, the 

prohibitions associated with Rule 101 would not 

exist under the proposed exception for 

Nonconvertible Securities that trade based on their 

yield and credit-worthiness. 

the Successor Models, have become 

widely relied upon to determine the 

probability of an issuer defaulting on its 

loan obligations.67 Many commercial 

data providers, as part of software suites 

that allow users to analyze securities, 

employ Structural Credit Risk Models as 

a way to measure the credit-worthiness 

of companies.68 Generally, these models 

assume that owners of a company’s 

equity will continue to pay the 

company’s liabilities if the company’s 

value exceeds its liabilities. 

Equivalently, if the equity owners were 

considered to own a call option on the 

value of the company with a strike price 

equivalent to the liabilities owed, the 

equity owners would exercise the call 

on the value of the company. If, 

however, the company’s liabilities 

exceed the company’s value, the models 

assume that the equity owners will 

choose to default on the company’s 

liabilities, or equivalently, the equity 

owners would not exercise the call on 

the value of the company. Accordingly, 

Structural Credit Risk Models, such as 

the Merton (1974) Model and the 

Successor Models, provide a method to 

estimate the probability that a company 

might default on its liabilities based on 

the Black-Scholes option pricing model. 

Structural Credit Risk Models 

typically use measures from firm 

accounting statements and firm-specific 

and aggregate market prices. Generally, 

Structural Credit Risk Models require 

input variables to calculate an estimated 

probability of default for a specified 

horizon, including market value and 

volatility of the assets, as well as 

assumptions regarding the threshold for 

firm asset values, below which the 

equity owner would default on its 

obligations (‘‘Default Point’’).69

Structural Credit Risk Models provide a 

probability that a firm’s assets will fall 

below the Default Point at or by the 

expiration of a defined period of time. 

Generally, the following variables are 

needed to calculate the probability of 

default: (1) The value of the firm, which 

can be based on observed market prices 

of a firm’s equity security or estimated 

based on a firm’s balance sheet; (2) the 

volatility of the firm’s equity or assets, 

which can also be based on market 

observations or estimated based on a 

firm’s balance sheet; (3) the risk-free 

rate; (4) a time horizon; and (5) the 

Default Point. Application of Structural 

Credit Risk Models may be limited in 

the absence of a market for a firm’s 

equity securities if the market price of 

the firm’s assets, which is required to 

calculate the probability of default, is 

difficult to determine.70

(c) Proposed Probability of Default 

Exception 

As discussed above, Section 939A of 

the Dodd-Frank Act requires the 

Commission to remove any reference to 

or requirement of reliance on credit 

ratings, and to substitute in such 

regulations such standard of creditworthiness as the Commission 

determines is appropriate for that 

regulation.71 The Commission believes 

that credit-worthiness, which was the 

basis of the Investment Grade Exception 

for Nonconvertible Securities in Rule 

101, is still appropriate to use as an 

exception to Rule 101.72 Specifically, 

securities of issuers of a certain credit 

quality trade based on yield and creditworthiness 73 and are less susceptible to 

manipulation because other similar 

Nonconvertible Securities are available 

to investors as an alternative to the 

security in distribution. If pricing of a 

Nonconvertible Security offering is 

inconsistent with pricing in the overall 

secondary market for similar 

Nonconvertible Securities, an investor 

may purchase alternative 

Nonconvertible Securities that have a 

better yield, yet are of comparable 

credit-worthiness, than the security 

being distributed. Accordingly, the 

ability to substitute similar 

Nonconvertible Securities in the market 

for the security in distribution limits the 

potential impact that a distribution 

participant might attempt to exert on the 

market and distribution of such 

security. Additionally, when debt has a 

very low probability of default, the 

cashflows are close to risk free. Thus, 

the price of the debt is mainly subject 

to fluctuations based on aggregate 

interest rates rather than firm-specific or 

security-specific news. Thus, 

Nonconvertible Securities of creditworthy issuers are less susceptible to 

the type of manipulation that Rule 101 

seeks to prevent.74 Furthermore, as 


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75See Regulation M Proposing Release, 61 FR 

17117 (stating reasons for the exceptions from 

Regulation M). 76The term ‘‘probability of default’’ as used in 

this release to describe the proposed requirement 

means the actual (or physical) probability, rather 

than the risk-neutral probability. 77See supra notes 65–68 and accompanying text; 

see also infra note 158. The Commission considered 

including reduced-form models in addition to 

Structural Credit Risk Models as part of the 

exception in Rule 101(c)(2)(i). Reduced-form 

models rely on statistical analysis rather than the 

balance sheet to determine a firm’s 

creditworthiness. However, unlike Structural Credit 

Risk Models, they lack in rigorous theoretical 

justification as well as economic interpretation of 

the resulted relationships between the model 

inputs. 

78Securities with low probability of default (by 

credit-worthy issuers) do not need to price default 

risk (because it is very low) and therefore trade 

based on other, observable characteristics, such as 

yields or maturity. This implies less price 

uncertainty, which leaves less room for 

manipulation of prices. 

79See supra note 32. 80See supra note 41. 

81The proposed exception would specify 12 

calendar months to provide a uniform time horizon 

to use in the Structural Credit Risk Models to 

calculate the probability of default. The 

Commission preliminarily believes that 12 calendar 

months would provide a minimum period of time 

for an estimation of probability of default that could 

address investor concerns that a Nonconvertible 

Security would default during or shortly after the 

distribution of the securities. Furthermore, the 

Commission preliminarily believes that 12 calendar 

months is the appropriate horizon to include in the 

Rule to calculate probability of default because it 

is the horizon that corresponds with vendor models 

that use Structural Credit Risk Models to calculate 

probability of default and map to investment grade 

ratings. Specifying the time horizon in the rule is 

intended to limit the ability of a distribution 

participant to modify the time horizon to generate 

a more favorable probability of default if such 

distribution participant chooses to calculate the 

probability of default on its own. 

82See infra Part VIII.B. 

83See infra Part V. 

84 Vendors offer a number of commercial 

applications based on Structural Credit Risk 

Models. The Commission preliminarily believes 

that these models are relied upon by market 

participants to analyze the credit quality of 

Nonconvertible Securities or the issuers of such 

securities. Furthermore, the probability of default 

calculated by Structural Credit Risk Models, such 

as the Merton (1974) Model and the Successor 

Models, can be calculated by distribution 

participants without the use of a vendor. 

85See ABA Letter at 15–17; see also Rothwell at 

2. 

distribution participants have relied on 

the Investment Grade Exception, which 

is based on credit-worthiness, to 

facilitate orderly distributions of 

Nonconvertible Securities, the proposed 

exception has limited potential to 

disrupt the trading market for securities 

that have been the subject of a 

reopening.75

As discussed below in Part VIII.B, 

Structural Credit Risk Models calculate 

a probability of default that provides a 

measure of the credit-worthiness of an 

issuer of a Nonconvertible Security. The 

Commission preliminarily believes that 

the probability of default as calculated 

by Structural Credit Risk Models is an 

appropriate substitute as a standard of 

credit-worthiness in Rule 101(c)(2). In 

particular, the probability of default 76

as estimated by Structural Credit Risk 

Models is widely used by market and 

distribution participants to measure 

credit-worthiness of issuers.77 As such, 

the Commission preliminarily believes 

that the use of Structural Credit Risk 

Models to determine credit-worthiness 

could be used as an alternative for 

Nonconvertible Securities with an 

investment grade rating for purposes of 

proposed Rule 101(c)(2)(i).78

The probability of default can be 

independently determined by Structural 

Credit Risk Models based on observable 

market events and information available 

on a firm’s balance sheet without 

reliance on an investment grade credit 

rating by an NRSRO. Probability of 

default can be used to identify securities 

that trade based on their yield and high 

credit-worthiness, similar to the 

Nonconvertible Securities that are 

excepted based on the existing 

Investment Grade Exception, and thus 

would be less susceptible to the 

manipulation that Rule 101 is designed 

to prevent. 

Commenters to the 2011 Proposal 

raised concerns regarding the 2011 

Proposal that the Commission 

preliminarily believes are not present 

regarding Structural Credit Risk Models. 

For example, commenters were 

concerned that it would be impractical 

under the 2011 Proposal to make 

consistent determinations among market 

participants even in the same 

distributions and that the standard 

proposed in the 2011 Proposal is 

impractical, forward-looking, and 

subjective.79 The Commission 

preliminarily believes the Structural 

Credit Risk Models can result in 

consistent determinations and can be 

replicated by distribution participants, 

particularly if distribution participants 

utilize the same model. Furthermore, 

the use of a bright-line test, such as a 

probability of default of 0.055% as 

discussed below, should address the 

concern of some commenters that the 

exception will impose new costs and 

delays in the offering process and 

reduce the attractiveness of registered 

offerings.80 Whereas the 2011 Proposal 

depended on a distribution participant’s 

subjective expectations about the future 

regarding how a security would trade in 

the market, the proposed standard 

specifically includes a 0.055% 

probability of default threshold. The 

Commission acknowledges that the 

complex nature of the models, 

assumptions, and estimated inputs used 

to estimate the probability of default 

may not be comparable across different 

issuers or if the estimates are done using 

different Structural Credit Risk Models, 

the results may not be comparable. The 

Commission, however, believes that the 

assumptions and estimates that are used 

to determine the probability of default 

using Structural Credit Risk Models are 

appropriately practical, as well as 

objective, and accordingly the proposed 

standard is not impractical or overly 

subjective. In particular, as noted 

throughout the release, market 

participants currently rely on Structural 

Credit Risk Models to assess the creditworthiness of issuers. 

Under the proposed amendment to 

Rule 101, the exception would be 

available to the Nonconvertible 

Securities of issuers for which the 

probability of default, estimated as of 

the day of the determination of the 

offering pricing and over the horizon of 

12 calendar months 81 from such day, is 

less than 0.055%,82 as determined and 

documented in writing 83 by the 

distribution participant using a 

Structural Credit Risk Model.84 As 

discussed in Part VIII.B, based on an 

analysis of the probability of default and 

investment grade ratings of a sample of 

Nonconvertible Securities available on 

the market as of October 22, 2021, the 

Commission preliminary believes that a 

probability of default, estimated as of 

the day of the determination of the 

offering pricing and over the horizon of 

12 calendar months from such day, that 

is less than 0.055%, as determined by a 

Structural Credit Risk Model, provides 

an appropriate substitute for investment 

grade ratings. Limiting the exception to 

issuers of Nonconvertible Securities that 

have a probability of default of less than 

0.055% should limit the exception to 

Nonconvertible Securities that are less 

susceptible to the type of manipulation 

that Regulation M is designed to 

prevent. 

Exceptions for investment grade rated 

Nonconvertible Securities existed in 

former Exchange Act Rule 10b–6, which 

preceded the adoption of Regulation M. 

As discussed above, Regulation M 

excepts securities based on their creditworthiness as determined by an 

investment grade rating from a NRSRO. 

As noted by commenters to the 2008 

Proposal and 2011 Proposal, the 

Investment Grade Exception has 

provided a bright-line test to identify 

securities that are less prone to the type 

of manipulation that Regulation M is 

designed to prevent.85 The Commission 

preliminarily believes a standard 

utilizing a threshold derived from 


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86See infra Part VIII.B. Although the proposed 

standard would include certain securities that are 

not investment grade as determined by an NRSRO, 

the model-implied probabilities of default generally 

use current estimates of equity valuation and 

volatility, and hence incorporate the most recent 

news affecting the valuation and perceived 

volatility of the firm. See infra Part VIII.B. As such, 

an estimate derived from Structural Credit Risk 

Models is more likely to reflect the most up-to-date 

indicator of an issuer’s credit-worthiness without 

being hampered by the lag that may exist with 

NRSRO-determined credit ratings. 

87See infra note 159. 88See supra note 66. 

Structural Credit Risk Models provides 

the advantage of serving as a bright-line 

test to identify securities that, similar to 

Nonconvertible Securities currently 

excepted from Rule 101 based on the 

Investment Grade Exception, trade 

based on their yield and creditworthiness. In particular, based on the 

Commission’s analysis comparing 

probabilities of default with NRSRO 

credit ratings, the Commission 

preliminarily believes that the 0.055% 

threshold would effectively identify 

securities that trade based on yield and 

credit-worthiness, because this 

threshold appropriately captures most 

of those securities that meet the creditworthiness standard under the existing 

Investment Grade Exception.86

Accordingly, the Commission 

preliminary believes that the 0.055% 

threshold appropriately calibrates the 

probability of default to determine the 

credit-worthiness of an issuer whose 

Nonconvertible Securities would trade 

based on yield and credit-worthiness, 

similar to the current Investment Grade 

Exception.87

The Commission acknowledges that a 

probability of default less than 0.055% 

could be both under- and overinclusive in capturing the securities that 

are excepted under the existing 

Investment Grade Exception in Rule 

101. As a result, the restrictions of Rule 

101 would apply to certain 

Nonconvertible Securities that are 

currently excepted securities under Rule 

101(c)(2). Furthermore, some securities 

that are not currently excepted 

securities under Rule 101 could become 

excepted securities under the proposed 

probability of default metric. The 

Commission preliminarily believes that 

it is appropriate to use a 0.055% 

threshold because even if it does not 

capture exactly the same set of 

securities covered under the existing 

investment grade standard, this 0.055% 

threshold would identify 

Nonconvertible Securities that are less 

susceptible to the manipulation that 

Regulation M is designed to prevent 

because they trade based on their yield 

and credit-worthiness as determined by 

the current financial condition of the 

issuer. 

Rule 101(c)(2)(i) would define the 

term Structural Credit Risk Model to 

mean any commercially or publicly 

available model that calculates the 

probability that the value of the issuer 

may fall below the Default Point based 

on an issuer’s balance sheet. These 

models, which estimate the probability 

of default related to the financial 

condition of the issuer based on the 

issuer’s liabilities, provide a measure of 

credit-worthiness specific to that issuer. 

Additionally, the definition would 

include only commercially or publicly 

available models. The Commission 

understands that distribution 

participants, such as underwriters and 

broker-dealers, currently use 

commercially available models from 

various vendors to measure and manage 

credit risk. These commercially 

available vendor models estimate a 

probability of default based on the 

issuer’s balance sheet information to set 

thresholds and market estimates of firm 

value and volatility. Furthermore, 

distribution participants can use 

commonly available spreadsheet 

software to calculate the probability of 

default based on publicly available 

models, which may be found in 

academic and professional journals.88

Limiting the definition of Structural 

Credit Risk Models to commercially or 

publicly available models is intended to 

capture these commercially and 

publicly available models that we 

understand distribution participants 

already use and have access to. At the 

same time, we intend to prevent parties 

with an interest in the price of the 

security that is the subject of a 

distribution and outcome of such 

distribution from developing their own 

models to achieve favorable results. 

(d) Request for Comment 

We solicit comments on all aspects of 

this proposal. We ask that commenters 

provide specific reasons and 

information to support their views. 

Commenters are requested to provide 

empirical data, economic studies, and 

other factual support for their views to 

the extent possible. 

1. Do commenters agree that the 

credit-worthiness of an issuer of 

Nonconvertible Securities reduces the 

risk of manipulation that Rule 101 is 

designed to prevent? Please explain. Is 

an exception based on probability of 

default appropriate to preserve Rule 

101’s anti-manipulation goals? Why or 

why not? 

2. Should the probability of default 

threshold be higher than 0.055%? For 

example, should the probability of 

default threshold be 0.06%, 0.07%, or 

some other threshold? If so, what should 

the probability of the default threshold 

be and why? 

3. Should the probability of default 

threshold be lower than 0.055%? For 

example, should the probability of 

default threshold be 0.05%, 0.04%, or 

some other threshold? If so, what should 

the probability of the default threshold 

be and why? 

4. Is the 12 calendar months used to 

calculate the probability of default an 

appropriate time horizon? Or should 

some other time horizon be used? Please 

explain. For example, should it be for 

the term of the Nonconvertible Security? 

If so, what should the time horizon be 

to calculate the probability of default for 

purposes of Rule 101? Please explain. 

5. Are there other models or model 

types besides Structural Credit Risk 

Models that the Rule should use to 

calculate the probability of default for 

purposes of Rule 101? If so, please 

provide the name of the model and 

provide support regarding why it would 

be an appropriate substitute for the 

Investment Grade Exception. Are there 

model types other than Structural Credit 

Risk Models that calculate a probability 

of default? For example, would a 

reduced-form model provide a 

probability of default calculation that 

would indicate a Nonconvertible 

Security is of such credit-worthiness 

that such security should be excepted 

from Rule 101? Please explain. 

6. What challenges, if any, would 

there be to relying on an exception to 

Rule 101 based on the probability of 

default as calculated using Structural 

Credit Risk Models, as defined in Rule 

101(c)(2)(i)? Is the definition of 

Structural Credit Risk Model clear? 

Should the exception list which models 

would be considered Structural Credit 

Risk Models? Is the requirement for the 

models to be commercially or publicly 

available clear, or is further guidance 

needed? Should the exception provide a 

test regarding what makes a model a 

Structural Credit Risk Model? For 

example, should the test for a Structural 

Credit Risk Model be limited to models 

published in academic or trade journals 

that refine the Merton (1974) Model? 

Please explain. 

7. Is there a standard other than 

Structural Credit Risk Models that Rule 

101 should use as a replacement for the 

Investment Grade Exception? If so, what 

other standard should proposed Rule 

101(c)(2)(i) use and why? 

8. Should the calculation of the 

probability of default in proposed Rule 


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89See 17 CFR 242.101(c)(2) (providing an 

exception for asset-backed securities ‘‘that are rated 

by at least one nationally recognized statistical 

rating organization, as that term is used in [Rule 

15c3–1 under the Exchange Act], in one of its 

generic rating categories that signifies investment 

grade’’). 

90Shelf registration is a procedure that allows 

companies to file a single registration statement 

covering more than one issuance of the same 

security, subject to certain requirements. See 

generally 17 CFR 230.415 (providing requirements 

for securities to be registered for an offering to be 

made on a continuous or delayed basis in the 

future). 

