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11 July 2008

Three notices.


[Federal Register: July 11, 2008 (Volume 73, Number 134)]
[Proposed Rules]               
[Page 40087-40106]
From the Federal Register Online via GPO Access [wais.access.gpo.gov]
[DOCID:fr11jy08-16]                         


[[Page 40087]]

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Part IV





Securities and Exchange Commission





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17 CFR Parts 229, 230, et al.



References to Ratings of Nationally Recognized Statistical Rating 
Organizations; Security Ratings; Proposed Rules


[[Page 40088]]


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SECURITIES AND EXCHANGE COMMISSION

17 CFR Parts 240, 242, and 249

[Release No. 34-58070; File No. S7-17-08]
RIN 3235-AK17

 
References to Ratings of Nationally Recognized Statistical Rating 
Organizations

AGENCY: Securities and Exchange Commission.

ACTION: Proposed rule.

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SUMMARY: This is one of three releases that the Securities and Exchange 
Commission (``Commission'') is publishing simultaneously relating to 
the use in its rules and forms of credit ratings issued by nationally 
recognized statistical rating organizations (``NRSROs''). In this 
release, the Commission proposes to amend various rules and forms under 
the Securities Exchange Act of 1934 (``Exchange Act'') that rely on 
NRSRO ratings. The proposed amendments are designed to address concerns 
that the reference to NRSRO ratings in Commission rules and forms may 
have contributed to an undue reliance on NRSRO ratings by market 
participants.

DATES: Comments should be received on or before September 5, 2008.

ADDRESSES: Comments may be submitted by any of the following methods:

Electronic Comments

     Use the Commission's Internet comment form (http://
www.sec.gov/rules/proposed.shtml); or
     Send an e-mail to rule-comments@sec.gov. Please include 
File Number S7-17-08 on the subject line; or
     Use the Federal eRulemaking Portal (http://
www.regulations.gov). Follow the instructions for submitting comments.

Paper Comments

     Send paper comments in triplicate to Secretary, Securities 
and Exchange Commission, 100 F Street, NE., Washington, DC 20549-1090.

All submissions should refer to File Number S7-17-08. This file number 
should be included on the subject line if e-mail is used. To help us 
process and review your comments more efficiently, please use only one 
method. The Commission will post all comments on the Commission's 
Internet Web site (http://www.sec.gov/rules/proposed.shtml). Comments 
are also available for public inspection and copying in the 
Commission's Public Reference Room, 100 F Street, NE., Washington, DC 
20549, on official business days between the hours of 10 a.m. and 3 
p.m. All comments received will be posted without change; we do not 
edit personal identifying information from submissions. You should 
submit only information that you wish to make publicly available.

FOR FURTHER INFORMATION CONTACT: Michael A. Macchiaroli, Associate 
Director, Thomas K. McGowan, Assistant Director, Randall W. Roy, Branch 
Chief, and Joseph I. Levinson, Attorney (Net Capital Requirements and 
Customer Protection) at (202) 551-5510; Michael Gaw, Assistant 
Director, Brian Trackman, Special Counsel, and Sarah Albertson, 
Attorney (Alternative Trading Systems) at (202) 551-5602; Paula Jenson, 
Deputy Chief Counsel, Joshua Kans, Senior Special Counsel, Linda Stamp 
Sundberg, Senior Special Counsel (Confirmation of Transactions) at 
(202) 551-5550; Josephine J. Tao, Assistant Director, Elizabeth A. 
Sandoe, Branch Chief, and Bradley Gude, Special Counsel (Regulation M) 
at (202) 551-5720; or Catherine Moore, Counsel to the Director at (202) 
551-5710, Division of Trading and Markets, Securities and Exchange 
Commission, 100 F Street, NE., Washington, DC 20549-6628.

SUPPLEMENTARY INFORMATION:

I. Introduction

    On June 16, 2008, in furtherance of the Credit Rating Agency Reform 
Act of 2006,\1\ the Commission published for notice and comment two 
rulemaking initiatives.\2\ The first proposes additional requirements 
for NRSROs \3\ that were directed at reducing conflicts of interests in 
the credit rating process, fostering competition and comparability 
among credit rating agencies, and increasing transparency of the credit 
rating process.\4\ The second is designed to improve investor 
understanding of the risk characteristics of structured finance 
products. Those proposals address concerns about the integrity of the 
credit rating procedures and methodologies of NRSROs in light of the 
role they played in determining the credit ratings for securities that 
were the subject of the recent turmoil in the credit markets.
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    \1\ Public Law 109-291, 120 Stat. 1327 (2006).
    \2\ Proposed Rules for Nationally Recognized Statistical Rating 
Organizations, Securities Exchange Act Release No. 57967 (June 16, 
2008), 73 FR 36212 (June 25, 2008).
    \3\ As described in more detail below, an NRSRO is an 
organization that issues ratings that assess the creditworthiness of 
an obligor itself or with regard to specific securities or money 
market instruments, has been in existence as a credit rating agency 
for at least three years, and meets certain other criteria. The term 
is defined in section 3(a)(62) of the Securities Exchange Act. A 
credit rating agency must apply with the Commission to register as 
an NRSRO, and currently there are nine registered NRSROs.
    \4\ See Press Release No. 2008-110 (June 11, 2008).
---------------------------------------------------------------------------

    Today's proposals comprise the third of these three rulemaking 
initiatives relating to credit ratings by an NRSRO that the Commission 
is proposing. This release, together with two companion releases, sets 
forth the results of the Commission's review of the requirements in its 
rules and forms that rely on credit ratings by an NRSRO. The proposals 
also address recent recommendations issued by the President's Working 
Group on Financial Markets (``PWG''), the Financial Stability Forum 
(``FSF''), and the Technical Committee of the International 
Organization of Securities Commissions (``IOSCO'').\5\ Consistent with 
these recommendations, the Commission is considering whether the 
inclusion of requirements related to ratings in its rules and forms 
has, in effect, placed an ``official seal of approval'' on ratings that 
could adversely affect the quality of due diligence and investment 
analysis. The Commission believes that today's proposals could reduce 
undue reliance on credit ratings and result in improvements in the 
analysis that underlies investment decisions.
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    \5\ See President's Working Group on Financial Markets, Policy 
Statement on Financial Market Developments (March 2008), available 
at http://www.ustreas.gov (``PWG Statement''); The Report of the 
Financial Stability Forum on Enhancing Market and Institutional 
Resilience (April 2008), available at http://www.fsforum.org (``FSF 
Report''); Technical Committee of the International Organization of 
Securities Commissions, Consultation Report: The Role of Credit 
Rating Agencies in Structured Finance Markets (March 2008), page 9, 
available at http://www.iosco.org.
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II. Background

    The Commission first used the term NRSRO in our rules in 1975 in 
the net capital rule for broker-dealers, Rule 15c3-1 under the Exchange 
Act (``Net Capital Rule'') \6\ as an objective benchmark to prescribe 
capital charges for different types of debt securities. Since then, we 
have used the designation in a number of regulations under the federal 
securities laws. Although we originated the use of the term NRSRO for a 
narrow purpose in our own regulations, ratings by NRSROs today are used 
widely as benchmarks in federal and state legislation, rules issued by 
other financial regulators, in the United States and abroad, and 
private financial contracts.
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    \6\ 17 CFR 240.15c3-1.

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[[Page 40089]]

    Referring to NRSRO ratings in regulations was intended to provide a 
clear reference point to both regulators and market participants. 
Increasingly, we have seen clear disadvantages of using the term in 
many of our regulations. Foremost, there is a risk that investors 
interpret the use of the term in laws and regulations as an endorsement 
of the quality of the credit ratings issued by NRSROs, which may have 
encouraged investors to place undue reliance on the credit ratings 
issued by these entities. In addition, as demonstrated by recent 
events,\7\ there has been increasing concern about ratings and the 
ratings process. Further, by referencing ratings in the Commission's 
rules, market participants operating pursuant to these rules may be 
vulnerable to failures in the ratings process. In light of this, the 
Commission proposes to amend the regulations.
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    \7\ See Proposed Rules for National Recognized Statistical 
Rating Organizations, Securities Exchange Act Release No. 57967.
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    We have identified a small number of rules and forms, however, 
where we believe it is appropriate to retain the reference to NRSRO 
ratings. These rules and forms generally relate to non-public reporting 
or recordkeeping requirements we use to evaluate the financial 
stability of large brokers or dealers or their counterparties and are 
unlikely to contribute to any undue reliance on NRSRO ratings by market 
participants.\8\
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    \8\ These include Rules 15c3-1g(c)(1)(i), 15c3-1g(e)(2)(i), 17i-
5, and 17i-8, which impose certain recordkeeping and reporting 
requirements for ultimate holding companies of broker-dealers and of 
supervised investment bank holding companies, and Forms 17-H and X-
17A-5 Part IIB, which require reports regarding the risk exposures 
of large broker-dealers and OTC derivatives dealers.
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III. Proposed Amendments

    We are proposing to remove references to NRSROs in the following 
rules and forms: Rule 3a1-1, Rule 10b-10, Rule 15c3-1, Rule 15c3-3, 
Rules 101 and 102 of Regulation M, Regulation ATS, Form ATS-R, Form 
PILOT, and Form X-17A-5 Part IIB.

