By Anne Sherry, J.D.
The SEC proposed amendments to remove the references to credit rating agencies from Rules 101 and 102 of Regulation M, which prohibits activities that could artificially influence the market for an offered security. These are the last references to credit ratings in the SEC’s ruleset, so if adopted, the amendments will fulfill Congress’s mandate under Dodd-Frank to remove all references to credit ratings and substitute another standard for creditworthiness, Chair Gary Gensler said in a statement (Removal of References to Credit Ratings from Regulation M, Release No. 34-94499, March 23, 2022).
Creditworthiness. Rule 101 applies to distribution participants and their affiliated purchasers, and Rule 102 applies to issuers, selling security holders, and their affiliated purchasers. Rules 101(c)(2) and 102(d)(2) currently except nonconvertible debt securities, nonconvertible preferred securities, and asset-backed securities that are rated investment grade by at least one NRSRO. The amendments propose to eliminate the Rule 102 exception. As for the Rule 101 exception, the proposal would replace the credit-rating requirement with requirements that the nonconvertible debt securities and nonconvertible preferred securities meet a specified probability of default threshold, and that the asset-backed securities be offered pursuant to an effective shelf registration statement filed on the Commission’s Form SF-3.
The Commission previously proposed two alternatives to the credit-rating references in the exceptions for certain investment grade securities, once in 2008 and once in 2011, but did not adopt any rules based on those proposals. Commenters universally opposed the 2008 proposal, which would have relied primarily on the concept of well-known seasoned issuers, but did not suggest any alternatives. Similarly, nearly all commenters expressed concerns about the 2011 proposal’s ideas for replacing the investment grade exceptions.
The SEC believes that the new proposal addresses several concerns raised by commenters on the prior proposals. The proposed structural credit risk models can result in consistent, replicable determinations by distribution participants (particularly if they use the same model), and the use of a bright-line threshold for probability of default should address concerns about new costs and delays in the offering process. Market participants currently rely on structural credit risk models to assess issuers’ creditworthiness, the proposing release observes.
Recordkeeping requirements. The SEC’s proposal would also require broker-dealers who are distribution participants or affiliated purchasers, and who rely on the proposed Rule 101 exception, to retain the written probability-of-default determination that supports that reliance. New paragraph (b)(17) of Rule 17a-4 would require broker-dealers to preserve that written determination for at least three years (in an easily accessible place for the first two of the three years).
Comment. The public comment period will remain open for 60 days following publication of the proposing release on the SEC’s website or 30 days following publication of the proposing release in the Federal Register, whichever period is longer. The Commission asks that commenters provide specific reasons and information to support their views, including empirical data, economic studies, and other factual support where possible.
The release is No. 34-94499.