91See Proposed Rule 101(c)(2)(ii). Currently, the 

exception for asset-backed securities is provided in 

the same paragraph as the exception for 

Nonconvertible Securities, in Rule 101(c)(2). See 17 

CFR 242.101(c)(2). The Commission is proposing to 

separate the existing exception into separate 

exceptions for Nonconvertible Securities and assetbacked securities in Proposed Rules 101(c)(2)(i) and 

101(c)(2)(ii), respectively. 

92See Asset-Backed Securities Disclosure and 

Registration, Release No. 34–72982 (Sept. 4, 2014) 

[79 FR 57184 (Sept. 24, 2014)] (‘‘Regulation AB II 

Adopting Release’’). Form SF–3 also carried over 

shelf-eligibility requirements for asset-backed 

securities that previously were located in Form S– 

3, such as transaction requirements regarding the 

percentage of delinquent assets and, for certain 

lease-backed securitizations, the portion of the pool 

attributable to residual value. See Regulation AB II 

Adopting Release, 79 FR 57265, n.936. 

101(c)(2)(i) be limited to distribution 

participants? Should the Rule permit 

distribution participants to rely on the 

probability of default calculated by 

persons that are not distribution 

participants? If so, who should the Rule 

include and why should such a person 

be specifically included in proposed 

Rule 101(c)(2)(i)? Are there any reasons 

why the Rule should not permit a 

distribution participant to perform its 

own calculation (subject to 

recordkeeping requirements as 

proposed)? Please explain. Should 

distribution participants be required to 

post or make the probability of default 

public on their website to rely on the 

exception? Please explain. 

9. Do commenters disagree with the 

Commission’s preliminary belief that 

market participants are currently relying 

on vendors’ widely available 

commercial applications based on 

Structural Credit Risk Models to analyze 

the credit quality of Nonconvertible 

Securities or the issuers of such 

security? Do distribution participants 

currently have access to vendor 

probability of default determinations? 

Please explain why or why not. 

10. How often do distribution 

participants rely on the Investment 

Grade Exception for Nonconvertible 

Securities where no other exception 

from Rule 101 is available? 

11. As discussed in Part III, the 

Commission understands that the 

Investment Grade Exception is used in 

limited circumstances, i.e., re-openings, 

sticky offerings, best efforts offerings, 

and foreign sovereign issuances. Are 

there other circumstances where 

distribution participants rely on the 

Investment Grade Exception? Please 

explain. Furthermore, as discussed 

above in this section, a sticky offering 

might indicate that an offering is not 

trading based upon its yield or credit 

quality. Specifically, the distribution 

participant is unable to sell its 

allotment. If the underlying premise of 

the exception were true, a distribution 

participant should be able to find 

someone willing to purchase the 

Nonconvertible Securities because the 

security would be trading based on its 

yield and price in relation to securities 

of similar credit-worthiness. Do sticky 

offerings of credit-worthy issuers 

disprove the underlying premise for 

excepting certain Nonconvertible 

Securities (i.e., that securities offerings 

that become sticky do not trade based 

on their yield and credit-worthiness, or 

are there other characteristics of sticky 

offerings that impact how these 

securities trade)? For example, do sticky 

offerings indicate that the creditworthiness of an issuer is not a sound 

basis on which to except 

Nonconvertible Securities, or that there 

may be other characteristics that may 

make the securities more at risk of 

manipulation? If so, what tools are 

available to distribution participants 

that could serve as an indicator of such 

characteristics that could be 

incorporated into the exception? Since 

whether a nonconvertible security will 

become sticky is unknown at the start of 

the Regulation M restricted period, 

should the Commission remove the 

exception from Rule 101 for investment 

grade Nonconvertible Securities 

completely? Why or why not? 

12. Would the Nonconvertible 

Securities proposed to be excepted be 

more vulnerable to manipulation than 

the securities that meet the existing 

investment grade standard? Why or why 

not? 

13. Please discuss whether and to 

what extent investors take into account 

reliance on the Investment Grade 

Exception for Nonconvertible Securities 

when making a decision to invest in 

such securities. Please also discuss 

whether, given that Rule 101 is directed 

at distribution participants and their 

affiliated purchasers, current Rule 101 

poses any danger of undue reliance on 

NRSRO ratings. 

14. Are there factors other than those 

identified in the proposed exception 

that influence the trading of 

Nonconvertible Securities? Are there 

additional requirements that the 

Commission should consider with 

respect to the proposed exception? Are 

there any requirements that the 

Commission should remove from the 

proposal? 

15. Would persons needing to use the 

proposed exception have access to 

adequate information to determine 

whether a particular security meets the 

exception in proposed Rule 101(c)(2)(i)? 

Why or why not? Should the exception 

require the issuer’s balance sheet to be 

audited? 

16. If the exception as proposed is 

adopted should the Commission include 

a period of time for distribution 

participants to implement the exception 

based on probability of default? For 

example, should the exception, if 

adopted, include a three month, nine 

month or twelve month implementation 

period? Please explain. Should the 

exception, if adopted, go into effect 

within a short period of time after 

publication, such as 30-calendar days 

from being published in the Federal 

Register? Please explain. 

2. Excepted Securities: Asset-Backed 

Securities Offered Pursuant to an 

Effective Shelf Registration Statement 

Filed on Form SF–3 

To implement Section 939A(b) of the 

Dodd-Frank Act, the Commission is, 

among other things, proposing to 

replace the existing exception provided 

in Rule 101(c)(2) for investment grade 

asset-backed securities 89 with an 

exception for asset-backed securities 

that are offered pursuant to an effective 

shelf registration 90 statement filed on 

Form SF–3,91 as discussed below. 

(a) Background: Form SF–3 

In 2014, the Commission adopted 

shelf eligibility criteria for asset-backed 

securities offerings registered on new 

Form SF–3 in part to implement Section 

939A(b) of the Dodd-Frank Act.92 Form 

SF–3 includes the following transaction 

requirements among other shelf 

eligibility criteria: 

• Delinquent assets do not constitute 

20% or more, as measured by dollar 

volume, of the asset pool as of the 

measurement date; 

• With respect to securities backed by 

certain leases, the portion of the 

securitized pool balance attributable to 

the residual value of the physical 

property underlying the leases does not 

constitute 20% or more, as measured by 

dollar volume, of the securitized pool 

balance as of the measurement date; 

• A certification by the chief 

executive officer of the depositor is 

made at the time of each takedown; 


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93See Registration Statement Under the 

Securities Act of 1933 (Form SF–3), available at 

https://www.sec.gov/files/2017-03/formsf-3.pdf; 

Regulation AB II Adopting Release, 79 FR 57189. 

94See Regulation AB II Adopting Release, 79 FR 

57189. 

95See Regulation AB II Adopting Release, 79 FR 

57265. 

96See Regulation AB II Adopting Release, 79 FR 

57278. 

97See Regulation AB II Adopting Release, 79 FR 

57283. 

98Regulation AB II Adopting Release, 79 FR 

57265, 57285. 

99See Regulation M Adopting Release, 62 FR 527; 

see also Prohibitions Against Trading by Persons 

Interested in a Distribution, Release No. 34–19565 

(Mar. 4, 1983) [48 FR 10628, 10631 (Mar. 14, 1983)] 

(stating the Commission’s belief that the 

‘‘fungibility’’ of certain types of securities makes 

manipulation of their price very difficult); supra 

note 50 and accompanying text. 

100See Regulation M Adopting Release, 62 FR 

527. 

101See Regulation M Adopting Release, 62 FR 

527. 

102See Regulation M Adopting Release, 62 FR 527 

(citations omitted). The Commission stated that 

such rationale also applies to the existing identical 

exception provided in Rule 102(d)(2) of Regulation 

M. Regulation M Adopting Release, 62 FR 531. 

103Public Law 111–203 sec. 939A(b) (requiring 

agencies to ‘‘seek to establish, to the extent feasible, 

uniform standards of credit-worthiness for use by 

each such agency, taking into account the entities 

regulated by each such agency and the purposes for 

which such entities would rely on such standards 

of credit-worthiness’’). 

104See Regulation M Adopting Release, 62 FR 

527. 

105See supra note 50 and accompanying text. The 

ability of a market participant to substitute a 

security that is similar, and that is of comparable 

Continued 

• An asset review provision in the 

underlying transaction agreements 

requires review of the pool assets, upon 

the occurrence of certain trigger events, 

for compliance with the representations 

and warranties made with regard to 

those assets; 

• A dispute resolution provision for 

repurchase requests is contained in the 

underlying transaction documents; and 

• A disclosure provision, as required 

in an underlying transaction agreement, 

of investors’ requests to communicate 

with other investors related to an 

investor’s rights under the terms of the 

asset-backed security was received 

during the reporting period by the party 

responsible for making Form 10–D 

filings.93

The Commission designed the shelf 

eligibility requirements to help ensure a 

certain ‘‘quality and character’’ in light 

of the requirement to reduce regulatory 

reliance on credit ratings.94 In 

particular, the shelf eligibility 

requirements were designed to help 

ensure that expected cash flows are 

sufficient to service payments or 

distributions in accordance with their 

terms; 95 that obligated parties more 

carefully consider the characteristics 

and quality of the assets that are 

included in the pool; 96 that assetbacked securities shelf offerings have 

transactional safeguards and features 

that make those certain securities 

appropriate to be issued without prior 

Commission staff review; 97 and that 

issuers design and prepare asset-backed 

securities offerings with greater 

oversight and care.98 As discussed 

below, the Commission believes that the 

asset-backed securities offered pursuant 

to an effective shelf registration 

statement filed on Form SF–3 trade 

primarily on the basis of yield and 

credit-worthiness. This proposed rule 

change would not limit a market 

participant’s ability to substitute a 

security that is similar, and that is of 

comparable credit-worthiness, to the 

security that is the subject of a 

distribution if the pricing of the security 

were inconsistent with pricing in the 

overall secondary market for similar 

asset-backed securities, thereby limiting 

the potential for manipulation. The 

Commission continues to believe that its 

original basis for excepting securities of 

a certain quality and character is 

appropriate and that such securities are 

less at risk of the manipulation that 

Regulation M addresses.99

(b) Existing Exception for Investment 

Grade Asset-Backed Securities 

As discussed above, Rule 101(c)(2) 

currently provides an exception for 

asset-backed securities that are rated by 

at least one NRSRO in one of its generic 

rating categories that signifies 

investment grade. The Commission 

excepted investment grade asset-backed 

securities from Rule 101 because such 

securities trade primarily on the basis of 

yield and credit rating.100 In providing 

this rationale, the Commission stated 

that the principal focus of investors in 

the asset-backed securities market is on 

the structure of a class of securities and 

the nature of the assets pooled to serve 

as collateral for those securities rather 

than on the identity of a particular 

issuer.101 The Commission also stated 

that Rule 101 excepts investment grade 

securities that are ‘‘primarily serviced 

by the cashflows of a discrete pool of 

receivables or other financial assets, 

either fixed or revolving, that by their 

terms convert into cash within a finite 

time period plus any rights or other 

assets designed to assure the servicing 

or timely distribution of proceeds to the 

security holders.’’ 102

(c) Proposed Amendments to Rule 101 

As discussed above, in accordance 

with Section 939A of the Dodd-Frank 

Act, the Commission proposes to 

remove Rule 101’s current exception for 

investment grade asset-backed securities 

based on NRSRO ratings. In place of that 

exception, the Commission is proposing 

a new exception in Rule 101(c)(2)(ii) for 

asset-backed securities that are offered 

pursuant to an effective shelf 

registration statement filed on Form SF– 

3. This proposed rule change, which 

would carry over the standard of creditworthiness included in the 

Commission’s Form SF–3, also helps to 

implement the mandate that, to the 

extent feasible, uniform standards of 

credit-worthiness be used.103

The proposed rule is not based on a 

probability of default threshold derived 

from Structural Credit Risk Models with 

respect to asset-backed securities. An 

exception for asset-backed securities 

that is based on a probability of default 

threshold may be unfeasible due to the 

potential widespread inability of 

distribution participants and their 

affiliated purchasers to collect all of the 

information required to calculate the 

probability of default, such as the value 

and volatility of the assets underlying 

asset-backed securities. Therefore, the 

Commission is proposing an exception 

for certain asset-backed securities based 

on a separate standard that is more 

consistent with the existing Investment 

Grade Exception for asset-backed 

securities, as discussed below. The 

proposed rule does not contain a 

standard of credit-worthiness that relies 

on Form SF–3 with respect to 

Nonconvertible Securities because the 

transaction requirements included in 

Form SF–3 are relevant only to assetbacked securities. As discussed below, 

because the transaction requirements 

included in Form SF–3 serve as an 

indicator of credit-worthiness, the 

proposed exception that relies on Form 

SF–3 would not apply to securities that 

are not subject to those transaction 

requirements. 

The proposed exception continues to 

be derived from the premise that certain 

asset-backed securities are traded based 

on factors such as their yield and creditworthiness.104 The Commission is 

proposing to except only the assetbacked securities offered pursuant to an 

effective shelf registration statement 

filed on Form SF–3 to further 

Regulation M’s anti-manipulation goals. 

This proposed requirement regarding an 

effective Form SF–3 would except from 

Rule 101 the types of asset-backed 

securities that would trade based on 

their yield and credit-worthiness due to 

their qualities and characteristics and 

that are therefore less prone to the type 

of manipulation that Regulation M seeks 

to prevent.105


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credit-worthiness, to the security that is the subject 

of a distribution limits the ability of a distribution 

participant or its affiliated purchaser from bidding 

up the price of the subject security. 106See supra note 102. 107See 17 CFR 239.45(b)(v), (vi); Form SF–3, 

I.B.1(e). 108Asset-Backed Securities, Release No. 33–8518 

(Dec. 22, 2004) [70 FR 1506, 1517 (Jan. 7, 2005)] 

(‘‘Regulation AB Release’’). In adopting the 20% 

delinquency concentration level, the Commission 

codified a staff position that an asset-backed 

security will not fail to meet the definition of 

‘‘asset-backed security’’ solely because such a 

security is supported by assets having total 

delinquencies of up to 20% at the time of the 

proposed offering. See Regulation AB Release, 70 

FR 1517 (citing Bond Mkt. Ass’n, SEC Staff NoAction Letter, 1997 WL 634124 (Oct. 8, 1997)). This 

threshold was the same threshold that was applied 

to certain other matters affecting registration and 

disclosure requirements for asset-backed securities 

(e.g., non-recourse commercial mortgage 

securitizations, pooling of corporate debt securities, 

and securitizations involving third-party credit 

enhancement). See Bond Mkt. Ass’n, SEC Staff NoAction Letter, 1997 WL 634124, at * 3. The staff 

position was based on the premise that such a 

threshold for total delinquency concentration 

would, by itself, not present a materially greater risk 

of asset non-performance or default at the security 

level. See Id., 1997 WL 634124, at * 4. 

109See Regulation AB Release, 70 FR 1517. 

110See Regulation M Adopting Release, 62 FR 

527. 

111See Regulation AB II Adopting Release, 79 FR 

57283. 

112See supra notes 94–98 and accompanying text. 

113See Regulation AB II Adopting Release, 79 FR 

57278. 

114See, e.g., Regulation AB II Adopting Release, 

79 FR 57277–78. 

115See Regulation M Adopting Release, 62 FR 

527; see also supra note 50 and accompanying text. 

The Commission believes that the 

transaction requirements included in 

Form SF–3 allow for shelf offerings of 

only those asset-backed securities that 

share the qualities and characteristics of 

the investment grade asset-backed 

securities currently excepted from the 

provisions of Rule 101: With respect to 

both sets of securities, the principal 

focus of investors is the structure of a 

class of securities and the nature of the 

assets pooled to serve as collateral for 

those securities, rather than on the 

identity of a particular issuer.106 First, 

eligibility for offering securities 

pursuant to a Form SF–3 is limited, in 

part, by the percentage of delinquent 

assets and, for certain lease-backed 

securitizations, by the portion of the 

pool attributable to the residual 

value.107 For an asset-backed securities 

offering with an effective Form SF–3, 

delinquent assets cannot constitute 20% 

or more of the asset pool. Delinquent 

assets may not convert into cash within 

a finite period of time, as required by 

the definition of ‘‘asset-backed 

security,’’ because they are not 

performing in accordance with their 

terms and management or that other 

action may be needed to convert the 

assets into cash. However, as expressed 

at the adoption of Form SF–3, in 

principle, asset-backed securities should 

be primarily dependent on the pool of 

assets self-liquidating instead of on the 

ability of the entity performing 

collection services.108 The application 

of the limitation on delinquent assets 

included in Form SF–3 was designed to 

ensure that attention is focused on the 

ability of collateral of the underlying 

asset pool to generate cash flow rather 

than on the identity of the issuer and its 

ability to convert those assets into 

cash,109 consistent with the 

Commission’s original basis for 

excepting investment grade asset-backed 

securities from Rule 101.110

Second, Form SF–3 includes certain 

transaction requirements with respect to 

the structure of the asset-backed 

security being offered. Such structural 

requirements include (1) a certification 

by the depositor’s chief executive officer 

that, among other things, the 

securitization structure provides a 

reasonable basis to conclude that the 

expected cash flows are sufficient to 

service payments or distributions in 

accordance with their terms; (2) a 

review of the asset-backed security’s 

pool of assets upon the occurrence of 

certain triggering events, including 

delinquencies, by a person that is 

unaffiliated with certain transaction 

parties, such as the sponsor, depositor, 

servicer, trustee, or any of their 

affiliates; and (3) a dispute resolution 

provision, contained in the underlying 

transaction documents, for any 

repurchase request. When adopting the 

requirements included in Form SF–3, 

the Commission stated that sponsors 

may have an increased incentive to 

carefully consider the characteristics of 

the assets underlying the securitization 

and accurately disclose these 

characteristics at the time of offering. 