A. Proposed Amendments to Rule 3a1-1, Regulation ATS, Form ATS-R, and 
Form PILOT

    In 1998, we established a new framework for the regulation of 
exchanges and alternative trading systems (``ATSs'').\9\ That framework 
allowed an ATS to choose whether to register as a national securities 
exchange or to register as a broker-dealer and comply with the 
requirements of Regulation ATS. As part of this framework, we adopted 
Rule 3a1-1 under the Exchange Act,\10\ Regulation ATS,\11\ and Forms 
ATS and ATS-R.
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    \9\ See Securities Exchange Act Release No. 40760 (December 8, 
1998), 63 FR 70844 (December 22, 1998) (``Regulation ATS Adopting 
Release'').
    \10\ 17 CFR 240.3a1-1.
    \11\ 17 CFR 242.300 to 242.303.
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    Rule 3a1-1(a) provides an exemption from the Exchange Act 
definition of ``exchange''--and thus the requirement to register as an 
exchange--for a trading system that, among other things, is in 
compliance with Regulation ATS.\12\ Rule 3a1-1(b) contains an exception 
to the exemption from the exchange definition. Under this exception, 
the Commission may require a trading system that is a ``substantial 
market'' to register as a national securities exchange if it finds that 
such action is necessary or appropriate in the public interest or 
consistent with the protection of investors.\13\ Specifically, the 
Commission may--after notice to an ATS and an opportunity for it to 
respond--require the ATS to register as an exchange if, during three of 
the preceding four calendar quarters, the ATS had: (1) 50% or more of 
the average daily dollar trading volume in any security and 5% or more 
of the average daily dollar trading volume in any class of securities; 
or (2) 40% or more of the average daily dollar volume in any class of 
securities.\14\
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    \12\ See 17 CFR 240.3a1-1(a)(2).
    \13\ See 17 CFR 240.3a1-1(b); Regulation ATS Adopting Release, 
63 FR at 70857.
    \14\ See 17 CFR 240.3a1-1(b)(1).
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    As the Commission explained in the Regulation ATS Adopting Release, 
it was reserving the right to require a ``dominant'' ATS to register as 
an exchange.\15\ The Commission noted, for example, that ``it may not 
be consistent with the protection of investors or in the public 
interest for a trading system that is the dominant market, in some 
important segment of the securities market, to be exempt from 
registration as an exchange if competition cannot be relied upon to 
ensure fair and efficient trading structures.'' \16\ The Commission 
also stated that it might be necessary to require an ATS to register as 
an exchange if it ``would create systemic risk or lead to instability 
in the securities markets' infrastructure.'' \17\ The Commission made 
clear that its authority under Rule 3a1-1 was discretionary: ``Although 
the standard for denying or withholding the exemption is based on 
objective factors, the Commission has discretion to initiate any 
process to consider whether to revoke a particular entity's exemption 
under the rule.'' \18\ Thus, while observing that some ATSs likely were 
above the volume thresholds of Rule 3a1-1, the Commission did not at 
the time believe it was appropriate to revoke the exemption for any 
such ATS.\19\
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    \15\ See 63 FR at 70857.
    \16\ Id. at 70858.
    \17\ Id.
    \18\ Id. at 70857-58.
    \19\ See id. at 70858.
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    The Commission set forth eight classes of securities in any one of 
which an ATS might achieve ``dominant'' status: (1) Equity securities; 
(2) listed options; (3) unlisted options; (4) municipal securities; (5) 
investment grade corporate debt securities; (6) non-investment grade 
corporate debt securities; (7) foreign corporate debt securities; and 
(8) foreign sovereign debt securities.\20\ Under the definitions 
provided in Rule 3a1-1, investment grade and non-investment grade 
corporate debt securities have three elements in common. They are 
securities that: (1) Evidence a liability of the issuer of such 
security; (2) have a fixed maturity date that is at least one year 
following the date of issuance; and (3) are not exempted securities, as 
defined in Section 3(a)(12) of the Exchange Act.\21\ The distinguishing 
characteristic of an investment grade corporate debt security under our 
current rules is that it has been rated in one of the four highest 
categories by at least one NRSRO. A non-investment grade corporate debt 
security under our current rules is a corporate debt security that has 
not received such a rating.
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    \20\ See 17 CFR 240.3a1-1(b)(3).
    \21\ Compare 17 CFR 240.3a1-1(b)(3)(v) with 17 CFR 240.3a1-
1(b)(3)(vi).
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    We preliminarily believe that distinguishing investment grade 
corporate debt securities and non-investment grade corporate debt 
securities as separate classes of securities under Rule 3a1-1 is not 
necessary to fulfill the purposes of that rule. We preliminary believe 
instead that combining all corporate debt securities into a single 
class for purposes of assessing whether an alternative trading system 
is ``dominant'' is appropriate. Accordingly, we propose to amend Rule 
3a1-1 by replacing paragraphs (b)(3)(v) and (b)(3)(vi) which define 
investment grade corporate debt securities and non-investment grade 
debt securities, respectively, with a single category ``corporate debt 
securities'' in paragraph (b)(3)(v).\22\ This new definition would 
retain verbatim the three elements common to the existing definitions 
of investment grade and non-investment grade debt securities. The 5% 
and 40% thresholds also would remain

[[Page 40090]]

unchanged. Under the proposed amendment to Rule 3a1-1, the Commission 
could, for example, determine that an ATS must register as an exchange 
if the system had--during three of the preceding four calendar 
quarters--50% or more of the average daily dollar trading volume in any 
security and 5% or more of the average daily dollar trading volume in 
corporate debt securities, or 40% of the average daily dollar trading 
volume in corporate debt securities.\23\
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    \22\ Existing paragraphs (b)(3)(vii) and (b)(3)(viii) would be 
unchanged but redesignated as paragraphs (b)(3)(vi) and (b)(3)(vii), 
respectively.
    \23\ The other six classes of securities--equity securities, 
listed options, unlisted options, municipal securities, foreign 
corporate debt securities, and foreign sovereign debt securities--
would remain unchanged. Therefore, as under existing Rule 3a1-1, the 
Commission also could determine that an ATS must register as an 
exchange if the system exceeded either volume threshold in any of 
these other classes of securities.
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    The Commission preliminarily believes that exceeding a volume 
threshold for a combined class of all corporate debt securities would 
be a sufficient indication that an ATS should be required to register 
as an exchange, and that it is not necessary or appropriate to assess 
trading volumes in the narrower segments of investment grade and non-
investment grade corporate debt securities. While the proposed 
amendment could reduce the likelihood that an ATS could be required to 
register as an exchange,\24\ we preliminarily believe that this change 
would nevertheless be appropriate. At this time, there does not appear 
to be a continuing need to analyze ``dominance'' in separate classes of 
investment grade and non-investment grade corporate debt securities, 
particularly in view of the fact that the Commission would continue to 
analyze for dominance in six other classes of securities (in addition 
to the new single class for corporate debt securities). The Commission 
notes that, in over nine years since the adoption of Rule 3a1-1, the 
Commission has never determined to require an ATS to register as an 
exchange because it had become ``dominant.'' Moreover, the Commission 
would continue to be able to exercise discretion about whether to 
revoke the exemption for any ATS that exceeded either threshold in Rule 
3a1-1. The Commission seeks comment on whether, in light of the 
proposed combination of investment grade and non-investment grade 
corporate debt securities into a single class, it should adopt lower 
thresholds at which an ATS that trades corporate debt securities should 
be required to register as an exchange. If so, what should those 
thresholds be and why?
---------------------------------------------------------------------------

