Rules and Forms at Issue in Removal of References to NRSRO Credit Ratings

The Commission has adopted some amendments and is considering other amendments that would eliminate references to NRSRO credit ratings in certain SEC rules and forms.

The rules and forms affected are:

The Commission on Sept. 17, 2009, voted to adopt amendments that would eliminate references in the following rules and forms:

References in Rules and Forms under the Securities Exchange Act of 1934:

Amendment to Rule 3a1-1: Under Rule 3a1-1, the Commission may require an Alternative Trading System (ATS) that qualifies as a "substantial market" in one of eight enumerated classes of securities, including investment grade corporate debt securities and non-investment grade corporate debt securities, to register as an exchange. The distinguishing characteristic of an investment grade corporate debt security is that it has been rated in one of the four highest categories by at least one NRSRO. The Commission will consider whether to amend Rule 3a1 1 by replacing investment grade corporate debt securities and non-investment grade corporate debt securities with a single category "corporate debt securities."

Amendment to Regulation ATS: The Commission will consider whether to adopt similar changes to Regulation ATS, establishing a single class of "corporate debt securities" and eliminating the existing separate classes of investment grade and non-investment grade corporate debt securities for purposes of: (1) the "fair access" requirement, whereby an ATS that exceeds certain volume thresholds in any class of securities must establish written standards for granting access to trading on its system and not unreasonably prohibit or limit any person in respect to access to the services it offers; and (2) compliance with standards regarding the capacity, integrity, and security of its automated systems.

Amendment to Form ATS-R and Form Pilot: The Commission will consider whether to adopt similar revisions to Form ATS-R and Form PILOT, combining separate categories for investment grade and non-investment grade corporate debt securities into a single category for "corporate debt securities." Form ATS-R requires each ATS to report the total unit volume and total dollar volume in the previous quarter for various categories of securities. Form PILOT requires an SRO that operates a pilot trading system without filing proposed rule changes with respect to that system, among other things, to report trading activity by classes of securities.

References in Rules under the Investment Company Act of 1940:

Amendment to Rule 5b-3: Rule 5b-3 is a look-through provision that allows an investment company ("fund") to treat a refunded bond it acquires as the U.S. Government securities that refund the payments due to investors under the bond. One of the rule's conditions is that an independent CPA must have certified that the Government securities will meet the payments due to investors under the refunded bond, unless the bond has the highest rating from an NRSRO. The Commission will consider whether to amend the rule so that the CPA certification condition will apply to all refunded securities, regardless of NRSRO ratings.

Amendment to Act Rule 10f-3: Rule 10f-3 permits funds to purchase securities in an underwritten offering in which a fund affiliate is a member of the underwriting syndicate. Under the current rule, municipal securities that a fund purchases must have received certain top NRSRO ratings. Under the amended rule, the municipal securities would have to meet certain liquidity and credit risk standards designed to protect the fund and its investors.

The Commission voted on Sept. 17 , 2009, to reopen the comment period on certain proposed rule changes to eliminate references to ratings issued by NRSROs in certain SEC rules and forms under the Exchange Act, the Investment Company Act, the Investment Advisers Act, and the Securities Act.

References in Rules under the Exchange Act:

Regulation M: The Commission proposed to remove NRSRO references from the exceptions in Rules 101(c) (2) and 102(d) (2) of Regulation M for investment-grade non-convertible debt securities, investment grade non-convertible preferred securities, and investment grade asset-backed securities. Specifically, the proposal would remove references to NRSRO ratings from the determination of whether such securities would be eligible for the exceptions, and instead would have excepted non-convertible debt securities and non-convertible preferred securities based on the "well-known seasoned issuer" concept of Securities Act Rule 405. The proposal would have also excepted asset-backed securities that are registered on Form S-3.

Rule 10b-10: Paragraph (a)(8) of Exchange Act Rule 10b-10 (the Commission's confirmation rule) requires a broker-dealer to inform a customer in the transaction confirmation if a debt security, other than a government security, is unrated by an NRSRO. The Commission proposed deleting paragraph (a)(8) from the Rule because of the concerns regarding undue reliance on NRSRO ratings and confusion about the significance of those ratings.

Net Capital Rule: The Commission proposed to remove, with limited exceptions, all references to NRSRO ratings from the net capital rule for broker-dealers, Rule 15c3-1 under the Exchange Act (''Net Capital Rule''). Under the Net Capital Rule, broker-dealers are required to maintain, at all times, a minimum amount of net capital, generally defined as a broker-dealer's net worth (assets minus liabilities), plus certain subordinated liabilities, less certain assets that are not readily convertible into cash (e.g., fixed assets), and less a percentage of certain other liquid assets (e.g., securities). When calculating net capital, broker-dealers are permitted to take a lower capital charge, called a "haircut," for certain types of securities that are rated investment grade by an NRSRO. In lieu of the references to NRSRO ratings in the Net Capital Rule, the Commission proposed substituting two subjective standards for credit risk and liquidity risk:

• For the purposes of determining haircuts on commercial paper, the Commission proposed to replace the current NRSRO ratings-based criterion with a requirement that the instrument be subject to a minimal amount of credit risk and have sufficient liquidity such that it can be sold at or near its carrying value almost immediately.
• For the purposes of determining haircuts on nonconvertible debt securities as well as on preferred stock, the Commission proposed to replace the current NRSRO ratings-based criterion with a requirement that the instrument be subject to no greater than moderate credit risk and have sufficient liquidity such that it can be sold at or near its carrying value within a reasonably short period of time.

References in Rules under the Securities Act:

The Commission also voted to re-open the comment period for proposals to replace investment grade ratings in certain eligibility criteria that permit issuers to conduct primary offerings "off the shelf" under Securities Act Rule 415 and Forms S-3 and F-3, and in other rules that refer to that eligibility criteria.

References to Rules under the Investment Company Act and the Investment Advisers Act:

Investment Company Act Rule 3a-7: Rule 3a-7 excludes from the definition of "investment company" structured finance vehicles if, among other things, the securities offered to retail investors are rated by at least one NRSRO in one of the four highest rating categories. The Commission proposed to eliminate the rule's reliance on NRSRO ratings by amending the rule to eliminate the exclusion for structured financings offered to the general public.

Investment Company Act Rule 5b-3: Rule 5b-3 is a look-through provision that allows a fund to treat the acquisition of a repurchase agreement (or "repo") as the acquisition of the securities collateralizing the repurchase agreement, if the securities are Government securities or have received certain NRSRO ratings. Rather than requiring a specific rating for the collateral securities, the Commission proposed to require that the fund's board of directors (or its designee) determine that the non-Government collateral securities present minimum credit risks and are highly liquid.

Investment Advisers Act Rule 206(3)-3T: Investment Advisers Act Rule 206(3) 3T provides a temporary alternative means for investment advisers that also are registered broker-dealers to satisfy the notice and consent requirements of Section 206(3) of the Advisers Act when they act in a principal capacity with certain of their advisory clients. The rule excludes securities from coverage under the rule if the adviser or a close affiliate is the issuer or underwriter, unless it is an underwriter of non-convertible debt securities that have received a rating in one of the four highest categories by at least two NRSROs.