The Commission also believed that 

investors should benefit from the 

reduced losses associated with 

nonperforming assets because, as a 

result of this new shelf requirement, 

sponsors will have less of an incentive 

to include nonperforming assets in the 

pool.111 Because the transactional 

safeguards included in Form SF–3 

provide incentives for obligated parties 

to, among other things,112 more 

carefully consider the quality and 

character of the assets that are included 

in the pool,113 asset-backed securities 

that are offered pursuant to an effective 

Form SF–3 should trade based on their 

yield and credit-worthiness rather than 

on the identity of a particular issuer.114

The application of the transaction 

requirements included in the 

Commission’s Form SF–3, therefore, 

should result in the offering of assetbacked securities that have similar 

qualities and characteristics to the 

investment grade asset-backed securities 

currently excepted under the existing 

provision in Rule 101(c)(2). 

The Commission believes that the 

requirement regarding an effective shelf 

registration statement filed on Form SF– 

3 is an appropriate substitute for the 

Investment Grade Exception currently 

provided in Rule 101(c)(2) because the 

proposed standard intends to limit 

eligibility for that exception to only 

those asset-backed securities that trade 

based on their yield and creditworthiness due to their particular 

qualities and characteristics. Because 

the ability of distribution participants 

and their affiliated purchasers to bid up 

the price of an asset-backed security 

offered pursuant to an effective Form 

SF–3, during a distribution, is limited 

by a market participant’s ability to 

substitute the security with other 

securities that are similar and of 

comparable credit-worthiness,115 the 

Commission believes that such a 

security is less susceptible to the types 

of manipulation that Regulation M seeks 

to prevent. 

(d) Request for Comment 

We solicit comments on all aspects of 

this proposal. We ask that commenters 

provide specific reasons and 

information to support their views. 

Commenters are requested to provide 

empirical data, economic studies, and 

other factual support for their views to 

the extent possible. 

17. How often and in which context 

is the Investment Grade Exception for 

asset-backed securities utilized where 

no other exception from Rule 101 is 

available? 

18. As discussed above, the existing 

Investment Grade Exception for assetbacked securities and the proposed 

exception provided in paragraph 

(c)(2)(ii) of Rule 101 are premised on the 

ability of a market participant to 

substitute a security (in distribution) 

with other securities that are similar and 

of comparable credit-worthiness if there 

is a pricing aberration in the secondary 

market for similar securities. What is the 

universe of securities that is likely to be 

substituted in such instance? Please 

explain. 

19. If the Investment Grade Exception 

for asset-backed securities is rarely, 

infrequently, or never used, or if the 

proposed standard for asset-backed 

securities has limitations in practice or 

otherwise, should the Commission 


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116Regulation M Adopting Release, 62 FR 530. 

Further, the Commission has also stated that ‘‘[a]n 

issuer or selling shareholder may have a substantial 

incentive to raise improperly the price of offered 

securities.’’ Regulation M Proposing Release, 61 FR 

17120. 

117The Commission initially proposed not to 

include the Investment Grade Exception in Rule 

102. Regulation M Proposing Release, 61 FR 17120 

(‘‘[T]he Commission preliminarily believes that it 

may not be appropriate to extend the . . . the 

exception for investment grade debt and investment 

grade preferred securities provided in Rule 101, to 

issuers, selling security holders, or their affiliated 

purchasers.’’) The Commission, however, adopted 

the Investment Grade Exception in Rule 102 ‘‘based 

on commenters’ views and the rationales indicated 

. . . for an identical exception to Rule 101.’’ 

Regulation M Adopting Release, 62 FR 531. 

118No commenter responding to the 2011 

Proposal mentioned issuers, selling security 

holders, or their affiliated purchasers relying on the 

Investment Grade Exception. However, one 

commenter to the 2008 Proposal commented that 

the substitution of the Investment Grade Exception 

with a WKSI standard would prevent foreign 

sovereign issuers or affiliated purchasers from 

purchasing the foreign sovereign’s bonds for its own 

general trading and investment activities, or for 

other public purposes, during the applicable 

restricted period. See Arnold & Porter Letter at 3. 

Given that the prohibitions of Regulation M apply 

only to bonds with the exact same terms of the bond 

in distribution, as discussed above in Part III, the 

Commission believes that the concerns raised by 

this commenter would rarely occur. Furthermore, 

the bond in distribution could be structured by the 

foreign sovereign in a manner so that Rule 102’s 

restrictions would not impede a foreign sovereign 

issuer or its affiliated purchasers from engaging in 

its own general trading and investment activities, or 

for other public purposes. 

119See supra Part IV.B.1. 

120Other than ‘‘exempted securities,’’ as defined 

in Section 3(a)(12) of the Exchange Act, the 

Investment Grade Exception provided in Rule 102 

is the only security-based exception that permits an 

issuer, selling shareholder, or its affiliates to 

purchase the securities in distribution absent a need 

for the issuer to facilitate an orderly distribution or 

to limit potential disruptions in the trading market. 

For example, the security-based exception for openended investment companies is designed to ensure 

that open-ended investment companies can redeem 

shares during a continuous distribution without (by 

itself engaging in that exact activity) violating 

Regulation M. See 17 CFR 242.102(d)(4). Rule 102 

does not provide an actively-traded securities 

exception like Rule 101 does. Instead, the relevant 

exception provided in Rule 102 is based on 

actively-traded reference securities, which is 

designed to allow issuers or selling security holders 

to purchase an actively-traded reference security 

Continued 

remove the exception for asset-backed 

securities completely? Why or why not? 

20. What specific trading activities 

that currently occur pursuant to the 

Investment Grade Exception would then 

be prohibited during the restricted 

period because no other exception is 

available? What are the advantages and 

disadvantages of such trading activities? 

Should the Commission explicitly 

except any such specific activities in 

lieu of providing a generic exception for 

investment grade asset-backed securities 

or an exception for asset-backed 

securities that are offered pursuant to an 

effective shelf registration statement 

filed on Form SF–3? What benefits or 

challenges would this approach create? 

21. Should the proposed exception be 

expanded to apply to all asset-backed 

securities, such as asset-backed 

securities registered on Form SF–1? 

What activities would then be allowed 

that were previously prohibited under 

Rule 101? To what extent would these 

additional activities be at risk of 

manipulation? Why or why not? 

22. Are there any types of assetbacked securities that should not be 

covered by the proposed exception? 

Please explain. 

23. Would the asset-backed securities 

excepted in the proposal be more 

vulnerable to manipulation than the 

securities that meet the existing 

investment grade standard? Why or why 

not? 

24. Is the proposal to except only 

asset-backed securities that are offered 

pursuant to an effective shelf 

registration statement filed on the 

Commission’s Form SF–3 an 

appropriate substitute for credit ratings 

in this context? What effect(s), if any, 

would the proposed modifications to 

the current exception have on the 

market for asset-backed securities? 

Please explain. 

25. How difficult and costly in 

practice would the requirements of the 

proposed exception be to apply? If the 

requirements are more difficult or costly 

to apply, how might this impact the 

scope of securities subject to the 

prohibitions of Regulation M? For 

example, to what extent, if any, might 

a narrower range of securities meet the 

exception as a result of the proposal, if 

adopted? If fewer securities are excepted 

from the prohibitions of Regulation M, 

in what ways and to what extent, if any, 

would this impact the market for those 

securities that would no longer qualify 

for an exception? 

26. Will fewer asset-backed securities 

issuances meet the requirement for this 

exception? If so, what impact would this 

proposed exception have on the market 

for new issuances of these securities? 

27. Please discuss whether and to 

what extent investors take into account 

reliance on the current Rule 101(c)(2) 

exception for investment grade assetbacked securities when making a 

decision to invest in such securities. 

28. Are there factors other than those 

identified in the proposed exception 

that influence the trading of such 

securities? Are there additional 

requirements that the Commission 

should adopt with respect to the 

proposed exception? Are there any that 

the Commission should remove from 

the proposal? 

29. Would a probability of default 

standard be appropriate for the 

exception for asset-backed securities? 

Are there models used to calculate a 

probability of default threshold (e.g., 

reduced-form models or structural 

models of credit risk) for asset-backed 

securities that would be relevant to 

consider based on the type of security 

involved? If so, what threshold should 

be included in the exception to Rule 101 

for asset-backed securities? What 

benefits would this approach provide? 

What other concerns could this 

approach raise? How would this 

approach address potential conflicts of 

interest involving the distribution 

participant or affiliated purchaser? 

Please explain. 

30. Are there any concerns with 

regard to distribution participants and 

affiliated purchasers’ ability to collect 

any of the information required for the 

probability of default calculation for 

asset-backed securities? If so, please 

explain. 

B. Rule 102 

1. Existing Investment Grade Exception 

Rule 102 contains fewer exceptions 

than Rule 101 does because issuers and 

selling security holders have the greatest 

interest in an offering’s outcome (and 

thereby should be subject to Regulation 

M’s prohibitions) but generally do not 

have the same market access needs as 

underwriters do (and as such are 

expected to have less of a desire to seek 

an exception).116 Despite these 

differences in the situation of issuers 

and selling security holders as 

compared to distribution participants, 

the exception for certain investment 

grade securities provided in former 

Exchange Act Rule 10b-6 was carried 

over to Regulation M as paragraph (d)(2) 

at the adoption of Rule 102.117

2. Proposed Removal of Investment 

Grade Exception 

The Commission is proposing to 

amend Rule 102 to remove the 

Investment Grade Exception. As noted 

above, there are limited situations in 

which issuers, selling security holders, 

or their affiliated purchasers rely on the 

Investment Grade Exception provided in 

Rule 102.118 Given this apparent limited 

reliance, coupled with the incentive for 

issuers, selling shareholders, and their 

affiliated purchasers to manipulate the 

market for the distributed security exists 

regardless of the credit quality of the 

security,119 the Commission believes 

that the existing exception should be 

eliminated without replacement.120


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issued by an unaffiliated entity in a hedging 

transaction. See Rule 101(c)(1) and Rule 102(d)(1). 

As the Commission stated in the adopting release 

regarding the actively-traded reference securities 

exception, the Commission believes that persons 

subject to Rule 102 should not be able to trade in 

their securities. See Regulation M Adopting Release 

at 531. As stated in the Regulation M Adopting 

Release, the Commission’s view is based on the 

issuers’ and selling security holders’ stake in the 

proceeds of the offering, and their generally lesser 

need to engage in securities transactions. Id. 

121See Regulation M Proposing Release, 61 FR 

17117 (stating reasons for exceptions from 

Regulation M). Disruption to the trading market 

may be limited because distribution participants 

would still be able to rely on the exception from 

Rule 101 if they meet the requirements of the 

proposed rules. While the one commenter that 

addressed sovereign issuers and Rule 102 pointed 

to certain exemptive orders issued in the early 

2000s to support a contention that sovereign issuers 

should continue to be excepted from Regulation M 

because the securities trade primarily on the basis 

of a spread to a United States Treasury security, all 

but one of the exemptive orders cited by the 

commenter only exempted the recipient from Rule 

101. See Arnold & Porter Letter at 3. For orders 

cited by this commenter that only provided an 

exemption from Rule 101, see Federative Republic 

of Brazil (Jan. 21, 2000; Apr. 29, 2003; July 3, 2003; 

Sept. 9, 2003; Oct. 15, 2003). See also Regulation 

M—Sovereign Bond Exemption (Jan. 12, 2003) 

(order exempting certain distributions of certain 

sovereign bonds from Rule 101, not Rule 102). For 

the one order cited by this commenter that provided 

an exception from Rule 102, see United Mexican 

States (Feb. 17, 1999). Because the proposed 

amendments would place distribution participants 

in a similar position to distribution participants 

trading the securities issued by the sovereign 

issuers pursuant to existing Rule 101 exemptive 

orders, and given that the exception under Rule 102 

appears seldom used, we believe it is appropriate 

to eliminate the exception in Rule 102 as proposed. 

122Regulation M Proposing Release, 61 FR 17120. 

See also Review of Antimanipulation Regulation of 

Securities Offerings, Release No. 34–33924 (Apr. 19, 

1994) [59 FR 21681, 21686 (Apr. 26, 1994)] (stating 

‘‘issuers and selling shareholders have a clear 

incentive to manipulate the price of the securities 

to be distributed. A very small change in the market 

price of a security, which in some circumstances 

may be accomplished at relatively little expense, 

can result in a substantial increase in offering 

proceeds.’’). 

123See Regulation M Adopting Release at 531. 

124See Arnold & Porter Letter. 

Further, the Commission believes that, 

while substituting an alternative 

standard of credit-worthiness may 

except securities that have little 

manipulative potential, retention of 

such an exception is not likely 

necessary to facilitate orderly 

distributions of securities or to limit 

potential disruptions in the trading 

market in light of issuers’ limited 

market access needs.121 Accordingly, 

the proposed amendment to Rule 102 

should protect investors and further 

Regulation M’s anti-manipulation goals 

in the rare event of an issuer or its 

affiliate desiring to purchase or bid for 

Nonconvertible Securities or assetbacked securities that are in 

distribution. 

Under the proposed amendment to 

Rule 102, an issuer of investment grade 

Nonconvertible Securities and assetbacked securities that is participating in 

a distribution of its own securities 

would not have an exception and would 

need to ensure that the applicable 

restricted period is complete before 

purchasing, bidding for, or attempting to 

induce others to purchase or bid for, the 

covered security. Market participants 

can structure their offerings to ensure 

compliance with Rule 102 by, for 

example, completing the distribution 

prior to purchasing any covered security 

and thus completing the applicable Rule 

102 restricted period, or distributing 

bonds with different terms from 

outstanding bonds. The Commission 

preliminarily believes that eliminating 

the exception is appropriate because it 

would decrease the risk of conduct 

raising improperly the price of an 

offered security without impeding the 

facilitation of orderly distributions of 

securities.122 For the same reason, while 

the Commission adopted the Investment 

Grade Exception in Rule 102 in 

response to commenters responding on 

the original Regulation M Proposing 

Release 123 and received one comment 

discussing this exception in response to 

the 2008 Proposal,124 the Commission is 

concerned that issuers and selling 

security holders have the greatest 

interest in an offering’s outcome thereby 

heightening the risk of manipulation. 

3. Request for Comment 

We solicit comments on all aspects of 

this proposal. We ask 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. 

31. Do issuers, selling security 

holders, and their affiliated purchasers 

have an incentive to manipulate 

securities that currently qualify for the 

Investment Grade Exception from Rule 

102? If yes, would substituting the 

probability of default approach for the 

current exception address this incentive 

to manipulate? 

32. If commenters are aware of 

situations where issuers, selling security 

holders, or their affiliated purchasers 

are currently relying on the Investment 

Grade Exception in Rule 102, do these 

activities raise improperly the price of 

the offered securities? Why or why not? 

33. If the Investment Grade Exception 

in Rule 102 proposed to be removed is 

adopted, would it result in potential 

disruptions to trading and if so, please 

explain. Can market participants 

structure their distributions to comply 

with Regulation M? In light of the 

proposed removal of the exception, 

would any alternative structures be 

detrimental to the capital raising 

process? 

34. Would the proposed removal of 

the Investment Grade Exception in Rule 

102 impede the facilitation of orderly 

distributions of securities or result in 

potential disruptions to trading 

markets? Why or why not? 

35. Should the Commission adopt an 

exception based on either the 

probability of default standard for 

Nonconvertible Securities or assetbacked securities that are offered 

pursuant to an effective shelf 

registration statement filed on Form SF– 

3 for Rule 102 instead of removing the 

Investment Grade Exception without 

substituting an alternative? Why or why 

not? Should the Commission adopt an 

exception for Rule 102 if a distribution 

participant determines that a security is 

an excepted security pursuant to Rule 

101(c)(2)? 

36. As discussed above, one 

commenter to the 2008 Proposal 

believed that the removal of the 

Investment Grade Exception for foreign 

sovereign bonds would impede a foreign 

sovereign or its affiliated purchasers 

from engaging in its own general trading 

and investment activities, or other 

public purposes. Should the 

Commission adopt an exception from 

Rule 102 for bonds issued by a foreign 

government or political subdivision 

thereof? For example, should the 

Commission except from Rule 102 any 

bond issued by a foreign sovereign or 

political subdivision thereof filed with a 

registration statement pursuant to 

Schedule B of the Securities Act? Do all 

bonds issued by foreign sovereigns or 

political subdivisions thereof trade 

based on a spread to U.S. Treasury 

securities? Please explain. 

V. Recordkeeping Requirement: Rule 

17a–4(b)(17) 

A. Proposed Recordkeeping 

Requirement 

The Commission is proposing a new 

recordkeeping requirement that brokerdealers who are distribution 

participants or affiliated purchasers 

must keep certain records pursuant to 

Rule 17a–4 under the Exchange Act, the 

Commission’s broker-dealer record 

retention rule. Proposed paragraph 

(b)(17) of Rule 17a–4 would require 

broker-dealers relying on the exception 

for Nonconvertible Securities to 

preserve the written probability of 

default determination made pursuant to 

proposed paragraph (c)(2)(i) of Rule 101. 

Accordingly, broker-dealers relying on 


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125See id. 

126 17 CFR 240.17a–4(b). 

127See 44 U.S.C. 3501 et seq. The burden 

associated with the information collection 

requirements are referred to as ‘‘PRA burdens.’’ 

128The Commission preliminarily believes that 

the proposed amendment to Rule 102 would not 

change the PRA burden estimates under the current 

OMB-approved collections of information for that 

rule because those estimates do not include any 

collections of information or burden related to the 

determination of whether a security qualifies for the 

Investment Grade Exception. The proposed 

amendment would eliminate the exception under 

Rule 102, so respondents would continue to incur 

no burden making a determination because they 

would not be making one. See Supporting 

Statement for the Paperwork Reduction Act 

Information Collection Submission for Rule 102 of 

Regulation M (OMB Control No. 3235–0467) (Feb. 

5, 2020), available at https://www.reginfo.gov/ 

public/do/PRAViewDocument?ref_nbr=201911- 

3235-012 (discussing the burden estimates under 

Rule 102). 

the exception in proposed paragraph 

(c)(2)(i) of Rule 101 would be required 

to preserve for a period of not less than 

three years, the first two years in an 

easily accessible place, the written 

probability of default determination 

made pursuant to proposed paragraph 

(c)(2)(i) of Rule 101. 