    \24\ For example, under existing Rule 3a1-1, an ATS that has 40% 
of the average daily dollar trading volume in non-investment grade 
corporate debt securities and 0% of the average daily dollar trading 
volume in investment grade corporate debt securities for three 
consecutive months could be required by the Commission to register 
as an exchange. Under the proposed amendment, the Commission could 
not do so because the ATS's combined average daily dollar trading 
volume in corporate debt securities would be less than 40%.
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    We are proposing similar changes to Regulation ATS, which 
establishes certain requirements applicable to ATSs that choose to 
register as broker-dealers and comply with Regulation ATS in lieu of 
exchange registration. Rule 301(b)(5) of Regulation ATS imposes a 
``fair access'' requirement, whereby an ATS that exceeds certain volume 
thresholds in any class of securities must establish written standards 
for granting access to trading on its system and not unreasonably 
prohibit or limit any person in respect to access to the services it 
offers.\25\ The fair access standard applies if an ATS has 5% or more 
of the average daily volume during at least four of the preceding six 
calendar months in any of the following: (1) Any individual NMS stock; 
\26\ (2) any individual equity security that is not an NMS stock and 
for which transactions are reported to a self-regulatory organization; 
(3) municipal securities; (4) investment grade corporate debt 
securities; and (5) non-investment grade corporate debt securities.\27\ 
The terms investment grade and non-investment grade debt security are 
defined in Rule 300 of Regulation ATS.
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    \25\ See 17 CFR 242.301(b)(5).
    \26\ See 17 CFR 240.600(a)(47) (defining ``NMS stock'').
    \27\ In proposing Regulation ATS, the Commission requested 
comment ``on whether categories of debt securities should be further 
divided based on an instrument's maturity, credit rating, or other 
criteria.'' Securities Exchange Act Release No. 39884 (April 21, 
1998), 63 FR 23504, 23519 (April 29, 1998). However, in adopting 
Regulation ATS, the Commission did not employ these narrower classes 
of debt securities. See Regulation ATS Adopting Release, 63 FR at 
70873.
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    We propose to amend Rules 300 and 301(b)(5) to establish a single 
class of corporate debt securities and to eliminate the existing 
separate classes of investment grade and non-investment grade corporate 
debt securities. Accordingly, paragraphs (i) and (j) of Rule 300 would 
be replaced with a new paragraph (i) defining ``corporate debt 
security'' to mean any security that: (1) Evidences a liability of the 
issuer of such security; (2) has a fixed maturity date that is at least 
one year following the date of issuance; and (3) is not an exempted 
security, as defined in Section 3(a)(12) of the Exchange Act. Existing 
paragraphs (i)(D) and (i)(E) of Rule 301(b)(5) would be replaced with a 
new paragraph (i)(D) providing that an ATS must comply with the access 
requirements set out in Rule 301(b)(5) if, with respect to corporate 
debt securities, such system accounts for 5% or more of the average 
daily volume traded in the United States for the requisite number of 
months. The 5% threshold at which an ATS would have to grant fair 
access to its system also would remain unchanged.\28\ As with the 
proposed changes to Rule 3a1-1, the other classes of securities would 
remain unchanged.
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    \28\ When the Commission originally adopted Regulation ATS, it 
set the fair access threshold at 20%. It later lowered the threshold 
to 5% in connection with the adoption of Regulation NMS. See 
Securities Exchange Act Release No. 51808 (June 9, 2005), 70 FR 
37496, 37550 (June 29, 2005).
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    In addition, Rule 301(b)(6) of Regulation ATS \29\ requires an ATS 
that exceeds certain volume thresholds in any class of securities to 
comply with standards regarding the capacity, integrity, and security 
of its automated systems. Five classes of securities are currently 
identified in Rule 301(b)(6): (1) NMS stocks; (2) equity securities 
that are not NMS stocks and for which transactions are reported to a 
self-regulatory organization; (3) municipal securities; (4) investment 
grade corporate debt securities; and (5) non-investment grade corporate 
debt securities.\30\ Consistent with the other proposed changes to 
Regulation ATS, the Commission also proposes to eliminate separate 
classes for investment grade and non-investment grade debt securities 
in Rule 301(b)(6) and replace them with a single category for 
``corporate debt securities,'' which would be defined in Rule 300. 
Existing paragraphs (i)(D) and (i)(E) of Rule 301(b)(6) would be 
replaced with a new paragraph (i)(D) providing that an ATS must comply 
with the capacity, integrity, and security requirements of Rule 
301(b)(6) if, with respect to corporate debt securities, such system 
accounts for 20% or more of the average daily volume traded in the 
United States for the requisite number of months. The 20% threshold and 
the other three classes of securities would remain unchanged.
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    \29\ 17 CFR 242.301(b)(6).
    \30\ 17 CFR 242.301(b)(6)(i).
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    For the same reasons we are proposing to amend Rule 3a1-1, we 
preliminarily believe that these proposed amendments to Regulation ATS 
would be appropriate, and that a volume threshold for a combined class 
of all corporate debt securities would be sufficient for the fair 
access requirement and the capacity, integrity, and security 
requirements. The Commission preliminarily believes that the purposes 
of Regulation ATS would still be

[[Page 40091]]

fulfilled if investment grade and non-investment grade corporate debt 
securities were combined into a single class. ATSs would continue to be 
subject to the fair access requirements and the capacity, integrity, 
and security requirements with respect to the other existing classes of 
securities and at the same volume thresholds (5% and 20%, 
respectively). The Commission seeks comment on whether, in light of the 
proposed combination of investment grade and non-investment grade 
corporate debt securities into a single class, it should adopt lower 
thresholds for fair access and the capacity, security, and integrity 
requirements under Regulation ATS. If so, what should those thresholds 
be and why?
    We are also proposing revisions to Form ATS-R, which is used by 
ATSs to report certain information about their activities on a 
quarterly basis.\31\ Currently, Form ATS-R requires each ATS to report 
the total unit volume and total dollar volume in the previous quarter 
for various categories of securities, including investment grade and 
non-investment grade corporate debt securities. Consistent with the 
proposed amendments to Regulation ATS described above, we also propose 
to revise Form ATS-R to eliminate the separate categories for 
investment grade and non-investment grade corporate debt securities, 
and instead create a single category for ``corporate debt securities.'' 
As with the proposed changes to Regulation ATS, ``corporate debt 
securities'' would be defined in the instructions to Form ATS-R to mean 
any security that: (1) Evidences a liability of the issuer of such 
security; (2) has a fixed maturity date that is at least one year 
following the date of issuance; and (3) is not an exempted security, as 
defined in Section 3(a)(12) of the Exchange Act. Because separate 
classes for investment grade and non-investment grade corporate debt 
securities are proposed to be eliminated for purposes of the thresholds 
in Rule 3a1-1 and Rules 301(b)(5) and 301(b)(6) of Regulation NMS, no 
purpose would be served by requiring ATSs to separately report their 
trading volumes for investment grade and non-investment grade debt 
securities on Form ATS-R. The figures for the separate classes would be 
added together and reported as a single item on the amended form. The 
Commission is not proposing any other changes to Form ATS-R.
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    \31\ Each ATS must file a Form ATS-R within 30 days of the end 
of each calendar quarter, and within ten days of a cessation of 
operations. See 17 CFR 242.301(b)(9).
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    We are also proposing to revise Form PILOT consistent with the 
proposed changes to Form ATS-R. Ordinarily, Section 19 of the Exchange 
Act \32\ and Rule 19-4 thereunder \33\ require a self-regulatory 
organization (``SRO'') to file with the Commission proposed rule 
changes on Form 19b-4 regarding any changes to any material aspect of 
its operations, including any trading system. Rule 19b-5 under the 
Exchange Act \34\ sets forth a limited exception to that requirement by 
permitting an SRO to operate a pilot trading system without filing 
proposed rule changes with respect to that system if certain criteria 
are met. One of those criteria is that the SRO file a Form PILOT in 
accordance with the instructions on that form. Like Form ATS-R, Form 
PILOT currently requires quarterly reporting of trading activity by 
classes of securities, including investment grade and non-investment 
grade corporate debt securities. For the same reasons we propose to 
amend Rule 3a1-1 and Regulation ATS, we also propose to revise Form 
PILOT to eliminate these two categories, replacing them with a single 
category of ``corporate debt securities.'' Corporate debt securities 
would be defined identically in Form PILOT and Form ATS-R. The 
Commission preliminarily believes that it is appropriate to obtain 
trading volumes from pilot trading systems for the combined class of 
corporate debt securities, and that separate reporting of the two 
classes is not necessary to adequately monitor the development of pilot 
trading systems. The Commission notes that, in over nine years since 
Rule 19b-5 and Form PILOT were adopted, no SRO has ever established a 
pilot trading system pursuant to Rule 19b-5 to trade corporate debt 
securities.
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    \32\ 15 U.S.C. 78s.
    \33\ 17 CFR 240.19b-4.
    \34\ 17 CFR 240.19b-5.
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    We generally request comment on all aspects of the proposed 
elimination of the reference to NRSRO ratings in Rule 3a1-1, Regulation 
ATS, Form ATS-R, and Form PILOT. In addition, we request comment on the 
following specific questions:
     Would the proposed amendments to Rule 3a1-1 have any 
significant impact on investors, market participants, the national 
market system, or the public interest?
     Would the proposed amendments to Regulation ATS have any 
significant impact on investors, market participants, the national 
market system, or the public interest?
     Would the proposed amendments affecting the fair access 
standards have other consequences, whether on investors, market 
participants, the national market system, or the public interest? Have 
investors experienced difficulty obtaining access to ATSs trading 
corporate debt securities? Would the proposed amendments impair or 
limit current investor access to ATSs?
     Would the proposed changes to Regulation ATS as they 
relate to the capacity, integrity, and security requirements have any 
adverse impact on investors, market participants, or the national 
market system as a whole?
     In view of the proposed combination of investment grade 
and non-investment grade corporate debt securities into a single class 
for purposes of Rule 3a1-1 and Regulation ATS, should the Commission 
also lower the thresholds in those rules for the combined class of 
corporate debt securities? If so, what should those thresholds be? Why 
are those suggested thresholds appropriate?
     Should the Commission retain investment grade and non-
investment grade corporate debt securities as separate classes of 
securities under Rule 3a1-1 and Regulation ATS and instead use 
different definitions of those terms that do not rely on NRSRO ratings? 
If so, how should investment grade and non-investment grade be defined?
     Would the proposed amendments to Form ATS-R or Form PILOT 
have any significant impact on investors, market participants, the 
national market system, or the public interest?