Under proposed paragraph (c)(2)(i) of 

Rule 101, broker-dealers relying on the 

exception would need to determine and 

document in writing that the probability 

of default of the issuer of 

Nonconvertible Securities is, estimated 

as of the day of the determination of the 

offering pricing and over the horizon of 

12 calendar months from such day, less 

than 0.055% using a Structural Credit 

Risk Model. Broker-dealers relying on 

the exception in proposed Rule 

101(c)(2)(i) would be required to 

preserve the written probability of 

default determination pursuant to Rule 

17a–4. The proposed amendment to 

Rule 17a–4 would modify the existing 

practices of broker-dealers who are 

distribution participants or affiliated 

purchasers to impose new 

recordkeeping burdens when relying on 

the exception in proposed Rule 

101(c)(2)(i). A broker-dealer that uses a 

vendor to determine the probability of 

default threshold could satisfy this 

recordkeeping requirement by 

maintaining documentation of the 

assumptions used in the vendor model, 

as well as the output provided by the 

vendor supporting the probability of 

default determination. A broker-dealer 

calculating the probability of default on 

its own could satisfy the recordkeeping 

requirement by maintaining 

documentation of the value of each 

variable used to calculate the 

probability of default, along with a 

record identifying the specific source(s) 

of such information for each variable. 

The proposed requirement to preserve 

the written probability of default 

determination pursuant to Rule 17a–4 is 

consistent with other retention 

obligations of records that Exchange Act 

rules impose on broker-dealers.125

Exchange members and broker-dealers 

are currently required to comply with 

the three-year preservation period in 

Rule 17a–4 for other records and should 

have procedures to satisfy such 

preservation requirements in place.126

The proposed recordkeeping 

requirement is intended to aid the 

Commission in its oversight of brokerdealers who are distribution 

participants or affiliated purchasers and 

rely on the exception in proposed 

paragraph (c)(2)(i) of Rule 101 by 

requiring such broker-dealers to retain 

the written probability of default 

determination supporting their reliance 

on the exception. The written records 

documenting the probability of default 

determination would be subject to 

review in regulatory examinations by 

Commission staff and self-regulatory 

organizations. 

B. Request for Comment 

We solicit comments on all aspects of 

this proposal. We ask that commenters 

provide specific reasons and 

information to support their views. 

37. Is the retention of information by 

distribution participants or affiliated 

purchasers for a period of three years, 

the first two years in an easily accessible 

place, in proposed paragraph (b)(17) of 

Rule 17a–4 appropriate? If not, what 

would be a more appropriate period of 

time, and why? Would investors, the 

Commission, or the public benefit from 

a retention period that is longer than 

three years? What would the costs be for 

broker-dealers who are distribution 

participants or affiliated purchasers for 

a retention period that is longer than 

three years? 

38. Is the retention requirement in 

proposed paragraph (b)(17) of Rule 17a– 

4 burdensome or costly? Please explain. 

If so, in what ways could modifications 

to the Rule as proposed reduce these 

burdens and costs? What would the 

costs be for broker-dealers who are 

distribution participants or affiliated 

purchasers to preserve the written 

probability of default determination? 

39. Should broker-dealers who are 

distribution participants or affiliated 

purchasers relying on the exception in 

proposed paragraph (c)(2)(i) of Rule 101 

be required to document information in 

addition to the proposed required 

documentation (i.e., the written 

probability of default determination)? 

For example, should a broker-dealer be 

required to retain the documentation 

governing the probability of default 

estimation if the broker-dealer uses a 

vendor model? 

VI. General Request for Comment 

The Commission solicits comment on 

all aspects of the proposed amendments 

to Rule 101, Rule 102, and Rule 17a–4, 

as well as any other matter that may 

impact any of the proposals discussed 

above. Please provide empirical data, 

when possible, and cite to economic 

studies, if any, to support alternative 

approaches. In particular, the 

Commission asks commenters to 

consider the following questions: 

40. In proposing the criteria above, 

the Commission has focused on 

indicators of credit-worthiness. Is 

credit-worthiness alone an appropriate 

signifier of whether a security is 

susceptible to manipulation under the 

conditions in which Rule 101 is 

concerned? Why or why not? 

41. Please comment in particular on 

any relevant changes to the 

Nonconvertible Securities or assetbacked securities markets since 

Regulation M was adopted in 1996 and 

how these developments should affect 

the Commission’s evaluation of the 

proposed amendments. How do these 

changes fit within the relevant changes 

to the debt markets (more generally) 

since Regulation M’s adoption? 

VII. Paperwork Reduction Act Analysis 

A. Background 

Certain provisions of proposed 

amendments impose ‘‘collection of 

information’’ requirements within the 

meaning of the Paperwork Reduction 

Act of 1995 (‘‘PRA’’).127 Specifically, the 

Commission estimates that respondents 

would incur PRA burden when 

determining whether a distribution of a 

nonconvertible security qualifies for the 

proposed exception from Regulation M. 

The Commission also believes that there 

would be PRA burdens associated with 

documenting this determination. These 

PRA burdens would be distinct from the 

existing OMB-approved collection of 

information burden estimates under 

Rule 101 and Rule 17a–4 because the 

Commission has not estimated that 

respondents incur PRA burdens when 

determining whether a security qualifies 

for the current Investment Grade 

Exception.128 The Commission is 

submitting the proposed amendments to 

the Office of Management and Budget 

(‘‘OMB’’) for review in accordance with 

the PRA. An agency may not conduct or 

sponsor, and a person is not required to 

respond to, a collection of information 

unless it displays a current valid control 

number. 


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129The Commission recognizes that some 

respondents may choose to utilize the probability 

of default estimates calculated and made available 

by a third-party vendor rather than perform the 

calculations themselves. The Commission’s burden 

estimate for the proposed amendment to Rule 101 

is based upon respondents gathering the required 

data and calculating the probability of default 

internally without the use of third-party vendors, 

because the Commission lacks granular information 

from which to base an estimate of the proportion 

of respondents that would use vendors. The 

Commission welcomes comments on this approach, 

including regarding the likelihood and cost of using 

third-party vendors, including any time burden 

associated with using such services. 

130Further, the Commission preliminarily 

believes that respondents that choose to utilize the 

probability of default estimates calculated and 

made available by a third-party vendor would 

already have access to the vendor’s software and 

systems containing these estimates, typically as part 

of an existing subscription, so they would not need 

to procure further services or subscriptions from 

The titles and control numbers for 

these collections of information are as 

follows: 

Rule Title OMB control 

No. 

Rule 101 ...................................................................................... Rule 101, 17 CFR 242.101 (Activities by Distribution Participants).3235–0464 

Rule 17a–4 .................................................................................. Records to be Preserved by Certain Brokers and Dealers ....... 3235–0279 

As discussed above, Regulation M is 

designed to preserve the integrity of the 

securities trading market as an 

independent pricing mechanism by 

prohibiting activities that could 

artificially influence the market for an 

offered security. Subject to exceptions, 

Rule 101 prohibits distribution 

participants and their affiliated 

purchasers from directly or indirectly 

bidding for, purchasing, or attempting to 

induce another person to bid for or 

purchase a covered security during a 

restricted period. Rule 17a–4 requires a 

broker-dealer to preserve certain records 

if it makes or receives them. 

In reference to the requirement in 

Section 939A, the Commission is 

proposing amendments to Rules 101 

and 102 to remove the existing 

exceptions for nonconvertible debt 

securities, nonconvertible preferred 

securities, and asset-backed securities 

that are rated by at least one NRSRO in 

one of its generic rating categories that 

signifies investment grade. With respect 

to Nonconvertible Securities in Rule 

101, the Commission proposes to 

substitute a standard that would except 

securities for which the probability of 

default, estimated as of the day of the 

determination of the offering pricing 

and over the horizon of 12 calendar 

months from such day, is less than 

0.055%, as determined by a Structural 

Credit Risk Model. Broker-dealers who 

are distribution participants and their 

affiliated purchasers that would be 

relying on the proposed exception from 

Rule 101 would be required to preserve 

for a period of not less than three years, 

the first two years in an easily accessible 

place, the written probability of default 

determination. The Commission is also 

proposing to except asset-backed 

securities that are offered pursuant to an 

effective shelf registration statement 

filed on Form SF–3. 

The discussion of estimates that 

follows is limited to a discussion of the 

new information collection 

requirements that result from the 

proposed amendments. The 

Commission is not estimating that the 

proposed amendments would increase 

or decrease the existing approved 

information collections under Rule 101 

and Rule 17a–4 because those 

information collections are not related 

to making a determination about 

whether a security qualifies for the 

Investment Grade Exceptions. The 

information collections in the proposed 

amendments are distinct, so they are the 

only information collections discussed 

herein. 

B. Proposed Use of Information 

The information collected under the 

proposal would be used to ensure that 

the nonconvertible debt securities most 

resistant to manipulation are excepted 

from Rule 101. Further, the Commission 

preliminarily believes that the 

information contained in the records 

required to be retained and kept 

pursuant to the proposed amendment to 

Rule 17a–4 would be used to assist the 

Commission in conducting effective 

examinations and oversight of 

distribution participants and their 

affiliated purchasers. 

C. Information Collections 

The proposed amendments that 

impose information collection burdens 

would apply to distribution participants 

and affiliated purchasers that choose to 

rely on the exception for a distribution 

of Nonconvertible Securities. As noted 

in Part VIII.A.1, there were 237 

underwriters of Nonconvertible 

Securities in 2020. The Commission 

preliminarily believes that this number 

will remain roughly consistent because 

of the capital, expertise, and 

relationships needed to underwrite a 

Nonconvertible Security. The 

Commission, therefore, is estimating 

that 237 respondents would be subject 

to PRA burdens under the proposed 

amendments. 

As discussed below, the Commission 

preliminarily believes that respondents 

would incur PRA burdens under the 

proposed amendments because 

distribution participants and their 

affiliated purchasers would be required 

to analyze each distribution of 

Nonconvertible Securities to determine 

whether the distribution qualifies for 

the exception. Respondents would also 

incur PRA burdens under Rule 17a–4 

because distribution participants would 

be required to keep certain records 

documenting this determination that 

support their reliance on the exception. 

1. Rule 101 

Under the proposed amendment to 

Rule 101, respondents wishing to rely 

on the exception for a distribution of 

Nonconvertible Securities would be 

required to gather the data serving as the 

inputs and then perform the analysis 

necessary to calculate the probability of 

default of the issuer whose securities are 

the subject of the distribution.129 This 

requirement would result in 

respondents incurring recordkeeping 

burden. The Commission preliminarily 

believes that this process would likely 

be highly automated, and that 

respondents would initially comply 

with this requirement by reprograming 

systems to create a means to calculate 

electronically the probability of default 

based on manually gathered and entered 

inputs for financial modeling. The 

Commission preliminarily believes that 

all respondents would be broker-dealers 

who have experience using their own 

proprietary version of a publicly 

available Structural Credit Risk Model 

so the initial configuration of systems 

will be handled internally and take 3 

hours per respondent. The Commission 

also preliminarily believes that brokerdealers already have the software and 

systems in place that would be required 

to make the calculations.130


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these vendors. The Commission welcomes 

comments on this preliminary belief and on any 

related costs and burdens. 

131 237 respondents × 3 hours = 711 hours. 

132This number was obtained from Mergent, a 

financial data provider. Data for 2021 is not yet 

available in Mergent. 

133 711 hours (initial burden) + 19,076 hours 

(ongoing annual burden) = 19,787 hours. 

134See 17 CFR 239.45. 

135As noted above, for the purposes of these 

estimates, the Commission assumes that no 

registrants are using vendors to rely on the 

proposed exceptions, however, the Commission 

also preliminarily believes that the burden 

associated with the proposed amendment to Rule 

17a–4 would not differ between respondents that 

rely on a third-party vendor and those that do not. 

136 237 respondents × 25 hours = 5,925 hours. 

137 237 respondents × 10 hours = 2,370 hours. 

138 5,925 hours (initial burden) + 2,370 hours 

(ongoing annual burden) = 8,295 hours. 

Accordingly, the Commission estimates 

that the total industry-wide initial 

burden for the proposed amendment to 

Rule 101 would be 711 hours.131

An issuer’s probability of default is 

forward-looking and changes over time, 

so the Commission preliminarily 

believes that respondents would 

manually gather the inputs required to 

calculate probability of default each 

time it participates in a distribution of 

debt securities. There were 19,076 

offerings of Nonconvertible Securities in 

2020.132 Because financial modeling 

generally, and the probability of default 

calculation more specifically, is wellknown by industry participants, the 

Commission preliminarily believes that 

respondents would have employees that 

are familiar with how to gather the 

required inputs. The Commission, 

therefore, estimates that would take 

respondents roughly 1 hour per 

distribution of Nonconvertible 

Securities on this requirement. 

Accordingly, the Commission estimates 

that the amendment to Rule 101 will 

result in an aggregate annual ongoing 

industry-wide burden of 19,076 hours. 

The Commission, therefore, estimates 

that the total PRA burden resulting from 

the proposed amendment to Rule 101 

would be 19,787 hours in the first 

year 133 and 19,076 hours thereafter. 

The Commission preliminarily 

believes that the proposed amendments 

would not result in respondents 

incurring PRA burden when 

participating in distributions of assetbacked securities because whether an 

asset-backed security has an effective 

registration statement on Form SF–3 is 

an objective, observable fact.134 Further, 

under the proposed amendments, there 

is no requirement for distribution 

participants or their affiliated 

purchasers to keep records documenting 

its reliance on the exception for 

distributions of asset-backed securities. 

2. Rule 17a–4 

The proposed amendment to Rule 

17a–4 would require broker-dealers 

relying on the exception in proposed 

paragraph (c)(2)(i) to preserve for a 

period of not less than three years, the 

first two years in an easily accessible 

place, the written probability of default 

determination. Because the burden to 

make these records is accounted for in 

the PRA estimates for the amendment to 

Rule 101, the burden imposed by these 

proposed new requirements under Rule 

17a–4 is limited to the maintenance and 

preservation of the written records.135

The Commission estimates that this 

recordkeeping requirement would 

impose an initial burden of 25 hours per 

respondent for updating the applicable 

policies and systems required to 

account for capturing the records made 

pursuant to proposed paragraph (c)(2)(i). 

Accordingly, the Commission estimates 

that the total industry-wide initial 

burden for this requirement would be 

5,925 hours.136 The Commission also 

estimates that respondents would incur 

an ongoing annual burden of 10 hours 

per firm for maintaining such records as 

well as to make additional updates to 

the applicable recordkeeping policies 

and systems to account for the proposed 

rules, leading to a total ongoing 

industry-wide burden of 2,370 hours.137

The Commission, therefore, estimates 

that the total PRA burden resulting from 

the proposed amendment to Rule 17a– 

4 would be 8,295 hours in the first 

year 138 and 2,370 hours thereafter. 

PRA SUMMARY TABLE

Initial 

burden hours 

Ongoing 

annual burden 

hours per year 

(after first 

year) 

Total PRA 

burden hours 

in first year 

Industry-Wide Burden due to Proposed Amendment to Rule 101 ............................................. 711 19,076 19,787 

Industry-Wide Burden due to Proposed Amendment to Rule 17a–4 ......................................... 5,925 2,370 8,295 

D. Collection of Information Is 

Mandatory 

Each collection of information 

discussed above would be a mandatory 

collection of information. 

E. Confidentiality 

The Commission would not typically 

receive confidential information as a 

result of this collection of information. 

To the extent that the Commission 

receives—through its examination and 

oversight program, through an 

investigation, or by some other means— 

records or disclosures from a 

distribution participant regarding the 

probability of default determination, 

such information would be kept 

confidential, subject to the provisions of 

applicable law. 

F. Retention Period of Recordkeeping 

Requirement 

Pursuant to proposed Rule 17a– 

4(b)(17) a broker-dealer who is a 

distribution participant or affiliated 

purchaser would be required to retain 

information for a period of not less than 

three years, the first two years in an 

easily accessible place. 

G. Request for Comment 

Pursuant to 44 U.S.C. 3506(c)(2)(B), 

the Commission solicits comments to (1) 

evaluate whether the proposed 

collections of information are necessary 

for the proper performance of the 

functions of the Commission, including 

whether the information would have 

practical utility; (2) evaluate the 

accuracy of the Commission’s estimate 

of the burden of the proposed 

collections of information and 

assumptions used therein; (3) determine 

whether there are ways to enhance the 

quality, utility, and clarity of the 

information to be collected; (4) 

determine whether there are ways to 

minimize the burden of the collections 

of information on those who are to 

respond, including through the use of 

automated collection techniques or 

other forms of information technology; 

and (5) evaluate whether the proposed 

amendments would have any effects on 

any other collection of information not 


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139See 15 U.S.C. 78c(f). 

140The term ‘‘fixed-income’’ in the Economic 

Analysis section refers to nonconvertible debt 

securities, nonconvertible preferred securities, and 

asset-backed securities. 

141U.S. Sec. and Exch. Comm’n, Annual Report 

on Nationally Recognized Statistical Rating 

Organizations 2 (2022), available at https://

www.sec.gov/files/2022-ocr-staff-report.pdf. 

142 Id. at 24. 

143The statistics are based on the data from 

Mergent. 

144The data for the asset-backed securities 

(including mortgage-backed securities) comes from 

Bloomberg. 

145See supra Part 0. 

146See 17 CFR 242.101(a), 102(a); see, e.g., 17 

CFR 242.101(c)(2), 102(d)(2). 

previously identified in this section. 

The Commission also requests that 

commenters provide data to support 

their discussion of the burden estimates. 

While the Commission welcomes any 

public input on this topic, the 

Commission asks commenters to 

consider the following questions: 

42. Is the Commission adequately 

capturing the respondents that would be 

subject to burdens under the proposed 

amendments? Specifically, would more 

or fewer than the 237 respondents 

determine the probability of default? 