B. Proposed Amendments to Rule 10b-10

    We propose to amend Rule 10b-10,\35\ the transaction confirmation 
rule for broker-dealers, to delete paragraph (a)(8) of that rule.\36\ 
Rule 10b-10 generally requires broker-dealers that effect transactions 
for customers in securities, other than U.S. savings bonds or municipal 
securities, which are covered by Municipal Securities Rulemaking Board 
rule G-15 (which applies to all municipal securities brokers and 
dealers), to provide customers with written notification, at or before 
the completion of each transaction, of certain basic transaction terms. 
This transaction confirmation must disclose, among other information: 
the date of the transaction; the identity, price, and

[[Page 40092]]

number of shares bought or sold; \37\ the capacity of the broker-
dealer; \38\ the dollar price or yield at which a transaction in a debt 
security was effected; \39\ and, under specified circumstances, the 
amount of compensation paid to the broker-dealer and whether the 
broker-dealer receives payment for order flow.\40\
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    \35\ 17 CFR 240.10b-10.
    \36\ Consistent with that change, we also are proposing to 
redesignate paragraph (a)(9) of the rule, related to broker-dealers 
that are not members of the Securities Investor Protection 
Corporation (``SIPC''), as paragraph (a)(8).
    \37\ See 17 CFR 240.10b-10(a)(1) (the confirmation must also 
include either the time of the transaction or the fact that it will 
be furnished upon written request).
    \38\ See 17 CFR 240.10b-10(a)(2).
    \39\ See 17 CFR 240.10b-10(a)(5) and (6).
    \40\ See, e.g., 17 CFR 240.10b-10(a)(2)(i)(B), (C) and (D).
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    The rule's requirements, portions of which have been in effect for 
over 60 years, provide basic investor protections by conveying 
information that allows investors to verify the terms of their 
transactions, alerts investors to potential conflicts of interest with 
their broker-dealers, acts as a safeguard against fraud, and provides 
investors a means to evaluate the costs of their transactions and the 
execution quality.\41\
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    \41\ See Securities Exchange Act Release No. 34962 (November 10, 
1994), 59 FR 59612, 59613 (November 17, 1994).
---------------------------------------------------------------------------

    Paragraph (a)(8) of Rule 10b-10 requires transaction confirmations 
for debt securities, other than government securities, to inform the 
customer if the security is unrated by an NRSRO. When we adopted 
paragraph (a)(8) in 1994, it was intended to prompt a dialogue between 
the customer and the broker-dealer if the customer had not previously 
been informed of the unrated status of the debt security. We stated 
that this disclosure was not intended to suggest that an unrated 
security is inherently riskier than a rated security.\42\ Upon further 
consideration and in light of present concerns regarding undue reliance 
on NRSRO ratings and confusion about the significance of those ratings, 
we believe it would be appropriate to delete this requirement. However, 
in proposing to no longer require broker-dealers to include in 
transaction confirmations the information that a debt security is 
unrated, we do not mean to suggest that information about an issuer's 
creditworthiness is not a relevant subject for discussion and 
consideration prior to purchasing a debt security. We would encourage 
investors to seek to understand all of the risks of securities, 
including credit-related risks, before buying. In addition, we note 
that deleting this requirement would not prevent broker-dealers from 
voluntarily continuing to include this information in transaction 
confirmations.
---------------------------------------------------------------------------

    \42\ See Securities Exchange Act Release No. 34962 (November 10, 
1994), 59 FR 59612 (November 17, 1994) (File No. S7-6-94).
---------------------------------------------------------------------------

    We generally request comment on all aspects of the proposed 
elimination of the NRSRO reference in Rule 10b-10. In addition, we 
request comment on the following specific questions:
     Have investors found confirmation disclosure about the 
fact that a debt security is not rated by an NRSRO to be useful?
     Are there any possible alternatives to deletion that would 
address concerns about undue reliance on NRSRO ratings or avoid 
confusion about the significance of those ratings? For example, should 
the confirmation disclose that the security is rated or not rated by an 
NRSRO, as the case may be, instead of just that the security is not 
rated?

C. Proposed Amendments to Rule 15c3-1

    Under the Net Capital Rule, broker-dealers are required to 
maintain, at all times, a minimum amount of net capital. The rule 
generally defines ``net capital'' 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 (haircut) of certain other liquid assets 
(e.g., securities).\43\ Broker-dealers are required to calculate net 
worth using generally accepted accounting principles.
---------------------------------------------------------------------------

    \43\ See 17 CFR 240.15c3-1(c)(2).
---------------------------------------------------------------------------