43. Is the Commission accurately 

estimating the amount of time it would 

take to program systems and gather the 

data required to perform the probability 

of default calculations? 

44. Would any aspects of the 

proposed amendments that are not 

discussed in this PRA Analysis affect 

the burden associated with the 

collection of information? 

45. Do commenters agree with the 

Commission’s preliminary belief that 

the proposed amendment to Rule 102 

would not change PRA burdens? 

46. Do commenters agree with the 

Commission’s preliminary belief that 

the proposed amendments would not 

result in respondents incurring PRA 

burden when participating in 

distributions of asset-backed securities? 

Any member of the public may direct 

to us any comments concerning the 

accuracy of these burden estimates and 

any suggestions for reducing the 

burdens. Persons submitting comments 

on the collection of information 

requirements should direct the 

comments to the Office of Management 

and Budget, Attention: Desk Officer for 

the Securities and Exchange 

Commission, Office of Information and 

Regulatory Affairs, 

MBX.OMB.OIRA.SEC_desk_officer@

omb.eop.gov, and send a copy to 

Vanessa Countryman, Secretary, 

Securities and Exchange Commission, 

100 F Street NE, Washington, DC 

20549–1090, with reference to File No. 

S7–11–22. OMB is required to make a 

decision concerning the collection of 

information between 30 and 60 days 

after publication of this release. 

Consequently, a comment to OMB is 

best assured of having its full effect if 

OMB receives it within 30 days of 

publication. Requests for materials 

submitted to OMB by the Commission 

with regard to these collections of 

information should be in writing, refer 

to File No. S7–11–22, and be submitted 

to the Securities and Exchange 

Commission, Office of FOIA Services, 

100 F Street NE, Washington, DC 

20549–2736. 

VIII. Economic Analysis 

The Commission is sensitive to the 

economic consequences and effects, 

including costs and benefits, of its rules. 

Some of these costs and benefits stem 

from statutory mandates, while others 

are affected by the discretion exercised 

in implementing the mandates. Section 

3(f) of the Exchange Act provides that 

whenever the Commission is engaged in 

rulemaking pursuant to the Exchange 

Act and is required to consider or 

determine whether an action is 

necessary or appropriate in the public 

interest, the Commission shall also 

consider, in addition to the protection of 

investors, whether the action will 

promote efficiency, competition, and 

capital formation.139 Additionally, 

Section 23(a)(2) of the Exchange Act 

requires the Commission, when making 

rules under the Exchange Act, to 

consider the impact such rules would 

have on competition. Section 23(a)(2) 

also provides that the Commission shall 

not adopt any rule which would impose 

a burden on competition that is not 

necessary or appropriate in furtherance 

of the purposes of the Exchange Act. 

The analysis below addresses the 

likely economic effects of the proposed 

amendments, including the anticipated 

benefits and costs of the amendments, 

and their likely effects on efficiency, 

competition, and capital formation. The 

Commission also discusses the potential 

economic effects of certain alternatives 

to the approach taken by these 

amendments. Some of the benefits and 

costs discussed below are difficult to 

quantify. For example, sticky offerings 

are generally not identified in the 

available data and may be difficult to 

trace in the appropriate records of the 

distribution participants. Therefore, 

much of the discussion of economic 

effects is qualitative. 

A. Baseline 

1. The Investment Grade Fixed Income 

Market 

To assess the economic effects of the 

proposed amendments, the Commission 

is using as the baseline the 

nonconvertible debt, nonconvertible 

preferred, and asset-backed securities 

markets as they exist at the time of this 

release, including applicable rules that 

the Commission has already adopted. 

The affected parties include 

Nonconvertible Security and assetbacked security (collectively ‘‘fixedincome securities’’) 140 distribution and 

market participants, such as issuers, 

selling security holders, underwriters, 

banks, broker-dealers, and their 

affiliated purchasers; fixed-income 

security investors, such as retail 

investors, mutual funds, exchange 

traded funds, and separate investment 

accounts; vendors of the relevant market 

data; and NRSROs. Currently a majority 

of the distribution participants in the 

relevant markets are subscribed to a 

major vendor of the market data 

necessary to evaluate various aspects of 

the distribution. Further, a rating by an 

NRSRO is necessary in order for 

distribution participants to rely on the 

Investment Grade Exception. Today 

there are nine credit rating agencies 

registered with the Commission as 

NRSROs.141 Three large NRSROs (S&P 

Global Ratings, Moody’s Investors 

Services, Inc., and Fitch Ratings, Inc.) 

have historically accounted for most of 

the market share in this market. As of 

December 31, 2020, these three market 

participants accounted for 94.7% of all 

of the NRSRO credit ratings 

outstanding.142

The affected securities are 

nonconvertible debt, nonconvertible 

preferred, and asset-backed securities. 

In 2020, there were 19,076 issues of 

nonconvertible debt, with 694 issuers 

and 237 participating underwriters 

involved.143 Additionally, in 2020, there 

were 152,069 issues of mortgage-backed 

securities with 195 underwriters 

involved and 7,255 issues of other assetbacked securities with 155 

underwriters.144

2. The Investment Grade Exception to 

Regulation M 

Regulation M is designed to prevent 

manipulative activities that could 

artificially influence the demand and 

pricing of covered securities.145 In 

particular, Rules 101 and 102 of 

Regulation M prohibit distribution and 

market participants from bidding for or 

purchasing a covered security, unless an 

exception, such as the Investment Grade 

Exception, applies.146 At the time the 

exception was included, the investment 

grade securities, that is securities 

characterized by sound creditworthiness, were considered to be 


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147See Regulation M Adopting Release, 62 FR 

527. 

148Some commenters note that best efforts 

offerings (see supra note 59) and foreign sovereign 

offerings (see supra note 62) could also be affected 

by the exceptions in Rules 101 and 102. 

149The estimate is obtained using Mergent data 

for the relevant fixed income securities during the 

past five years as of Oct. 2021. 

150See SIFMA Letter 3 at 6; John Berkery & 

Remmelt Reigersman, Re-openings: Issuing 

Additional Debt Securities of an Outstanding 

Series, Mayer Brown 1–2 (2020), available at 

https://www.mayerbrown.com/-/media/files/ 

perspectives-events/publications/2020/05/ 

reopenings_-issuing-additional-debt-securities-ofan-outstanding-series.pdf. See also Arnold & Porter 

Letter at 3. 

151Sullivan & Cromwell Letter at 4. 

152See supra Part IV.A.1.c. for a relevant 

discussion. 

153See supra Part IV.B. 

154See supra Part III (discussing the history of the 

Investment Grade Exceptions). 

155Public Law 111–203 sec. 939A(a). The 

Commission has issued several releases concerning 

the removal of references to credit ratings: Security 

Ratings, Release No. 34–64975 (July 27, 2011) [76 

FR 46603 (Aug. 3, 2011)]; Removal of Certain 

References to Credit Ratings Under the Securities 

Exchange Act of 1934, Release No. 34–71194 (Dec. 

27, 2013) [79 FR 1522 (Jan. 8, 2014)]; Removal of 

Certain References to Credit Ratings under the 

Investment Company Act, Release No. IC–30847 

(Dec. 27, 2013) [79 FR 1316 (Jan. 8, 2014)]; AssetBacked Securities Disclosure and Registration, 

Release No. 34–72982 (Sept. 4, 2014) [79 FR 57184 

(Sept. 24, 2014)]; Removal of Certain References to 

Credit Ratings and Amendment to the Issuer 

Diversification Requirement in the Money Market 

Fund Rule, Release No. IC–31828 (Sept. 16, 2015) 

[80 FR 58124 (Sept. 25, 2015)]. 

156See for example the seminal model by Robert 

C. Merton, On the Pricing of Corporate Debt: The 

Risk Structure of Interest Rates, 29 Journal of 

Finance 449, 449–70 (1974), along with related 

successive refinement models such as Fischer Black 

& John C. Cox, Valuing Corporate Securities: Some 

Effects of Bond Indenture Provisions, 31 J. Fin. 351, 

351–67 (1976); Robert Geske, The Valuation of 

Corporate Liabilities as Compound Options, 12 J. 

Fin. & Quantitative Analysis 541, 541–52 (1977); 

and Oldrich A. Vasicek, Credit Valuation, KMV 

(Mar. 22, 1984), among others. 

157See supra note 67. 

158An alternative set of models used to derive 

probability of default are ‘reduced-form models’. 

The reduced-form models rely on statistical 

analysis rather than the balance sheet to determine 

a firm’s creditworthiness. However, compared to 

Structural Credit Risk Models, they lack in rigorous 

theoretical justification as well as economic 

interpretation of the resulted relationships between 

the model inputs. See, e.g., Edward Altman, Andrea 

Resti, & Andrea Sironi, Default Recovery Rates in 

Credit Risk Modeling: A Review of the Literature 

and Empirical Evidence, 33 Econ. Notes 183 (2004) 

(discussing the competing models), available at 

https://onlinelibrary.wiley.com/doi/10.1111/j.0391- 

5026.2004.00129.x. 

traded primarily on yield and maturity, 

rather than the factors that determine 

credit-worthiness of the issuer and add 

uncertainty to the pricing of the 

issue.147 Thus sound credit-worthiness 

was considered to be a good proxy for 

manipulation risk. Such issues were 

presumed to have low probability of 

default and were thus considered to 

have low pricing uncertainty and low 

manipulation risk, which formed the 

basis for the exception. The Commission 

continues to believe that sound creditworthiness is a good proxy for 

manipulation risk since securities 

issued by firms with sound creditworthiness trade primarily on yield and 

maturity and not on issuer-specific 

characteristics that may increase pricing 

uncertainty. 

The Commission believes that the 

application of the Investment Grade 

Exception to Rules 101 and 102 is 

primarily limited to two cases:148

Reopenings (an offering of an additional 

principal amount of securities that are 

identical to the securities already 

outstanding) and sticky offerings (an 

offering where a lack of demand results 

in an underwriter being unable to sell 

all of the securities in a distribution). 

Reopenings are used infrequently and 

constitute about 3% of the relevant 

securities’ markets’ issuance volume.149

Sticky offerings are not identified in the 

relevant databases, making it difficult to 

assess their relative magnitude. 

Reopenings are used in situations 

when such financing method offers the 

benefit of cost-effectiveness. For 

example, it may be cheaper for an issuer 

to offer a series of small offerings as 

opposed to one large offering, as the 

latter could result in a lower offering 

price due to the supply pressure. 

Further, since a reopening issue is 

fungible with securities already in 

circulation and can be traded 

interchangeably with these securities in 

the secondary market, it provides 

additional liquidity benefits to the 

investors.150

Sticky offerings typically result when 

a large investor fails to fulfill its 

expressed purchase interest in the 

issue,151 which could be due to a 

negative factor that transpired in regard 

to the issue or issuer. In such cases it 

may become challenging to trade the 

issue based solely on the yield and 

maturity (otherwise it would have 

become possible to find another 

purchaser in a timely manner). This 

may give rise to a heightened risk of 

manipulation even if the security is 

rated as investment grade. 

The Commission preliminarily 

believes that the exception based on 

investment grade rating is rarely used in 

practice in Rule 102. Rule 102 prohibits 

trading of the securities fungible with 

the securities being issued by issuers, 

selling security holders, and their 

affiliated purchasers.152 However, 

issuers and selling security holders 

generally do not have the same market 

access needs as underwriters and are 

not expected to buy the securities they 

are issuing.153

The Investment Grade Exception was 

included in the regulation as it was 

considered a good proxy for the 

likelihood of manipulation risk.154

However, the reference to NRSRO 

ratings in the Commission’s rules may 

encourage investors to place undue 

reliance on the NRSRO ratings. 

Additionally, even though creditworthiness has been historically 

considered a good proxy for 

manipulation risk, it is still not a precise 

measure of such risk and therefore there 

are costs associated with using such a 

proxy that currently exist in the relevant 

markets. Specifically, in some instances 

distribution participants may choose to 

engage in manipulative activities of the 

securities of issuers with sound creditworthiness. As a result, under the 

existing rules, situations may arise in 

which securities with high 

manipulation risk are excepted from 

Regulation M. 

B. Benefits of the Proposed Amendment 

As mentioned above, Section 939A of 

the Dodd-Frank Act requires the 

Commission to ‘‘remove any reference 

to or requirement of reliance on credit 

ratings, and to substitute in such 

regulations such standard of creditworthiness as the Commission 

determines to be appropriate.’’ 155 In 

this proposed rule, the Commission 

proposes to rely upon the Structural 

Credit Risk Models to measure creditworthiness.156 These models have 

become widely used to estimate the 

probability of default of an issuer.157

Structural Credit Risk Models 

typically take the issuer balance sheet 

measures of debt obligations as given 

and estimate a probability of default 

based on the market value and volatility 

of the firm’s equity. The value of equity 

is viewed in these models as the value 

of a call option on firm assets where the 

strike price is the total notional value of 

debt. Since the market value of equity, 

the volatility of equity, and the notional 

value of debt can be calculated from the 

market and balance sheet data, under 

the Structural Credit Risk Models the 

volatility of the value of the assets and 

the market value of assets, which are not 

observable, can be estimated. The 

probability of default can be calculated 

as the probability that the call option 

will expire out-of-the-money, which 

occurs when the value of the company 

falls below the book value of the debt. 

As discussed above, Structural Credit 

Risk Models are based on the structure 

of the balance sheet.158 The key 


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159The most recent available investment grade 

status (as of the last available Mergent update 

through Dec. 2020) for nonconvertible securities 

issued between 2016 and 2020 was obtained from 

Mergent while the probability of default estimates 

were obtained for a cross-section of securities 

available in Bloomberg as of Oct. 22, 2021, which 

represents an average trading day with respect to 

the relevant market metrics. Since the cross-section 

of the relevant securities does not change 

considerably from day to day and the relevant 

metrics are typically calculated based on the data 

over a several months period or longer, it is 

unlikely that the results of the analysis are 

considerably affected by the specific day selected 

for the analysis. Please refer to Mario Bondioli, 

Martin Goldberg, Nan Hu, Chngrui Li, Olfa 

Maalaoui, & Harvey J. Stein, The Bloomberg 

Corporate Default Risk Model (DRSK) for Private 

Firms (working paper Aug. 27, 2021), available at 

https://ssrn.com/abstract=3911330 (retrieved from 

SSRN Elsevier database), for methodology 

description of Bloomberg probability of default 

measure. 

160This is consistent with the following SEC staff 

statement in COVID–19 Market Monitoring Group, 

Credit Ratings, Procyclicality and Related Financial 

Stability Issues: Select Observations, SEC (July 15, 

2020) (‘‘Cost of debt capital is driven by a wide 

range of financial and non-financial factors and 

forces; ratings downgrades are generally lagging 

indicators of cost of debt capital.’’), available at 

https://www.sec.gov/news/public-statement/covid19-monitoring-group-2020-07-15. 

161Some academic studies find evidence that 

Structural Credit Risk Models may be able to 

respond to aggregate and firm specific news faster 

than credit ratings. Also, such models are able pick 

up on differences in default risk within a credit 

rating bucket. However, credit ratings do not 

necessarily imply probabilities of default and thus 

may not be directly comparable to probability of 

default estimated using a Structural Credit Risk 

Model. See Jing-zhi Huang & Hao Zhou, 

Specification Analysis of Structural Credit Risk 

Models (Fed. Res. Bd., Fin. & Econ. Discussion 

Series, 2008–552008), available at https://

www.federalreserve.gov/pubs/feds/2008/200855/ 

200855pap.pdf; Moody’s Analytics, EDF Overview 

(2011) (outlining the approach by Moody’s KMV), 

available at https://www.moodysanalytics.com/-/ 

media/products/EDF-Expected-Default-FrequencyOverview.pdf; Giuseppe Montesi & Giovanni Papiro, 

Risk Analysis Probability of Default: A Stochastic 

Simulation Model, 10 J. Credit Risk 29 (2014). 

162See a relevant discussion in supra Part 

IV.A.1.c). 

assumption of a Structural Credit Risk 

Model is that default occurs when the 

value of the company falls below the 

book value of the debt. Since the future 

value of the firm is unknown, a 

Structural Credit Risk Model must make 

assumptions about the probability 

distribution of possible firm values in 

different scenarios, some of which may 

trigger default. These assumptions 

include the current firm value and the 

volatility of firm value, for which the 

observed market value of equity and the 

volatility of equity is often an input. 

Some models include assumptions over 

the firm’s dividend policy. 

The Commission preliminarily 

believes that the probability of default 

based on the Structural Credit Risk 

Models is an appropriate proxy for 

credit-worthiness. As discussed 

previously, the Commission continues 

to believe that credit-worthiness is an 

appropriate standard to reflect 

manipulation risk since securities 

issued by firms with sound creditworthiness trade primarily on yield and 

maturity and have low pricing 

uncertainty. Thus, the probability of 

default based on Structural Credit Risk 

Models is a reasonable proxy for 

manipulation risk. 

The Commission calibrated the 

0.055% threshold in the sample of 

nonconvertible fixed income securities 

so as to capture approximately 90% of 

the investment grade securities in our 

sample of nonconvertible fixed income 

securities (2436 distinct investment 

grade issues with probability of default 

below 0.055% out of 2710 total 

investment grade rated issues in the 

sample). This threshold also captures 

125 distinct non-investment grade 

issues with probability of default below 

0.055%. Overall, 2561 issues meet the 

proposed exception as compared with 

the 2710 issues under the current 

exception.159 The securities with 

probability of defaults within the first 

12 months, as estimated based on a 

widely accepted Structural Credit Risk 

Model, below the 0.055% threshold are 

proposed to be excepted from Rule 101. 

An advantage of using probabilities of 

default implied by Structural Credit 

Risk Models instead of NRSRO credit 

ratings is that these model-implied 

probabilities of default generally use 

current estimates of equity valuation 

and volatility, and hence incorporate 

most recent news affecting the valuation 

and perceived volatility of the firm. In 

contrast, credit rating agencies are 

generally slower than the market in 

updating credit ratings and outlooks and 

thus may reflect less up-to-date 

information.160 161

Distribution participants should be 

able to calculate the probability of 

default internally using Structural 

Credit Risk Models. One of the benefits 

of the proposed amendment is that the 

distribution participants will have the 

flexibility of selecting the model they 

find most convenient to assess the 

credit-worthiness of issuers for the 

purposes of using the exception. This 

means the distribution participants will 

no longer have to rely on an NRSRO 

rating for the issue for purposes of the 

Regulation M exception and will no 

longer have to rely on an NRSRO’s 

choice of the model for such purposes. 

Furthermore, the Commission 

preliminarily believes that multiple 

vendors currently provide estimates of 

the probability of default based upon 

Structural Credit Risk Models as a part 

of default packages that include various 

market data and metrics.162

Removing the reference to credit 

ratings from Rules 101 and 102 of 

Regulation M may also have a benefit of 

expanded options available to 

distribution participants compared to 

the Regulation M Investment Grade 

Exception requirement, as the proposed 

requirement will no longer rely on a 

limited number of vendors providing 

credit ratings, which may reduce 

possible negative consequences from 

limited competition. Structural Credit 

Risk Models as a measure for creditworthiness could therefore serve as a 

better proxy for manipulation risk than 

credit ratings because, by prescribing a 

methodology rather than a metric 

generated by only a certain category of 

regulated vendors (that is, NRSROs), 

distribution participants may have more 

options for either using a vendor 

supplied Structural Credit Risk Model 

or using their own proprietary version 

of a publicly available Structural Credit 

Risk Model. 

Under the proposed amendments, the 

Structural Credit Risk Models cannot, as 

a practical matter, apply to asset-backed 

securities due to the complexity of the 

structure of such instruments. In the 

case of asset-backed securities, the 

Commission preliminarily believes that 

securities that are offered pursuant to an 

effective shelf registration statement 

filed on Form SF–3 should also be 

excepted from Rule 101. Form SF–3 

requirements provide objective criteria 

that also ensure that the securities with 

the least amount of manipulation risk 

are allowed to rely on the Regulation M 

exception. Specifically, Form SF–3 

requirements limit the number of 

nonperforming assets in the assetbacked security pool, require review of 

the pool assets, and require certification 

by the chief executive officer, among 

other things. The Commission continues 

to believe, as noted when it adopted 

these requirements, that use of Form 

SF–3 incentivizes sponsors to carefully 

review and disclose the underlying 

assets’ characteristics, reducing the 

overall uncertainty about the assetbacked security and therefore the risk of 

manipulation. Accordingly, assetbacked securities that are offered 

pursuant to an effective shelf 

registration statement filed on Form SF– 

3 have similar qualities and 

characteristics to the investment-grade 

asset-backed securities currently 

excepted from Rule 101(c)(2). Further, 

an analysis of a merged sample of Form 

SF–3 filers and Bloomberg credit ratings 


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163We note that 770 investment grade assetbacked security issuances (by 191 issuers) from the 

2021 Bloomberg sample did not merge with the 

sample of Form SF–3 filers in part due to 

necessarily present imperfections in issuer name 

matching and in part due to a much smaller number 

of Form SF–3 filers (62 issuers). This may imply a 

possibility that a fairly large number of issuances 

that are able to rely on the exception currently will 

be excluded under the proposed standard. The 

asset-backed securities eligible for Rule 144A were 

excluded from the analysis as they are able to rely 

on a different exception. 

164See also a relevant discussion in supra note 

120. Eliminating the Investment Grade Exception, 

however, could affect the ability of foreign 

sovereign issuers to purchase any of such issuer’s 

securities. See discussion in infra Part VIII.C.5 and 

Arnold & Porter Letter at 3. 

165See supra Part VII.C.1. 

166The Commission estimates the wage rate based 

on salary information for the securities industry 

compiled by SIFMA. See Management & 

Professional Earnings in the Securities Industry— 

2013, SIFMA (Oct. 7, 2013), available at https://

www.sifma.org/resources/research/managementand-professional-earnings-in-the-securitiesindustry-2013/. These estimates are modified by the 

Commission staff to account for an 1800 hour workyear and multiplied by 5.35 (professionals) or 2.93 

(office) to account for bonuses, firm size, employee 

benefits and overhead. These figures have been 

adjusted for inflation through the end of 2021 using 

data published by the Bureau of Labor Statistics. 

237 distribution participants × 3 hours × $338 hour 

for a compliance manager = $240,318.00. 

167See supra Part V.C.1. 

168 19,076 offerings × 1 hour × $338 hour for a 

compliance manager = $6,447,688. 

169See supra note 84. 

170See supra Part IV.A.1.c). 

171See supra Part VII.C.2. 

172 237 distribution participants × 25 hours × 

$338 hour for a compliance manager = $2,002,650. 

173See supra Part V.C.1. 

174 237 distribution participants × 10 hours × 

$338 for a compliance manager = $801,060. 

for year 2021 asset-backed securities 

issuances demonstrates that 78% of 

Form SF–3 filers’ issuances have 

investment grade status (362 out of 464 

rated issuances), while the remaining 

22% of issuances have non-investment 

grade status (102 issuances).163 To the 

extent that asset-backed securities for 

which a Form SF–3 is filed includes 

securities that have low manipulation 

risk but lack an investment grade rating, 

the additional benefit of the proposed 

amendments is allowing such low 

manipulation risk issues to rely on the 

exception and encouraging participation 

in the relevant market. 

The Commission is proposing to 

eliminate the exception entirely from 

Rule 102, as discussed above, given the 

heightened risk of manipulation that 

exists for issuers and selling security 

holders and absence of a need to 

facilitate an orderly distribution or to 

limit potential disruptions in the trading 

market, coupled with our understanding 

that the Investment Grade Exception is 

generally not relied upon in practice, as 

issuers and selling security holders who 

are subject to Rule 102, unlike brokerdealers, typically do not trade 

outstanding issues of their own 

securities that are identical to the issue 

being distributed in the secondary 

market.164 The economic benefit of the 

proposed amendment is that it may 

contribute to the Dodd-Frank Act goals 

of reducing perceived government 

endorsement of NRSROs and overreliance on credit ratings by market 

participants in Regulation M by 

removing the relevant reference to credit 

ratings. 

C. Costs of the Proposed Amendment 

The Commission recognizes that some 

of the affected distribution participants 

may bear costs from the proposed 

amendments. The proposed 

amendments may alter the universe of 

securities that can rely on the exception 

and additionally may prevent issuers 

from using the exception in some cases 

potentially leading to fewer issues of the 

affected securities. If some distribution 

participants decide not to participate in 

certain issues as a result of the proposed 

amendments, the costs of the affected 

issues may increase. For example, when 

fewer banks or broker-dealers are 

available, these distribution participants 

may be able to charge higher fees. 

Additionally, as the result of the 

proposed amendments fewer issues may 

take place, potentially limiting issuers’ 

ability to raise capital and affecting 

investors in the relevant securities as 

the available security selection and 

liquidity may be reduced. 

There are several types of costs that 

could arise: (1) Costs associated with 

calculations or obtaining the probability 

of default estimate; (2) costs associated 

with maintaining records related to the 

probability of default estimation; (3) 

costs due to the probability of default 

being an imperfect proxy for creditworthiness, (4) asset-backed securities’ 

costs associated with the proposed 

amendments, (5) costs related to Rule 

102 amendments (6) indirect and other 

costs of the amendments. We discuss 

these costs in detail below. 

1. Costs Associated With Obtaining the 

Estimate of the Probability of Default 

Distribution participants may incur 

costs related to determining the 

probability of default. Consistent with 

the PRA section,165 the Commission 

estimates that it would take a 

distribution participant 3 hours to 

establish a system to gather the data 

serving as the inputs and then perform 

the analysis necessary to calculate the 

probability of default of the issuer 

whose securities are the subject of the 

distribution, for an aggregate cost of 

$240,318.166 Consistent with the PRA 

section,167 the Commission also 

estimates that it would take a 

distribution participant one hour to 

gather the inputs required to calculate 

probability of default each time it 

participates in a distribution of 

Nonconvertible Securities. There were 

19,076 offerings of Nonconvertible 

Securities in 2020. Therefore, it is 

estimated that annually distribution 

participants would spend $6,447,688 168

in the aggregate complying with this 

requirement. 

Any costs associated with using a 

vendor to obtain probability of default 

estimate should be minimal, as the 

Commission preliminarily believes that 

distribution participants engaged in the 

offering of Nonconvertible Securities 

would typically already have 

subscriptions to vendors that provide 

calculations regarding the probability of 

default based on Structural Credit Risk 

Models.169 Furthermore, we believe that 

distribution participants, in particular 

those that choose to determine the 

probability of default estimate 

internally, would already have the 

computational resources necessary to 

conduct such analysis internally.170

2. Costs Associated With Maintaining 

Records Related to the Probability of 

Default Estimation 

Distribution participants would also 

incur costs related to capturing and 

maintaining records regarding the 

probability of default determination. 

Consistent with the PRA section,171 the 

Commission estimates that it would take 

a distribution participant 25 hours to 

update the applicable policies and 

systems required to account for 

capturing the records made pursuant to 

proposed Rule 101(c)(2)(i), for an 

aggregate cost of $2,002,650.172

Consistent with the PRA section,173 the 

Commission also estimates that it would 

take a distribution participant 10 hours 

to maintain such records as well as to 

make additional updates to the 

applicable recordkeeping policies and 

systems to account for the proposed 

rules. Therefore, it is estimated that 

annually broker-dealers would spend 

$801,060 174 in the aggregate complying 

with this requirement. 

3. Costs Associated With Structural 

Credit Risk Model Based Probability of 

Default Being an Imperfect Proxy for 

Credit-Worthiness 

As discussed previously, the 

proposed Structural Credit Risk Models 

are designed to measure creditworthiness, and credit-worthiness itself 


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175See, for example, Rothwell at 2 and ABA at 

15 –17. 

176See, e.g., John Y. Campbell, Jens Hilscher, & 

Jan Szilagyi, In Search of Distress Risk, 63 J. Fin. 

2899 (2008), available at https://scholar.harvard.

edu/files/campbell/files/campbellhilscherszilagyi_

jf2008.pdf. 

177See COVID–19 Market Monitoring Group, 

supra note 160 (‘‘Cost of debt capital is driven by 

a wide range of financial and non-financial factors 

and forces; ratings downgrades are generally lagging 

indicators of cost of debt capital.’’). 

178The definition of Structural Credit Risk 

Models for purposes of Rule 101(c)(2)(i) is limited 

to commercially or publicly available models, 

which would limit a distribution participant’s 

ability to develop its own models to achieve 

favorable results. 

179COVID–19 Market Monitoring Group, supra 

note 160 (‘‘Cost of debt capital is driven by a wide 

range of financial and non-financial factors and 

forces; ratings downgrades are generally lagging 

indicators of cost of debt capital.’’). 

is considered to be a good measure of 

manipulation risk. There are costs that 

are currently present in the relevant 

markets associated with creditworthiness being an imperfect proxy for 

manipulation risk. However, in the 

absence of a better proxy for 

manipulation risk, credit-worthiness has 

continued to successfully serve the 

purpose of measuring such risk for 

many years. This is also supported by 

the comments stating that investment 

grade standard has been successfully 

used in Rules 101 and 102 exception.175

The proposed amendments are not 

expected to alter those costs and the 

discussion that follows focuses instead 

on the costs associated with the 

proposed Structural Credit Risk Models 

as a proxy for credit-worthiness. 

The use of any model to estimate 

credit-worthiness necessarily provides 

an imperfect measure. Structural credit 

risk models are no exception. We note, 

however, that NRSROs similarly may 

rely on imperfect models of estimating 

issuer credit-worthiness. Moreover, 

models such as Structural Credit Risk 

Models often are a part of the analysis 

involved in obtaining a credit rating.176

Some ways to implement Structural 

Credit Risk Models make use of 

historical trading data to produce a 

reliable estimate of the model input 

parameters. These data may not be 

available for certain infrequently traded 

securities. In some circumstances the 

market for a security has not yet been 

established and sufficient trading data 

are unavailable, making it difficult to 

apply the exception. 

Additionally, Structural Credit Risk 

Models rely on a number of parameter 

estimates such as firm market value and 

volatility, which could be difficult to 

assess as these values change with 

market conditions and business 

fluctuations. A changing term structure 

of interest rates and noise trading in the 

market can further distort the 

probability of default estimates. 

Incorrect parameter estimates may result 

in the incorrect estimates of default 

probability and allow distribution 

participants to rely on the exception for 

risky issues or prevent distribution 

participants from relying on the 

exception for safe issues. Implied 

probabilities of default are sensitive to 

market prices and estimates of market 

volatility and consequently tend to be 

counter cyclical, increasing during 

market downturns, which are often also 

periods of increased uncertainty. A 

constant threshold which is not timevarying would potentially result in 

fewer firms qualifying for the exception 

during market downturns, which may 

result in more issuances during this 

period not qualifying or firms choosing 

not to issue, hence increasing their cost 

of capital or limiting their access to 

capital. While credit rating downgrades 

are also counter cyclical, they tend to be 

slow in incorporating updates 177 and 

relatively fewer firms will have an 

investment grade credit rating during 

downturns, the impact of the counter 

cyclicality of default probabilities 

implied by Structural Credit Risk 

Models would be stronger relative to 

using credit ratings: During periods of 

distress, using these probabilities of 

default will likely result in fewer firms 

with an investment grade credit rating 

falling below the threshold, and thus 

fewer firms qualifying for the exception 

relative to using credit ratings. 

Distribution participants would, 

however, be able to adjust the required 

estimated model parameters and inputs 

frequently as market conditions change, 

mitigating the costs discussed above. 

Due to the number of variations 

among Structural Credit Risk Models 

and their estimated inputs, the 

probability of default estimates may be 

subjective to some extent and not 

comparable across different issuers or 

for the same issuer across different 

issues if estimates are based on different 

models, or done by different researchers 

or vendors. The latter may affect market 

participants’ ability to effectively rely 

on the estimates to make comparative 

assessments across multiple securities. 

However, this is also true of the credit 

ratings that often rely on similar models, 

which mitigates these costs of the 

proposed amendments relative to the 

market baseline. 

In addition, as discussed previously 

in reference to the selected threshold, 

the amendment may expand slightly the 

universe of firms that qualify for the 

exception and include firms that did not 

receive an investment grade credit 

rating, but have a structural credit 

model implied probability of default 

that falls below the threshold. The debt 

prices of these firms may be prone to 

manipulation if the price of their debt 

is relatively less sensitive to aggregate 

interest rate changes. 

Additionally, this amendment may 

create potential opportunities for new 

products offered by the vendors 

designed specifically for a given issue or 

issuer. A custom designed estimate paid 

for by the issuer may lead to potential 

conflicts of interest since the vendor is 

incentivized in this case to produce an 

estimate which would allow the issuer 

to rely on the exception. However, the 

existing major vendors supplying 

probability of default estimates have 

numerous clients currently using this 

information for business purposes other 

than the Rule 101 exception. Therefore, 

given the reputational concerns it is 

unlikely that these vendors would 

produce a slightly different product to 

cater specifically to the use of these 

estimates for purposes of relying on the 

Rule 101 exception. Additionally, the 

model input estimates or assumptions 

may be tweaked by the distribution 

participants in such a way as to produce 

the desired estimation result if the 

model is estimated internally and may 

result in market participants’ adjusting 

the models so as to be able to rely on 

the exception.178 This may result in an 

additional cost of adding some 

manipulation risk to the relevant 

markets if manipulation prone issues 

are allowed to rely on the exception as 

a result. 

Finally, the proposed threshold of 

0.055% for the exception is based on 

model assumptions and historical data. 

Future market evolution may result in 

this threshold becoming either too large 

or too small, allowing risky issues to 

rely on the exception or preventing safe 

issues from using it. This may vary by 

industry, with the threshold being more 

restrictive in some industries relative to 

the original NRSRO investment grade 

designation. Moreover, probabilities of 

default as implied by Structural Credit 

Risk Models tend to be counter-cyclical 

and can spike in periods of crisis due to 

decreases in market valuation and 

increases in equity volatility. 

Consequently, fewer investment grade 

firms would fall below the threshold. 

Credit rating by NRSROs are also 

countercyclical but tend to be slow 

moving, since credit rating changes 

often lag updates to firm conditions that 

would impact cost of capital.179


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180Arnold & Porter Letter at 3. 

181See supra note 121. 

4. Costs Associated With Asset-Backed 

Securities’ Amendments 

The proposed amendments may 

render some asset-backed securities 

ineligible to rely on the exception from 

the Regulation M. This may increase 

issuance costs for the distribution 

participants. For instance, brokerdealers may reduce an offering’s size or 

increase fees if required to comply with 

Regulation M. Additionally, distribution 

participants may need to establish new 

business relationships due to Regulation 

M restrictions. Furthermore, some 

issuers may decide not to issue the 

affected securities if required to comply 

with Regulation M restrictions. As a 

result, some asset-backed securities’ 

issues may not take place, which could 

affect issuers’ ability to raise capital and 

could affect investors in the relevant 

markets by potentially reducing the 

selection of the available asset-backed 

securities. 

5. Costs Associated With Amendments 

to Rule 102 

As discussed previously, the effect of 

eliminating the exception from Rule 102 

is expected to be minimal since the 

exception is likely not useful from a 

practical standpoint, because the issuers 

and selling security holders who are 

subject to Rule 102 typically do not 

trade their own securities that are being 

issued. However, as was identified 

previously in a comment letter, an 

Investment Grade Exception from Rule 

102 could affect the ability of foreign 

sovereign issuers or their affiliates to 

purchase any of such issuer’s 

securities.180 In the past the 

Commission has issued exemptive relief 

for some foreign sovereign issuers 

because they trade, as represented in 

incoming letters, based on a yield 

spread to US treasuries.181 This might 

mean that bonds of foreign sovereign 

issuers are less susceptible to 

manipulation risk since there is less 

uncertainty in regards to their valuation. 