    In computing their net capital under the provisions of the Net 
Capital Rule, broker-dealers are required to deduct from their net 
worth certain percentages of the market value of their proprietary 
securities positions. A primary purpose of these ``haircuts'' is to 
provide a margin of safety against losses that might be incurred by 
broker-dealers as a result of market fluctuations in the prices of, or 
lack of liquidity in, their proprietary positions. We apply a lower 
haircut to certain types of securities held by a broker-dealer that 
were rated investment grade by a credit rating agency of national 
repute since those securities typically were more liquid and less 
volatile in price than securities that were not so highly rated.\44\
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    \44\ See 17 CFR 240.15c3-1(c)(2)(vi)(E) (haircuts applicable to 
commercial paper), 17 CFR 240.15c3-1(c)(2)(vi)(F) (haircuts 
applicable to nonconvertible debt securities), and 17 CFR 240.15c3-
1(c)(2)(vi)(H) (haircuts applicable to cumulative nonconvertible 
preferred stock). The term NRSRO is also used in appendices to the 
Net Capital Rule. See 17 CFR 240.15c3-1a(b)(1)(i)(C) (defining the 
term ``major market foreign currency'') and 17 CFR 240.15c3-1f(d) 
(determining the capital charge for credit risk arising from certain 
OTC derivatives transactions).
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    We are proposing to remove, with limited exceptions, all references 
to NRSROs from the Net Capital Rule.\45\ The broker-dealers subject to 
the Net Capital Rule are sophisticated market participants regulated by 
at least one SRO.\46\ As regulated entities, broker-dealers must meet 
certain financial responsibility requirements, including maintaining 
minimum amounts of liquid assets as net capital, safeguarding customer 
funds and securities, and making and preserving accurate books and 
records. Accordingly, we preliminarily believe that broker-dealers 
would be able to assess the creditworthiness of the securities they 
hold without undue hardship and, therefore, that exclusive reliance on 
NRSRO ratings for the purposes of the Net Capital Rule is no longer 
necessary, although broker-dealers that wish to continue to rely on 
such ratings may do so.
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    \45\ In 2003, the Commission published a concept release in 
which we sought comment on the use of NRSRO ratings in our rules, 
and specifically sought comment on eliminating the minimum quality 
standards established with the use of NRSRO ratings in Exchange Act 
Rule 15c3-1. See Rating Agencies and the Use of Credit Ratings Under 
the Federal Securities Laws, Securities Exchange Act Release No. 
47972 (June 4, 2003), 68 FR 35258 (June 12, 2003). (Comments on the 
concept release are available at: http://www.sec.gov/rules/concept/
s71203.shtml.) As discussed above, recent events have highlighted 
the need to revisit our reliance on NRSRO ratings in the context of 
these developments. See also the extensive discussion of market 
developments in the Release No. 57967.
    \46\ The SROs regulating broker-dealers include the Financial 
Industry Regulatory Authority, the Municipal Securities Rulemaking 
Board, and the national securities exchanges.
---------------------------------------------------------------------------

    We are proposing the substitution of two new subjective standards 
for the NRSRO ratings currently relied upon under the Net Capital Rule. 
For the purposes of determining the haircut on commercial paper,\47\ we 
propose to replace the current NRSRO ratings-based criterion--being 
rated in one of the three highest rating categories by at least two 
NRSROs--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,\48\ we propose to replace the current NRSRO ratings-
based criterion--being rated in one of the four highest rating 
categories by at least two NRSROs--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

[[Page 40093]]

near its carrying value within a reasonably short period of time. This 
latter formulation would apply as well to long or short positions that 
are hedged with short or long positions in securities issued by the 
United States or any agency thereof or nonconvertible debt securities 
having a fixed interest rate and a fixed maturity date and which are 
not traded flat or in default as to principal or interest.\49\
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    \47\ See 17 CFR 240.15c3-1(c)(2)(vi)(E).
    \48\ See 17 CFR 240.15c3-1(c)(2)(vi)(F)(1) and (c)(2)(vi)(H).
    \49\ See 17 CFR 240.15c3-1(c)(2)(vi)(F)(2).
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    We preliminarily believe that these new standards would continue to 
advance the purpose the NRSRO ratings-based standards were designed to 
advance, which is to enable broker-dealers to make net capital 
computations that reflect the market risk inherent in the positioning 
of those particular types of securities. The prior standards--being 
rated in one of the three or four highest rating categories by at least 
two NRSROs--were designed based on the practice of many credit rating 
agencies to have at least eight categories for their debt securities 
with the top four commonly referred to as ``investment grade.'' \50\ 
While the proposed standards, like the prior standards, do not use the 
term ``investment grade,'' they are meant to serve the same purpose as 
the prior standards. As such, the category of securities that have ``no 
greater than moderate credit risk'' and can be sold at or near their 
carrying value within a reasonably short period of time should 
encompass all investment grade securities. The proposed new criteria 
for commercial paper to be used for net capital purposes are securities 
that are ``subject to a minimal amount of credit risk'' and can be sold 
at or near their carrying value almost immediately. In each case, the 
proposed liquidity standard would reflect the fact that only liquid 
assets are relevant for the purposes of the Net Capital Rule.
---------------------------------------------------------------------------

    \50\ See Oversight of Credit Rating Agencies Registered as 
Nationally Recognized Statistical Rating Organizations, Securities 
Exchange Act Release No. 55857 (June 5, 2007), 72 FR 33564 (June 18, 
2007).
---------------------------------------------------------------------------

    We further believe that broker-dealers have the financial 
sophistication and the resources necessary to make the basic 
determinations of whether or not a security meets the requirements in 
the proposed amendments and to distinguish between securities subject 
to minimal credit risk and those subject to moderate credit risk. The 
broker-dealer would have to be able to explain how the securities it 
used for net capital purposes meet the standards set forth in the 
proposed amendments.
    Notwithstanding our belief that broker-dealers have the financial 
sophistication and the resources to make these determinations, we 
believe it would be appropriate, as one means of complying with the 
proposed amendments, for broker-dealers to refer to NRSRO ratings for 
the purposes of determining haircuts under the Net Capital Rule. As 
such, if we adopt the proposed amendments, after considering comments, 
we expect to take the view in the adopting release that securities 
rated in one of the three highest categories by at least two NRSROs 
would satisfy the requirements of proposed new paragraph (c)(2)(vi)(E) 
and securities rated in one of the four highest rating categories by at 
least two NRSROs to satisfy the requirements of proposed new paragraphs 
(c)(2)(vi)(F) and (c)(2)(vi)(H). We emphasize, however, that references 
to such NRSRO ratings would be just one means of satisfying the 
requirements of the proposed amendments but would not the only means of 
doing so.
    We are also proposing to remove references to NRSRO ratings from 
Appendices E and F to Rule 15c3-1 and make conforming changes to 
Appendix G of Rule 15c3-1 and the General Instructions to Form X-17 A-
5, Part IIB.\51\ Appendix E of the Net Capital Rule sets forth a 
program that allows a broker-dealer to use an alternative approach to 
computing net capital deductions, subject to certain conditions, most 
importantly the broker-dealer's ultimate holding company consenting to 
group-wide Commission supervision as a consolidated supervised entity 
(``CSE'').\52\ Appendix F to the Net Capital Rule sets forth a similar 
program for OTC derivatives dealers. In each case, the program sets 
forth an alternative means of establishing net capital requirements 
under the Net Capital Rule by which the broker-dealer or OTC 
derivatives dealer, as applicable, may elect to determine counterparty 
risk. This may be done either based on NRSRO ratings by requesting 
Commission approval to determine credit risk weights based on internal 
calculations.
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    \51\ 17 CFR 240.15c3-1e, 240.15c3-1f, and 240.15c3-1g; see 17 
CFR 249.617.
    \52\ See 17 CFR 240.15c3-1e.
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    We are proposing to delete the provisions of Appendices E and F 
permitting reliance on NRSRO ratings for the purposes of determining 
counterparty risk. As a result of these deletions, a broker-dealer that 
is part of a CSE or a OTC derivatives dealer that wished to use the 
approach set forth Appendix E or F, respectively, to determine 
counterparty risks would be required, as part of its initial 
application to use the alternative approach or in an amendment, to 
request Commission approval to determine credit risk weights based on 
internal calculations. Based on the strength of the broker-dealer/CSE 
or OTC derivatives dealer's internal credit risk management system, we 
may approve the application. A broker-dealer or OTC derivatives dealer 
that obtained such approval would be required to make and keep current 
a record of the basis for the credit risk weight of each counterparty. 
To date, a total of seven entities have applied for and been granted 
permission to use the methods set forth in Appendix E, while five have 
applied for and been granted permission to use the methods set forth in 
Appendix F. We do not currently anticipate that any additional firms 
will apply for permission to use either Appendix E or Appendix F. All 
of the approved firms have already developed models to calculate market 
and credit risk under the alternative net capital calculation methods 
set forth in the appendices as well as internal risk management control 
systems.\53\ As such, each firm already employs the non-NRSRO ratings-
based method that would, under the proposed amendments, become the only 
option for determining counterparty credit risk under Appendices E and 
F. We are also proposing conforming amendments to Appendix G of Rule 
15c3-1 and the General Instructions to Form X-17 A-5, Part IIB. The 
proposed amendments would delete references to the provisions of 
Appendices E and F, respectively, that are proposed to be deleted.
---------------------------------------------------------------------------

    \53\ See, e.g., Alternative Net Capital Requirements for Broker-
Dealers That Are Part of Consolidated Supervised Entities, 
Securities Exchange Act Release No. 49830 (June 8, 2004), 69 FR 
33428 at 33456 (June 21, 2004).
---------------------------------------------------------------------------