Eliminating the exception from Rule 102 

may increase issuance costs or deter 

market participants from issuing such 

securities with low manipulation risk. 

6. Indirect and Other Costs of the 

Amendments 

Besides the direct effects on the 

distribution participants and affected 

securities discussed above the proposed 

amendment may also generate indirect 

effects on investors in these securities 

and NRSROs. For instance, if issuer 

participation in the relevant security 

issues becomes limited, some issues 

may not take place that otherwise 

would. Investors may face a more 

limited choice of investment 

instruments as a result, for example in 

the case of reopenings. This may further 

affect liquidity of their portfolios since 

reopenings can offer additional liquidity 

benefits as the securities offered in 

reopenings are interchangeable with the 

existing issues. However, as already 

discussed, these costs are expected to be 

minimal as reopenings are used 

infrequently. 

The proposed amendment does not 

rely on an NRSRO rating in order to 

determine if an issue can rely on the 

exception. This may diminish NRSROs’ 

clientele to the extent NRSROs choose 

not to provide Structural Credit Risk 

Model-based estimates of the probability 

of default for their existing clients 

opting to rely on the exception. 

However, the amendment may increase 

the clientele of the vendors that supply 

relevant data and metrics to the 

distribution participants if such vendors 

already supply probability of default 

estimates or choose to offer this estimate 

as a part of their services. In addition, 

if firms do not solicit credit rating 

services from NRSROs beyond the 

estimate of a probability of default 

implied by a Structural Credit Risk 

Model, investors will not be able to 

benefit from the information provided 

by a credit rating report and ongoing 

coverage of the firm that otherwise 

would be provided through the 

distribution participant. 

D. Efficiency, Competition, and Capital 

Formation 

As discussed previously, distribution 

participants will have flexibility to 

select the best Structural Credit Risk 

Model to access credit-worthiness as a 

measure of manipulation risk for their 

business. This may encourage market 

participation in affected security issues 

and, as a result, could improve 

competition between issuers for the 

investors as well as between other 

distribution participants. Further, 

widely available estimates of the 

probability of default as well as an 

option of internal model estimation 

could lead to a more competitive 

environment as the requirement to rely 

on proprietary credit risk models of a 

small number of NRSROs is removed. 

The improved competition, market 

participation and efficiency ultimately 

should lead to more efficient capital 

formation as the access to and 

functioning of the relevant fixed income 

markets improves. We note however 

that these effects are not expected to be 

significant because the exceptions in 

Rules 101 and 102 affect only a small 

portion of the relevant market as 

discussed previously. 

However, while unlikely, it is 

possible that a new business model 

could emerge in the relevant markets 

that leads to conflicts of interest and 

neutralizes the effects discussed above. 

For instance, distribution participants 

could contract with a vendor or a credit 

rating agency directly to create a custom 

estimate of the probability of default. 

This could result in a business model 

where an issuer pays for the supplied 

estimate and where vendors may be 

incentivized to produce an estimate 

designed to fit the desired estimation 

result. Thus issues that otherwise would 

not be able to rely on the exception 

could end up being excepted potentially 

increasing the manipulation risk in the 

relevant markets, which in turn could 

negatively affect competition and 

capital formation. 

Further, the positive effects discussed 

above could be offset by the fact that 

some issuers may face higher costs or no 

longer be able to use the exception, for 

example, due to imperfect model 

estimates as a result of market 

fluctuations or changing market. High 

costs of issuance or inability to rely on 

the exception may deter participants 

from issuing the affected securities, 

which could impact the competition 

and capital formation in the relevant 

markets. Further, potential negative 

effects of non-uniform estimates and 

subjectivity additionally reduce these 

benefits. Finally, potentially increased 

issuance costs due to some asset-backed 

securities being ineligible for the 

exception may also negatively affect 

market participation and competition of 

the relevant markets. 

E. Reasonable Alternatives 

Alternative 1 discussed below deals 

with the proposed threshold, 2–4 

propose alternative approaches to using 

Structural Credit Risk Models as a 

standard of credit-worthiness to 

measure manipulation risk. Alternative 

5 discusses elimination of the 

exception, alternative 6 deals with assetbacked securities, while alternative 7 

discusses Rule 102 options. 

1. Alternative Threshold for Probability 

of Default 

The proposed threshold of 0.055% 

was chosen so as to capture most of the 

investment grade securities while at the 

same time capturing the fewest of the 

non-investment grade securities. 

However, a different threshold could be 

used in the proposed exception, which 

would capture different proportions of 

investment and non-investment grade 

securities. For example, a higher 


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18334 Federal Register / Vol. 87, No. 61 / Wednesday, March 30, 2022 / Proposed Rules 

182 2883 issues captured by the new proposed 

standard (with probability of default below 0.5%) 

consist of 2673 investment grade issues and 210 

non-investment grade rated issues. 

183 1811 issues captured by the new proposed 

standard (with probability of default below 0.01%) 

consist of 1760 investment grade issues and 51 noninvestment grade rated issues. 

184Empirical duration is bond duration 

calculated based on historical data rather than a 

formula. Typically, it is estimated using a 

regression analysis of the relationship between 

market bond prices and Treasury yields. 

185 2011 Proposing Release, 76 FR 26557–64. 

186See also a related discussion in supra note 70. 187 2008 Proposing Release, 73 FR 40095–97. 

threshold of 0.5% is estimated to 

capture about 98.6% of investment 

grade securities (2673 out of 2710 

investment grade issues), overall 

resulting in 2883 issues that can rely on 

the exception under the proposed 

standard.182 A lower threshold of 0.01% 

is estimated to capture about 65% of 

investment grade securities (1760 out of 

2710 investment grade issues) and 

overall results in 1811 issues that can 

rely on the exception under the 

proposed standard.183 The advantage of 

a higher threshold is that it captures a 

larger set of investment grade securities, 

but at the expense of also capturing a 

small set of non-investment grade 

securities, which could be more prone 

to manipulation risk. As alternatives, 

the Commission could increase the 

threshold, which would allow more 

investment grade securities to rely on 

the exception at expense of potentially 

a higher manipulation risk; or decrease 

the threshold, which would limit the 

ability of some of the investment grade 

securities to use the exception, but 

would potentially also limit the number 

of non-investment grade securities 

allowed to rely on the exception and, as 

a result, also limit manipulation risk. 

As an alternative to providing a 

specific number as a threshold, the 

Commission could specify a method for 

distribution participants to use in 

calculating such a threshold. For 

example, such method could involve 

calculating probability of default for a 

sample of nonconvertible securities 

similar to the distribution participant’s 

securities issued over a specified time 

interval and comparing it to investment 

grade status or another specified 

standard of credit-worthiness. A longer 

time interval would capture more issues 

and improve statistical accuracy at 

expense of having market conditions 

potentially changing and generating 

incorrect estimates. A shorter time 

interval ensures the market conditions 

have not changed but includes fewer 

issues resulting in a smaller sample and 

lower statistical accuracy. 

The main advantage of specifying a 

method as opposed to a number for the 

threshold is its flexibility with respect 

to changing market conditions. The 

main disadvantage of this alternative is 

subjectivity of the analysis involved, 

which may lead to non-uniform 

application of the Regulation M 

exception across issues or issuers; or 

lead to market participants adjusting the 

estimation to be able to rely on the 

exception. 

2. Exception Based on Security 

Characteristics 

As an alternative replacement for the 

reference to investment grade securities, 

the Commission has considered analysis 

that could be based on security 

characteristics, such as (1) total amount 

of issue outstanding (public float); (2) 

yield to maturity of the security during 

a past trading period; or (3) empirical 

duration.184 Other relevant security 

characteristics that could be used are 

outlined in the 2011 Proposal.185 Such 

analysis could be performed internally 

or externally and could be additionally 

verified by a third party. Below we 

discuss public float, yield to maturity 

and empirical duration criteria in more 

detail. 

• Exception Based on the Total 

Amount of Issue Outstanding (Public 

Float). 

To the extent that it is more difficult 

to manipulate price of a larger issue, 

public float could be used as an 

alternative criterion to reflect 

manipulation risk. This criterion has the 

advantage of being straightforward and 

easy to evaluate. Due to its simplicity it 

lacks the estimation issues associated 

with other measures such as the 

probability of default. However, 

determination of a threshold for public 

float to select securities for the 

exception is complicated due to its 

considerable variation across issuers or 

industries. A specific threshold 

selection could potentially disadvantage 

smaller issuers—especially during 

periods of market downturns when 

valuations are low.186

• Exception Based on Yield to 

Maturity. 

Securities that are traded primarily on 

yield and maturity have low 

manipulation risk, as discussed before, 

since their pricing does not reflect 

issuer specific risks. Yield to maturity, 

therefore, can be used as an alternative 

criterion to evaluate manipulation risk. 

However, using yield to maturity as a 

criterion for securities eligible for the 

exception is also problematic. Even 

though this criterion is similarly easy to 

obtain and lacks any major estimation 

issues, selecting a threshold is not 

straightforward. For instance, yield to 

maturity differs considerably by 

industry. Selecting a fixed threshold 

may result in some industries being 

under-represented and others overrepresented in the pool of eligible 

issues. Moreover, yield to maturity often 

moves with risk-free rates; thus fewer 

firms would be excepted during periods 

of high interest rates. 

• Exception Based on Empirical 

Duration. 

Empirical duration is another 

alternative proxy that can be used to 

evaluate Nonconvertible Securities for 

an exception from Regulation M. 

Negative empirical duration might be an 

indication that a Nonconvertible 

Security or its issuer is of low creditworthiness. A Nonconvertible Security 

with negative empirical duration is less 

impacted by changes in interest rates 

than Nonconvertible Securities of 

credit-worthy issuers and trades similar 

to equity securities. Although negative 

empirical duration may demonstrate 

that a particular issuer or security is not 

credit-worthy, it has some limitations 

that impact the viability of negative 

empirical duration as a substitute for the 

Investment Grade Exception. In 

particular, this measure relies heavily 

on statistical analysis, requires the 

Nonconvertible Security to be traded, 

and may lack intuitive interpretation, 

which renders empirical duration a poor 

proxy for the type of manipulation that 

Regulation M is designed to prevent. 

3. Exception Based on Issuer 

Characteristics 

The Commission has also considered 

an exception based on issuer 

characteristics, for example, the interest 

coverage ratio, the WKSI standard, as 

suggested in the 2008 Proposal,187 or a 

criterion based on a reduced-form credit 

risk model, as an alternative to the 

Structural Credit Risk Models. We 

discuss these alternatives below. 

• Exception Based on the WKSI 

Standard. 

The Commission could adopt the 

WKSI standard as a criterion to 

determine eligibility for the exception. 

The issuers that fall under the WKSI 

definition are large and established 

firms that typically have sound creditworthiness. The advantage of this 

characteristic is its simplicity and 

straightforward calculations. However, 

the WKSI standard as discussed in the 

2008 Proposal was heavily criticized, for 

instance for allowing risky high-yield 

issues to be eligible for the exception 

and preventing issues by smaller but 


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188ABA Letter at 15–17 and SIFMA Letter 1 at 13. 

189The reduced-form credit risk models are 

discussed, for example, in Robert Litterman & 

Thomas Iben, Corporate Bond Valuation and the 

Term Structure of Credit Spreads, 17 (3) Fin. 

Analysts J. 52, 52–64 (1991); Robert A. Jarrow & 

Stuart M. Turnbull, Pricing Derivatives on Financial 

Securities Subject to Default Risk, 50 J. Fin. 53, 53– 

86 (1995); Robert A. Jarrow, David Lando, & Stuart 

M. Turnbull, A Markov Model for the Term 

Structure of Credit Risk Spreads, 10 Rev. Fin. Stud. 

481, 481–523 (1997); Darrell Duffie & Kenneth J. 

Singleton, Modeling the Term Structures of 

Defaultable Bonds, 12 Rev. Fin. Stud. 687, 687–720 

(1999). 

190See Removal of Certain References to Credit 

Ratings Under the Securities Exchange Act of 1934, 

Release No. 34–71194 (Dec. 27, 2013) [79 FR 1522, 

1527–28 (Jan. 8, 2014)]. 

191This is unlike the Structural Credit Risk Model 

based probability of default that would imply the 

same costs for all the participants who obtain the 

estimated values. 

otherwise credit-worthy issuers from 

relying on the exception.188

• Exception Based on the Interest 

Coverage Ratio. 

Another possible issuer-based 

criterion for exception eligibility is the 

interest coverage ratio. A high interest 

coverage ratio typically indicates the 

issuer’s ability to repay debt and can be 

used as a criterion to reflect creditworthiness. It has the advantage of being 

a simple and easy to calculate value. 

However, the interest coverage ratio is 

an accounting measure that can result in 

inconsistent outcomes as it is based on 

the reported earnings rather than cash 

flows. Reported earnings may differ 

based on accounting practices of the 

firm. The proposed Structural Credit 

Risk Models have an advantage over 

interest coverage ratio since they are not 

dependent on reported earnings, which 

are heavily influenced by accounting 

practices. 

• Exception Based on Reduced-Form 

Credit Risk Model. 

An alternative to using Structural 

Credit Risk Models is reduced-form 

credit risk models.189 The latter models 

could be a good measure of creditworthiness and of manipulation risk to 

the extent that credit-worthiness is a 

good proxy for manipulation risk. 

Unlike structural models, reduced-form 

models do not assume default occurs 

when firm value falls below a threshold. 

The default is instead assumed to follow 

an unobserved process and the default 

model can be fitted to the market data. 

The advantage of these models is they 

do away with some of the unrealistic 

requirements of Structural Credit Risk 

Models, for example when the firm 

value, its volatility or other required 

parameters are unobserved. Even though 

such models can be considered more 

flexible and may provide better fit for 

the observed default events, their ability 

to predict future defaults may not 

necessarily exceed that of the structural 

models. In addition, unlike structural 

models, they suffer from a lack of 

theoretical background of the assumed 

relationships, or the intuitive 

interpretation of the model 

dependencies and why the defaults 

occur. Unrestricted use of these models 

might also provide more opportunity to 

choose a reduced-form model 

specification which enables use of the 

exception. 

4. Exception Based on Issuer and Issue 

Characteristics 

The Commission considered, as 

another alternative, an analysis based on 

both security and issuer characteristics; 

for example, characteristics outlined in 

Exchange Act Rule 15c3–1. Rule 15c3– 

1 specifies a set of factors to determine 

a minimum amount of credit risk 

broker-dealers can use to determine if a 

security can qualify for lower haircuts: 

(1) Credit spreads; (2) securities-related 

research; (3) internal or external credit 

assessments; (4) default statistics; (5) 

inclusion in an index; (6) enhancements 

and priorities; (7) price, yield and/or 

volume; or (8) asset-class specific 

factors.190 Some of these factors, such as 

default statistics or credit assessments, 

measure issuer credit-worthiness, while 

others, such as price, yield, or volume, 

measure the manipulation risk present 

in each specific issue, providing a good 

overall assessment of manipulation risk. 

The advantage of this alternative is 

that it would align the exception with 

already existing standards that brokerdealers might apply to determine 

whether a security has a minimal 

amount of credit risk. The standard in 

Rule 15c3–1 was adopted in 2013 as a 

replacement for a reference to 

investment grade securities pursuant to 

Section 939A of the Dodd-Frank Act. 

Such test could have minimum 

additional costs for broker-dealers who 

already have all the necessary 

procedures in place for its application. 

However, the scope and objectives of 

the 15c3–1 standard and the exception 

in Rules 101 and 102 of Regulation M 

are different: The 15c3–1 standard 

applies only to broker-dealers, which 

already have the necessary 

arrangements in place to apply 15c3–1 

standard, whereas the Regulation M 

exceptions affect a broader range of 

market participants. For example, banks 

involved in the relevant security issues 

will also be affected. Depending on 

these other participants’ systems and 

regulatory obligations, it may be costly 

for them to replace the investment grade 

standard with the minimal credit risk 

standard. This could result in a 

situation where different distribution 

participants are facing different costs,191

possibly deterring some market 

participants. 

5. Elimination of the Exception 

The Commission also considered 

eliminating the exception for fixedincome securities. The advantage of this 

alternative is a more uniform 

application of Regulation M, which 

eliminates the situations when 

manipulation-prone securities fall under 

the exception due to limitations of 

proxies used to select the securities to 

be excepted. For instance, as discussed 

above, there are various limitations of 

the Structural Credit Risk Models’ 

applications, which may limit the 

ability of certain issuers to rely on the 

exception or allow issuers with a higher 

risk of having their securities 

manipulated to avoid Regulation M. If 

the exception is eliminated, any 

limitations of such a proxy for 

manipulation risk are eliminated as 

well. 

In addition, this approach could 

ultimately relieve broker-dealers from 

the need to spend time or costs to 

implement, understand, and calibrate 

any proposed standard such as a 

Structural Credit Risk Model. The 

Commission preliminarily believes that 

most broker-dealers already have the 

capability to undertake those 

calculations themselves or procure them 

from a data vendor and would benefit 

from the continued availability of an 

exception despite the costs. 

However, this approach raises a 

number of concerns. Specifically, 

eliminating the exception could make 

some offerings in the excepted securities 

considerably more costly. For example, 

with respect to reopenings, brokerdealers who might otherwise elect to 

reopen a bond offering may determine 

not to do so to avoid restrictions of 

Regulation M that could arise during 

such a reopening if it becomes a sticky 

offering. This could increase the cost of 

the issue that has to rely on the nextbest alternative structure. Further, an 

alternative transaction structure, if 

selected, may decrease the liquidity of 

the securities being issued because they 

would not be fungible with the 

previously issued securities. This may 

also result in some distribution 

participants, such as broker-dealers, 

deciding not to participate. This could 

limit the number of available 

participants, potentially increasing fees 

faced by the issuers. Further, if certain 


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192See supra note 120. 

issues do not take place under the 

proposed amendments, it could reduce 

the selection of available securities for 

the investors in the relevant markets 

and may limit issuers’ ability to raise 

capital. 