    We generally request comment on all aspects of the proposed 
elimination of the use of NRSRO ratings in the Net Capital Rule. In 
addition, we request comment on the following specific questions:
     Would internal evaluations of individual debt securities 
by broker-dealers for purposes of determining the capital charges 
(``internal processes'') instead of reliance on NRSRO ratings 
accomplish the stated goals of the Commission's net capital 
requirements?
     What are the benefits, other than those we have 
identified, of the use of internal processes?
     Besides the use of internal processes by broker-dealers, 
are there potential alternate means of establishing creditworthiness 
for the purposes of the Net Capital Rule without reference to NRSRO 
ratings? Commenters who

[[Page 40094]]

believe that this is the case should include detailed descriptions of 
such alternate means.
     Are we correct in our preliminary belief that broker-
dealers have the financial sophistication and the resources necessary 
to generate internal processes and make the basic determinations of 
whether or not a security is meets the requirements in the proposed 
amendments and to distinguish between securities subject to minimal 
credit risk and those subject to moderate credit risk? If not, how 
should the proposed rule be modified to address those concerns?
     What would be the potential consequences of using internal 
processes for purposes of the net capital rule and how could these be 
addressed? For example, one concern is that a broker-dealer would have 
an incentive to downplay the credit risk associated with a particular 
security in order to minimize capital charges. How could this concern 
be addressed?
     If we provided for the use of internal processes, should 
we require that the persons responsible for developing a broker-
dealer's internal processes and applying them to individual securities 
for the purposes of the Net Capital Rule be separate from employees who 
perform other functions for the broker-dealer, such as making 
proprietary investment decisions for the broker-dealer?
     What would be the appropriate level of regulatory 
oversight for broker-dealers employing internal processes?
     Should we require any policies and procedures with regard 
to the basic determinations as to whether a security meets the 
standards in the proposed amendments?
     Should we explicitly define the terms used in the proposed 
new standards in Rules 15c3-1(c)(2)(vi)(E), (F), and (H)?
     If we adopt the proposed standards, would broker-dealers 
find it useful to employ market-based models, including models using 
credit spreads to satisfy the requirements of the proposed standards? 
Should we provide guidance about the use of these models?
     What is the likelihood that small broker-dealers would 
purchase credit ratings or the models used to develop those ratings 
from large broker-dealers?
     If we adopt the proposed amendments after considering 
comments, should we take the view in the adopting release that 
securities rated in one of the three highest categories by at least two 
NRSROs satisfy the requirements of proposed new paragraph (c)(2)(vi)(E) 
and securities rated in one of the four highest rating categories by at 
least two NRSROs to satisfy the requirements of proposed new paragraphs 
(c)(2)(vi)(F) and (c)(2)(vi)(H)? Commenters should include detailed 
descriptions of any subset of broker-dealers they believe should be 
able to continue to rely on NRSRO ratings and the rationale therefor.
     What factors should we take into account when considering 
the potential regulatory compliance costs of removing references to 
NRSROs from the Net Capital Rule? Commenters should include detailed 
descriptions of any potential costs.

D. Proposed Amendment to Rule 15c3-3

    Note G to Exhibit A of Rule 15c3-3 under the Exchange Act (the 
``Customer Protection Rule''), which provides the formula for the 
determination of broker-dealers' reserve requirements, allows a broker-
dealer to include as a debit in the formula the amount of customer 
margin related to customers' positions in security futures products 
posted to a registered clearing or derivatives organization that 
maintains the highest investment grade rating from an NRSRO.\54\ This 
standard, which is one of four different means by which a registered 
clearing or derivatives organization can be judged to meet the 
requirements of paragraph (b)(1) of Note G,\55\ is consistent with the 
customer protection function of Rule 15c3-3 and is necessary because of 
the unsecured nature of the customer positions in security futures 
products margin debit. We propose to replace this standard with a 
requirement that the registered clearing or derivatives organization to 
which customers' positions in security futures products are posted has 
the highest capacity to meet its financial obligations and is subject 
to no greater than minimal credit risk.
---------------------------------------------------------------------------

    \54\ 17 CFR 240.15c3-3a(b)(1)(i).
    \55\ A broker-dealer may also include customer margin related to 
customers' positions in security futures products posted to a 
registered clearing or derivatives organization (1) that maintains 
security deposits from clearing members in connection with regulated 
options or futures transactions and assessment power over member 
firms that equal a combined total of at least $2 billion, at least 
$500 million of which must be in the form of security deposits; (2) 
that maintains at least $3 billion in margin deposits; or (3) which 
does not meet the other requirements but which the Commission has 
agreed, upon a written request from the broker-dealer, that the 
broker-dealer may utilize. 17 CFR 240.15c3-3a(b)(1)(ii)-(iv).
---------------------------------------------------------------------------

    We preliminarily believe that these new standards would continue to 
advance the purpose the NRSRO-ratings standard was designed to advance, 
namely to ensure both of the long-term financial strength of a clearing 
organization to which customers' positions in security futures products 
are posted and its general creditworthiness.\56\ Although the rule was 
originally designed to provide an indication of long-term financial 
strength and general creditworthiness from an independent source,\57\ 
we preliminarily believe that broker-dealers, as sophisticated market 
participants and regulated entities that are subject to financial 
responsibility requirements, have the financial sophistication and the 
resources necessary to make this determination. The broker-dealer would 
have to be able to explain how the registered clearing or derivatives 
organization to which customers' positions in security futures products 
are posted meets the standard in the proposed amendment.
---------------------------------------------------------------------------

    \56\ See Rule 15c3-3 Reserve Requirements for Margin Related to 
Security Futures Products, Securities Exchange Act Release No. 50295 
(August 31, 2004), 69 FR 54182, 54185 (September 7, 2004).
    \57\ Id.
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    We also believe, however, that it would be appropriate, as one 
means of complying with the proposed amendment, for broker-dealers to 
refer to NRSRO ratings for the purposes of paragraph (b) of Note G. As 
such, if we adopt the proposed amendments after considering comments, 
we expect to take the view in the adopting release that we would 
continue to consider a registered clearing agency or derivatives 
clearing organization that maintains the highest investment-grade 
rating from an NRSRO to satisfy the requirements of that provision. We 
emphasize, however, that the references to such NRSRO ratings would be 
just one means of satisfying the requirements of the proposed 
amendments and would not be the only means of doing so.
    We request comment on the following specific questions in 
connection with Exhibit A to the Customer Protection Rule:
     As an alternative to relying on an NRSRO rating to 
distinguish the creditworthiness of a registered clearing agency or 
derivatives clearing organization, should we prescribe a minimum net 
worth or asset test for the organizations? Alternatively, should we 
prescribe a test based on a minimum level of members of the 
organization or minimum level of clearing deposits held by the 
organization? Commenters that support any of these proposals should 
provide details (e.g., the minimum levels in dollar amounts) as to how 
they should be implemented.
     Would it be more appropriate to delete current paragraph 
(b)(1)(i) of Note G to Exhibit A to the Customer

[[Page 40095]]

Protection Rule in its entirety? Put differently, do the guidelines 
offered by current paragraphs (b)(1)(ii)-(iv) of Note G in and of 
themselves provide sufficient means by which a registered clearing or 
derivatives organization could be judged to meet the requirements of 
paragraph (b)(1) of Note G?
     If we adopted the proposed amendment to Note G to Exhibit 
A of Rule 15c3-3, should we explicitly define the terms used in the 
proposed new standard?
     Is it appropriate to allow broker-dealers to make the 
determination of whether a clearing organization possesses the highest 
capacity to meet its financial obligations and is subject to no greater 
than minimal credit risk? If not, what are suggested ways that the 
proposed rule could be amended to address that concern?
     Should we require any policies and procedures with regard 
to the determination whether a registered clearing or derivatives 
organization meets the standard in the proposed amendment?
     What would be the potential consequences of allowing 
broker-dealers to determine whether a clearing organization possessed 
the highest capacity to meet its financial obligations and was subject 
to no greater than minimal credit risk and how could these be 
addressed? For example, one concern is that a broker-dealer would have 
an incentive to downplay the credit risk associated with a particular 
clearing organization in order to be able to post customers' positions 
in security futures products to it. How could this concern be 
addressed?
     If we adopt the proposed amendments after considering 
comments, should we take the view in the adopting release that we would 
consider a registered clearing agency or derivatives clearing 
organization that maintains the highest investment-grade rating from an 
NRSRO to satisfy the requirements of that provision? Commenters should 
include detailed descriptions of any subset of broker-dealers they 
believe should be able to continue to rely on NRSRO ratings and the 
rationale therefore.
     What factors should we take into account when considering 
the potential regulatory compliance costs of removing references to 
NRSROs from paragraph (b)(1) of Note G to Rule 15c-3a? Commenters 
should include detailed descriptions of any potential costs.

E. Proposed Amendments to Rules 101 and 102 of Regulation M

1. Regulation M
    As a prophylactic, anti-manipulation set of rules, Regulation M is 
designed to protect the integrity of the securities trading market as 
an independent pricing mechanism by prohibiting activities that could 
artificially influence the market for the offered security. Rules 101 
and 102 of Regulation M specifically prohibit issuers, selling security 
holders, underwriters, brokers, dealers, other distribution 
participants, and any of their affiliated purchasers, from directly or 
indirectly bidding for, purchasing, or attempting to induce another 
person to bid for or purchase, a covered security until the applicable 
restricted period has ended.\58\
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    \58\ ``Covered security'' is defined as ``any security that is 
the subject of a distribution or any reference security.'' 17 CFR 
242.100.
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2. Current Rule 101(c)(2) and Rule 102(d)(2) Exceptions
    Both rules currently except ``investment grade nonconvertible and 
asset-backed securities.'' \59\ These exceptions apply to 
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.\60\ 
The current exceptions for certain investment grade debt and preferred 
securities rated by a NRSRO were originally based on the premise that 
these securities are traded on the basis of their yields and credit 
ratings, are largely fungible and, thus, are less likely to be subject 
to manipulation.\61\ With respect to asset-backed securities, the 
current exceptions were premised on the fact that asset-backed 
securities also trade primarily on the basis of yield and credit rating 
and that asset-backed securities investors are concerned with ``the 
structure of the class of securities and the nature of the assets 
pooled to serve as collateral for those securities.'' \62\
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    \59\ 17 CFR 242.101(c)(2) and 242.102(d)(2).
    \60\ Id.
    \61\ Securities Exchange Act Release No. 19565 (March 4, 1983); 
48 FR 10628 (March 14, 1983). See also Securities Exchange Act 
Release No. 18528 (March 3, 1982); 47 FR 11482 (March 16, 1982).
    \62\ Securities Exchange Act Release No. 38067 (December 20, 
1996); 62 FR 520 (January 3, 1997).
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3. Proposed Amendments' Elimination of the NRSRO Reference
    In light of our effort to reduce undue reliance on NRSRO ratings, 
we believe that it is appropriate to alter the current exceptions in 
Rules 101 and 102 to eliminate the reference to NRSROs. We propose to 
remove Rules 101 and 102's current exceptions for investment grade 
nonconvertible debt securities, nonconvertible preferred securities, 
and asset-backed securities based on NRSRO ratings. In place of those 
exceptions, we propose new exceptions for nonconvertible debt 
securities and nonconvertible preferred securities based on the ``well-
known seasoned issuer'' (``WKSI'') concept of Securities Act of 1933 
(``Securities Act'') Rule 405.\63\ We are also proposing to except 
asset-backed securities from Rules 101 and 102 if those securities are 
registered on Form S-3.\64\
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    \63\ 17 CFR 230.405.
    \64\ Asset-backed securities are defined out of the WKSI 
standard at subparagraph (1)(iv) of the definition and, further, 
could not meet the requirements of (1)(i)(A) or (B) of the 
definition because they are generally one-time issuers. Id.
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    The proposed exceptions continue to be based on the premise that 
these securities are traded on factors such as their yields and are 
largely fungible. In addition we believe that the marketplace is more 
likely to have access to a significant amount of useful and high-
quality public information concerning these securities that may assist 
investors in assessing the creditworthiness of the issuer on their own 
without needing to unduly rely on a NRSRO.\65\ We understand that WKSI 
and Form S-3 issuers are some of the largest and highest quality 
issuers of nonconvertible debt, nonconvertible preferred securities and 
asset-backed securities which makes default generally less likely. But 
the availability of this information or quality of underlying assets is 
not enough to justify the exceptions in and of itself, the security 
must also trade in such a way that it is resistant to manipulation. 
This is why we are proposing to continue to limit these exceptions to 
nonconvertible debt, nonconvertible preferred, and asset-backed 
securities as those securities trade largely on the basis of their 
yield and are largely fungible.
---------------------------------------------------------------------------

    \65\ See Securities Exchange Act Release No. 52056 (July 19, 
2005); 70 FR 44722 (August 3, 2005). See also Note 61, infra.
---------------------------------------------------------------------------

a. Proposed Rules 101(c)(2)(i) and 102(d)(2)(i)--Nonconvertible Debt 
and Preferred Securities
    The proposed exceptions for nonconvertible debt and nonconvertible 
preferred securities would require that the issuer of such securities 
meet the requirements of the WKSI definition and meet the requirements 
for nonconvertible securities other than common equity in paragraph 
(1)(i)(B)(1)

[[Page 40096]]

of the definition of WKSI in Rule 405. As proposed, the exceptions 
would be available for nonconvertible debt or nonconvertible preferred 
securities issued by a WKSI issuer, regardless of the method the issuer 
used to attain WKSI status. However, in order to rely on the proposed 
exceptions, the security must be issued by an issuer who also meets the 
requirements of paragraph (1)(i)(B)(1) of the definition of WKSI in 
Rule 405.\66\ This would require that the issuer 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.\67\ This would limit the 
exceptions to securities whose issuers have an existing public market 
in nonconvertible securities other than common equity that is publicly 
known and followed and, thus, are less likely to be subject to 
manipulation.
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    \66\ A nonconvertible debt or nonconvertible preferred security 
issued by an issuer who is a WKSI based on the common equity 
calculation in paragraph (1)(i)(A) of the definition of WKSI in Rule 
405 would still be able to rely on the proposed exception if the 
issuer can also meet the requirements of paragraph (1)(i)(B)(1) of 
the definition of WKSI in Rule 405.
    \67\ 17 CFR 230.405, paragraph (1)(i)(B)(1) of the definition of 
WKSI.
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    With respect to these proposed exceptions for nonconvertible debt 
and non-convertible preferred securities utilizing a WKSI requirement, 
we have noted that WKSI issuers:

    [A]re followed by sophisticated institutional and retail 
investors, members of the financial press, and numerous sell-side 
and buy-side analysts that actively seek new information on a 
continual basis. Unlike smaller or less mature issuers, large 
seasoned public issuers tend to have a more regular dialogue with 
investors and market participants through the press and other media. 
The communications of these well-known seasoned issuers are subject 
to scrutiny by investors, the financial press, analysts, and others 
who evaluate disclosure when it is made.\68\
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    \68\ Securities Exchange Act Release No. 52056 (July 19, 2005); 
70 FR 44722 (August 3, 2005).

Thus, we believe that the nonconvertible debt and nonconvertible 
preferred securities that fall within the proposed exceptions should be 
resistant to manipulation because of their fungibility, trading based 
on yield, and this wide industry following.
b. Proposed Rules 101(c)(2)(ii) and 102(d)(2)(ii)--Asset-Backed 
Securities
    The proposed changes to the asset-backed securities exceptions 
would require that the offer and sale of the security is registered 
using Form S-3.\69\ We believe that the proposed amendments should 
provide exceptions to only those asset-backed securities that are 
approximately the equivalent quality of securities that are currently 
excepted from Rules 101 and 102. Additionally, the proposal is also 
based on the premise that asset-backed securities trade primarily on 
the basis of yield and that asset-backed securities investors are 
primarily concerned with the structure of the class of securities and 
the nature of the assets pooled to serve as collateral for those 
securities and, thus, such securities are less likely to be subject to 
manipulation.\70\
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    \69\ The Commission is also proposing to revise the General 
Instruction I.B.5 to Form S-3 (which sets the eligibility 
requirements for asset-backed securities to use that form) to remove 
references to NRSROs. Securities Act Release No. 8940 (July 1, 2008) 
(File No. 27-18-08).
    \70\ These were the reasons that we originally excepted such 
securities. Securities Exchange Act Release No. 38067 (December 20, 
1996); 62 FR 520 (January 3, 1997).
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4. Bright-Line Alternative/Existing Benchmarks
    We believe that the proposed amendments are appropriate 
replacements for the NRSRO investment grade standard for the following 
reasons. We believe that the proposals will capture securities that are 
more likely to be resistant to manipulation similar to the current 
exceptions because they are based on the same premises as the current 
exceptions (such as high liquidity and fungibility).\71\ Second, the 
proposals provide a bright line demarcation and objective criteria for 
the exceptions. As both the WKSI and Form S-3 standards as utilized by 
this proposal are established benchmarks, they should be familiar to 
those persons subject to Rules 101 and 102 and easily applied by such 
persons seeking to rely on the proposed exceptions. Thus, we believe 
that the proposals are comparable in scope to the existing exceptions 
but use alternate benchmarks that provide an equally bright line that 
is not unduly reliant on NRSRO ratings.
---------------------------------------------------------------------------