However, these costs might be 

mitigated because a party subject to the 

prohibitions of Rules 101 or 102 could 

structure its buying activity before or 

after the applicable restricted period so 

as not to incur any costs associated with 

relying on the exceptions. 

The above arguments apply to all 

currently excepted investment grade 

securities because any such issue can 

become a sticky offering and the 

distribution participants have to 

account and adjust for this possibility 

ex-ante. In a scenario where an 

underwriter is unable to sell its allotted 

securities to the public on or promptly 

after the pricing date, there is no 

exception on which to rely, the 

underwriter/broker-dealer would likely 

ex-ante adjust the cost of issuance to 

reflect this added risk. Broker-dealers 

could be more cautious in structuring 

potentially sticky offerings if they know 

they will be required to comply with 

Regulation M (and have no exceptions 

available), by reducing an offering’s size 

or increasing fees as a risk premium. 

This could potentially raise the cost of 

investment grade offerings. However, 

this could also decrease the probability 

of an offering to become sticky, 

potentially reducing manipulation risk 

in the relevant markets. 

The removal of the exception could 

also affect the liquidity of the fixedincome issues if reopenings of issues 

already in circulation are more costly, 

potentially reducing issuers’ reliance on 

this financing structure, which 

negatively impacts the investors in the 

relevant markets. 

This alternative could also disrupt 

some established business relationships. 

In certain circumstances new 

relationships may need to be 

established. For example, if an offering 

becomes sticky, the issuer may need to 

seek a different broker-dealer to comply 

with the Regulation M requirements. 

This would increase costs of the affected 

security offerings, including the new 

broker dealer fees or the search costs, 

especially when the market has a 

limited number of available brokerdealers. 

6. Alternative for Asset-Backed 

Securities 

As an alternative for asset-backed 

securities the Commission could use a 

standard based on the value at risk. 

Value at risk measures the percentage 

loss of the security in the worst case 

scenarios over a specified time period. 

It can be estimated by performing a 

simulation over the underlying 

securities’ pool and determining the 

cash flows available to the asset-backed 

security in each scenario. A number of 

commercially available options can be 

used to perform this analysis. Value at 

risk can be a good indicator of 

manipulation risk since low value at 

risk indicates that the majority of the 

cash flows are sufficiently assured. The 

price of the asset-backed security in this 

case is more certain and is less subject 

to manipulation risk. 

However, value at risk is by 

construction estimated for a specified 

time period and thus only accounts for 

the potential losses during such period, 

while losses may also occur after this 

time period. In this case the price of the 

asset-backed security may depend on 

issue-specific factors and be prone to 

manipulation despite the estimated 

value at risk over the specified time 

period being low. This may allow 

securities with high manipulation risk 

to rely on the exception. 

7. Alternatives for Rule 102 Exception 

The Commission considered 

exempting all bonds issued by a foreign 

government or political subdivision 

thereof from Rule 102 of Regulation M. 

This would allow such issuers to avoid 

compliance costs associated with 

Regulation M requirements as discussed 

above. However, this alternative implies 

excepting non-investment grade foreign 

sovereign securities along with 

investment grade foreign sovereign 

securities. This may introduce 

considerable risk that some foreign 

sovereign issuers with low creditworthiness and which are subject to a 

considerable geopolitical risk are 

allowed to rely on Regulation M 

exception. This could potentially result 

in a high pricing uncertainty and a high 

manipulation risk introduced into the 

relevant markets. 

The Commission also considered 

excepting asset-backed securities from 

Rule 102 that are offered pursuant to an 

effective shelf registration statement 

filed on Form SF–3. However, this 

alternative might introduce risk 

regarding issuers, selling shareholders, 

or their affiliated purchasers engaging in 

activity to favorably affect the 

distribution based on their interest in an 

offering’s outcome, without any benefit 

to facilitating orderly distributions or to 

limiting potential disruptions in the 

trading market.192 These market 

participants, unlike distribution 

participants, may have an interest in the 

specific pricing of the issue and could 

benefit from engaging in activity that 

impacts the market. Thus, excepting 

such asset-backed securities from 

requirements of Regulation M could 

introduce manipulation risk in the 

relevant markets. 

F. Request for Comment 

We solicit comments on all aspects of 

this proposal. We ask 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. 

47. Are commenters aware of any 

additional examples of situations when 

Structural Credit Risk Models cannot be 

applied or are difficult to apply? Please 

explain why these situations occur. 

48. Are there any assumptions or 

inputs of Structural Credit Risk Models 

that may be relevant to the estimation of 

the probability of default and may 

require additional clarification? 

49. Do commenters agree with the 

Commission’s assessment of the 

availability and associated costs of the 

estimates for probability of default 

based on Structural Credit Risk Models? 

Similarly, do commenters agree with the 

Commission’s assessment of availability 

and associated costs of the necessary 

software or other resources necessary to 

obtain the estimates internally? Are 

there any factors that the Commission 

failed to consider? 

50. Do commenters agree with the 

Commission’s assessment of the 

proposed method of threshold 

measurements? Would a different 

method of threshold have greater 

benefits or fewer costs than the 

proposed method of threshold 

measurements? It is difficult to select a 

threshold that would capture all of the 

investment grade securities and none of 

the non-investment grade securities due 

to the imperfect correlation of credit 

ratings and probability of default. 

Should the current method used to 

calculating the threshold aim at 

capturing a larger set of investments 

grade securities, such as a set above 

90%, or aimed at capturing a smaller set 

of non-investment grade securities, such 

as fewer than 125 issues? Should a 

different date other than October 22, 

2021, for the analysis be selected? 

Should the Commission propose a 

method for calculating the threshold 

instead of proposing a number? Should 

the Commission provide guidance on 

the sample of securities, time interval, 

standard of credit-worthiness as a basis 

for comparison, or other specifications 

that should be used in this method? 


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193 5 U.S.C. 603(a). 

194 5 U.S.C. 605(b). 

195See 17 CFR 240.17a–5(d). 

196See 17 CFR 240.0–10(c). 

197 17 CFR 240.0–10. 

198 17 CFR 240.0–10(a). 

199Public Law 104–121, Title II, 110 Stat. 857 

(1996). 

51. Are commenters aware of any 

available data that may help identify 

how many issuances of asset-backed 

securities with investment grade rating 

might be excluded under the proposed 

standard? 

52. Are commenters aware of cases 

when incorrect estimates of Structural 

Credit Risk Models’ parameters result in 

inaccurate probability of default 

estimates? For example, cases when the 

estimated probability of default is high 

for an issuer with sound creditworthiness and vice versa. Please 

provide the supporting data and 

calculations if available. 

53. Are there cases where probability 

of default is not a reasonable proxy for 

credit-worthiness and therefore 

manipulation risk? If so, why is it a poor 

proxy in those cases? 

54. What concerns, if any, do 

commenters have regarding the counter 

cyclicality of probabilities of default 

implied by Structural Credit Risk 

Models? 

IX. Regulatory Flexibility Act 

Certification 

Section 3(a) of the Regulatory 

Flexibility Act of 1980 193 (‘‘RFA’’) 

requires the Commission to undertake 

an initial regulatory flexibility analysis 

of the proposed rule 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.194

Pursuant to Section 605(b) of the RFA, 

the Commission hereby certifies that the 

proposed amendments to the rule, 

would not, if adopted, have a significant 

economic impact on a substantial 

number of 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,195 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.196

With respect to the amendments to 

Rules 101 and 102, it is unlikely that 

any broker-dealer who is defined as a 

‘‘small business’’ or ‘‘small 

organization’’ as defined in Rule 0– 

10 197 could be an underwriter or other 

distribution participant as it would not 

have sufficient capital to participate in 

underwriting activities. Small business 

or small organization for purposes of 

‘‘issuers’’ or ‘‘person’’ other than an 

investment company is defined as a 

person who, on the last day of its most 

recent fiscal year, had total assets of $5 

million or less.198 We believe that none 

of the various persons that would be 

affected by this proposal would qualify 

as a small entity under this definition as 

it is unlikely that any issuer of that size 

had investment grade securities that 

could rely on the existing exception. 

Therefore, we believe that these 

amendments would not impose a 

significant economic impact on a 

substantial number of small entities. 

We encourage written comments 

regarding this certification. The 

Commission solicits comment as to 

whether the proposed amendments to 

Rules 101 and 102, and Rule 17a–4 

could have an effect on small entities 

that has not been considered. We 

request that commenters describe the 

nature of any impact on small entities 

and provide empirical data to support 

the extent of such impact. 

X. Consideration of Impact on the 

Economy 

For purposes of the Small Business 

Regulatory Enforcement Fairness Act of 

1996,199 the Commission is also 

requesting information regarding the 

potential impact of the proposed 

amendments on the economy on an 

annual basis. In particular, comments 

should address whether the proposed 

changes, if adopted, would have a 

$100,000,000 annual effect on the 

economy, cause a major increase in 

costs or prices, or have a significant 

adverse effect on competition, 

investment, or innovations. Commenters 

are requested to provide empirical data 

and other factual support for their views 

to the extent possible. 

Statutory Basis and Text of Proposed 

Amendments 

Pursuant to the Exchange Act, 15 

U.S.C. 78a et seq., and particularly 

Sections 3(b), 15, 23(a), and 36 (15 

U.S.C. 78c(b), 78o, 78w(a), and 78mm) 

thereof, and Sections 939 and 939A of 

the Dodd-Frank Act, the Commission is 

proposing to amend Exchange Act Rules 

101 and 102. 

List of Subjects in 17 CFR Part 240 and 

242 

Broker-dealers, Fraud, Issuers, 

Reporting and recordkeeping 

requirements, Securities. 

Text of Rule Amendments 

For the reasons in the preamble, title 

17, chapter II of the Code of Federal 

Regulations is proposed to be 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, 78c–3, 78c–5, 78d, 78e, 78f, 

78g, 78i, 78j, 78j–1, 78k, 78k–1, 78l, 78m, 

78n, 78n–1, 78o, 78o–4, 78o–10, 78p, 78q, 

78q–1, 78s, 78u–5, 78w, 78x, 78dd, 78ll, 

78mm, 80a–20, 80a–23, 80a–29, 80a–37, 80b– 

3, 80b–4, 80b–11, and 7201 et seq., and 8302; 

7 U.S.C. 2(c)(2)(E); 12 U.S.C. 5221(e)(3); 18 

U.S.C. 1350; Pub. L. 111–203, 939A, 124 Stat. 

1376 (2010); and Pub. L. 112–106, sec. 503 

and 602, 126 Stat. 326 (2012), unless 

otherwise noted. 

* * * * * 

Section 240.17a–4 also issued under secs. 

2, 17, 23(a), 48 Stat. 897, as amended; 15 

U.S.C. 78a, 78d–1, 78d–2; sec. 14, Pub. L. 94– 

29, 89 Stat. 137 (15 U.S.C. 78a); sec. 18, Pub. 

L. 94–29, 89 Stat. 155 (15 U.S.C. 78w); 

* * * * * 

■ 2. Amend § 240.17a–4 by adding 

paragraph (b)(17) to read as follows: 

§ 240.17a–4 Records to be preserved by 

certain exchange members, brokers and 

dealers. 

* * * * * 

(b) * * * 

(17) The written probability of default 

determination pursuant to 

§ 242.101(c)(2)(i) of this chapter (Rule 

101 of Regulation M). 

* * * * * 

PART 242—REGULATIONS M, SHO, 

ATS, AC, NMS, AND SBSR 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–1(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. Amend § 242.101 by revising 

paragraph (c)(2) to read as follows: 


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18338 Federal Register / Vol. 87, No. 61 / Wednesday, March 30, 2022 / Proposed Rules 

§ 242.101 Activities by distribution 

participants. 

* * * * * 

(c) * * * 

(2) Certain nonconvertible and assetbacked securities. (i) The 

nonconvertible debt securities and 

nonconvertible preferred securities of 

issuers for which the probability of 

default, estimated as of the day of the 

determination of the offering pricing 

and over the horizon of 12 calendar 

months from such day, is less than 

0.055%, as determined and documented 

in writing by the distribution 

participant using a structural credit risk 

model; provided, however, that, for 

purposes of this paragraph, the term 

‘‘structural credit risk model’’ shall 

mean any commercially or publicly 

available model that calculates the 

probability that the value of the issuer 

may fall below a threshold based on an 

issuer’s balance sheet; or 

(ii) Asset-backed securities that are 

offered pursuant to an effective shelf 

registration statement filed on Form SF– 

3 (17 CFR 239.45). 

* * * * * 

§ 242.102 [Amended] 

■ 5. Amend § 242.102 by removing and 

reserving paragraph (d)(2). 

By the Commission. 

Dated: March 23, 2022. 

Vanessa A. Countryman, 

Secretary. 

[FR Doc. 2022–06583 Filed 3–29–22; 8:45 am] 

BILLING CODE 8011–01–P 

DEPARTMENT OF HOMELAND 

SECURITY 

Coast Guard 

33 CFR Part 165 

[Docket Number USCG–2022–0190] 

RIN 1625–AA00 

Special Local Regulation, Sabine 

River, Orange, TX 

AGENCY: Coast Guard, Homeland 

Security (DHS). 

ACTION: Notice of proposed rulemaking. 

SUMMARY: The Coast Guard is proposing 

to establish a temporary safety zone for 

certain navigable waters of the Sabine 

River, extending the entire width of the 

river, adjacent to the public boat ramp 

located in Orange, TX. The special local 

regulation is necessary to protect 

persons and vessels from hazards 

associated with a high-speed boat race 

competition in Orange, TX. Entry of 

vessels or persons into this zone would 

be prohibited unless authorized by the 

Captain of the Port Marine Safety Unit 

Port Arthur or a designated 

representative. We invite your 

comments on this proposed rulemaking. 

DATES: Comments and related material 

must be received by the Coast Guard on 

or before April 29, 2022. 

ADDRESSES: You may submit comments 

identified by docket number USCG– 

2022–0190 using the Federal Decision 

Making Portal at https://

www.regulations.gov. See the ‘‘Public 

Participation and Request for 

Comments’’ portion of the 

SUPPLEMENTARY INFORMATION section for 

further instructions on submitting 

comments. 

FOR FURTHER INFORMATION CONTACT: If 

you have questions about this proposed 

rulemaking, call or email Mr. Scott 

Whalen, Marine Safety Unit Port Arthur, 

U.S. Coast Guard; telephone 409–719– 

5086, email Scott.K.Whalen@uscg.mil. 

SUPPLEMENTARY INFORMATION: 

I. Table of Abbreviations 

CFR Code of Federal Regulations 

DHS Department of Homeland Security 

FR Federal Register 

NPRM Notice of proposed rulemaking 

§ Section 

U.S.C. United States Code 

II. Background, Purpose, and Legal 

Basis 

On March 9, 2022, the City of Orange, 

TX, notified the Coast Guard that it 

would be sponsoring high speed boat 

races from 9 a.m. to 6 p.m. on May 21 

and 22, 2022, adjacent to the public boat 

ramp in Orange, TX. The Captain of the 

Port Marine Safety Unit Port Arthur 

(COTP) has determined that potential 

hazards associated with high speed boat 

races would be a safety concern for 

spectator craft and vessels in the 

vicinity of these race events. 

The purpose of this rulemaking is to 

ensure the safety of vessels and the 

navigable waters of the Sabine River 

adjacent to the public boat ramp in 

Orange, TX, before, during, and after the 

scheduled event. The Coast Guard is 

proposing this rulemaking under 

authority in 46 U.S.C. 70034 (previously 

33 U.S.C. 1231). 

III. Discussion of Proposed Rule 

The COTP is proposing to establish a 

special local regulation from 8:30 a.m. 

on May 21, 2022, through 6 p.m. on May 

22, 2022. The safety zone would be 

enforced from 8:30 a.m. to 6 p.m. on 

both May 21st and May 22nd. The safety 

zone would cover all navigable waters 

of the Sabine River, extending the entire 

width of the river, adjacent to the public 

boat ramp located in Orange, TX, 

bounded to the north by the Orange 

Public Wharf and latitude 30°05′50′′ N 

and to the south at latitude 30°05′33′′ N. 

The duration of the safety zone is 

intended to protect participants, 

spectators, and other persons and 

vessels, in the navigable waters of the 

Sabine River during high-speed boat 

races and will include breaks and 

opportunity for vessels to transit 

through the regulated area. 

No vessel or person would be 

permitted to enter the safety zone 

without obtaining permission from the 

COTP or a designated representative. 

They may be contacted on VHF–FM 

channel 13 or 16, or by phone at 409– 

719–5070. 

The COTP or a designated 

representative may prohibit or control 

the movement of all vessels in the zone. 

When hailed or signaled by an official 

patrol vessel, a vessel shall come to an 

immediate stop and comply with the 

directions given. Failure to do so may 

result in expulsion from the area, 

citation for failure to comply, or both. 

The COTP or a designated 

representative may terminate the 

operation of any vessel at any time it is 

deemed necessary for the protection of 

life or property. The COTP or a 

designated representative may terminate 

enforcement of the special local 

regulation at the conclusion of the 

event. 

IV. Regulatory Analyses 

We developed this proposed rule after 

considering numerous statutes and 

Executive orders related to rulemaking. 

Below we summarize our analyses 

based on a number of these statutes and 

Executive orders, and we discuss First 

Amendment rights of protestors. 

A. Regulatory Planning and Review 

Executive Orders 12866 and 13563 

direct agencies to assess the costs and 

benefits of available regulatory 

alternatives and, if regulation is 

necessary, to select regulatory 

approaches that maximize net benefits. 

This NPRM has not been designated a 

‘‘significant regulatory action,’’ under 

Executive Order 12866. Accordingly, 

the NPRM has not been reviewed by the 

Office of Management and Budget 

(OMB). 

This regulatory action determination 

is based on the proposed size, location 

and duration of the rule. The safety zone 

would encompass a less than half-mile 

stretch of the Sabine River for eight 

hours on each of two days. The Coast 

Guard would notify the public by 

issuing Local Notice to Mariners (LNM), 


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