    \71\ See Securities Exchange Act Release Number 19565 (March 4, 
1983); 48 FR 10628 (March 14, 1983); Securities Exchange Act Release 
Number 18528 (March 3, 1982); 47 FR 11482 (March 16, 1982); and 
Securities Exchange Act Release Number 38067 (December 20, 1996); 62 
FR 520 (January 3, 1997).
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5. Comments
    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.
     Are the WKSI requirements appropriate for use in a trading 
(as opposed to disclosure) context? What effect(s) of the proposed 
exceptions, if any, would you anticipate in the investment grade debt 
market and the high-yield debt market?
     Should the Rule 101(c)(2) and 102(d)(2) exceptions be 
based on criteria other than the WKSI requirements for nonconvertible 
debt and nonconvertible preferred securities and Form S-3 registration 
for asset-backed securities?
     Would the WKSI nonconvertible debt and nonconvertible 
preferred securities excepted in the proposal be as resistant to 
manipulation as those same securities that meet the existing investment 
grade standard?
     Please provide comment as to whether the proposal would 
capture the same type and quantity of securities that fall within the 
current Rule 101(c)(2) and Rule 102(d)(2) exceptions.
     Do the proposed WKSI and Form S-3 benchmarks adequately 
identify nonconvertible debt, nonconvertible preferred securities, and 
asset-backed securities that are of high quality with low default risk? 
Please distinguish the characteristics of nonconvertible debt, 
nonconvertible preferred securities, and asset-backed securities that 
meet these proposed benchmarks and those that do not.
     Is the proposed WKSI criterion easily applied by all 
persons subject to Rules 101 and 102 with respect to nonconvertible 
debt and nonconvertible preferred securities issued by issuers who are 
WKSI by virtue of $700 million market value of common equity?
     Would persons other than issuers who are subject to Rules 
101 and 102 have access to adequate information to determine if a 
particular security fits into the exceptions?
     Should asset-backed securities registered on Form S-3 be 
excepted from Rules 101 and 102 of Regulation M? Have there been 
developments in the asset-backed securities market that might indicate 
whether such securities should be eliminated from the proposed 
exceptions or should continue to be excepted from Rules 101 and 102?
     How frequently is the current asset-backed exception from 
Rules 101 and 102 relied upon?
     Is it appropriate to also except asset-backed securities 
registered on Form F-3? If yes, please explain.
     We ask for specific comment as to any relevant changes to 
the debt market since Regulation M was adopted in 1996 and the way debt 
issues are brought to market and trade.
     Do nonconvertible debt securities continue to trade based 
on their yield

[[Page 40097]]

and fungibility? Nonconvertible preferred securities? Asset-backed 
securities? Are there other factors that influence the trading of such 
securities?

IV. Request for Comment

    We generally request comment on all aspects of our proposal to end 
our regulatory reliance on NRSRO credit ratings. In addition, we 
request comment on the following specific questions:
     Should we eliminate the NRSRO designation from all our 
rules or only from select rules? Commenters who believe that certain 
rules should retain references to NRSROs or NRSRO ratings should 
identify each rule they believe should retain the use of the NRSRO 
concept and explain the rationale for doing so.
     Does the use of the NRSRO designation in our rules cause 
investors to overly rely on NRSRO credit ratings? Would its elimination 
mitigate this over reliance?
     Does the use of the NRSRO designation in our rules 
adversely impact competition among credit rating agencies by favoring 
those agencies that are registered as NRSROs? Would its elimination 
mitigate this negative impact?

V. Paperwork Reduction Act

    Certain provisions of the proposed amendments to the rules and 
forms contain ``collection of information requirements'' within the 
meaning of the Paperwork Reduction Act of 1995.\72\ The hours and costs 
associated with preparing and filing the disclosure, filing the forms 
and schedules and retaining records required by these regulations 
constitute reporting and cost burdens imposed by each collection of 
information. An agency may not conduct or sponsor, and a person is not 
required to respond to, a collection of information unless it displays 
a currently valid control number. The titles of the affected 
information forms are Rule 10b-10, ``Confirmation of Transactions,'' 
(OMB Control Number 3235-0444), Rule 15c3-1 (OMB Control Number 3235-
0200), Rule 15c3-3 (OMB Control Number 3235-0078), Form ATS-R (OMB 
Control Number 3235-0509), Form PILOT (OMB Control Number 3235-0507), 
and Form X-17A-5, Financial and Operational Combined Uniform Single 
Report, Part IIB, OTC Derivatives Dealer (OMB Control Number 3235-
0498). For the reasons discussed below, we do not believe the proposed 
amendments if adopted would result in a material or substantive 
revision to these collections of information.\73\
---------------------------------------------------------------------------

    \72\ 44 U.S.C. 3501 et seq.
    \73\ 5 CFR 1320.5(g).
---------------------------------------------------------------------------

    The proposed amendments to Form ATS-R and Form PILOT would revise 
the forms to provide that information which is currently reported as 
separate items, i.e., investment grade debt corporate debt securities 
and non-investment grade corporate debt securities, would be combined 
and reported as a single item, i.e., corporate debt securities. In all 
other respects, the information collected on these forms would remain 
unchanged. Accordingly, we do not believe the proposed amendment would 
result in a substantive revision to those collections of information if 
adopted.
    The proposed amendment to Rule 10b-10 would eliminate a requirement 
for transaction confirmations for debt securities (other than 
government securities) to inform customers if a security is unrated by 
an NRSRO. This proposed amendment would alter neither the general 
requirement that broker-dealers generate transaction confirmations and 
send those confirmations to customers, nor the potential use of 
information contained in confirmations by the Commission, self-
regulatory organizations, and other securities regulatory authorities 
in the course of examinations, investigations and enforcement 
proceedings. Moreover, the proposed amendment is not expected to change 
the cost of generating and sending confirmations, and, we believe that 
broker-dealers may not need to incur significant costs if they choose 
not to input information that a debt security is unrated into their 
existing confirmation systems. Accordingly, we do not believe the 
proposed amendment would result in a material or substantive revision 
to these collections of information if adopted.
    The proposed amendment to Rule 15c3-1 would potentially modify 
broker-dealers' existing practices to impose additional recordkeeping 
burdens. The proposed amendment would replace NRSRO ratings-based 
criteria for evaluating creditworthiness with new subjective standards 
based on the broker-dealer's own evaluation of creditworthiness, 
although broker-dealers would still be able to refer to NRSRO ratings 
for those purposes. The broker-dealer would have to be able to explain 
how the securities it used for net capital purposes meet the standards 
set forth in the proposed amendments. As such, we believe that firms 
would be required to develop (if they have not already) criteria for 
assessing the creditworthiness of securities to be included in net 
capital calculations and apply those criteria to such securities. In 
addition, the expectation that the broker-dealer be able to explain 
that any securities used for net capital purposes meet the standards 
set forth in the proposed amendments would result in the creation and 
maintenance of records of those assessments.
    We believe that all broker-dealers already have policies and 
procedures in place for evaluating the overall risk and liquidity 
levels of the securities they use for the purposes of the Net Capital 
Rule and that they keep records of the assessments of securities they 
make for net capital purposes; however, the proposed requirements, 
which specifically address credit risk, could result in additional 
burdens. The proposed amendments would apply to the approximately 550 
broker-dealers that take haircuts on securities pursuant to the Net 
Capital Rule. We estimate that on average, broker dealers will spend 
ten hours developing a system of standards for evaluating 
creditworthiness for the purposes of the Net Capital Rule, resulting in 
an aggregate initial burden of 5,500 hours. This estimate is based on 
our belief that many of these broker-dealers already have their own 
criteria in place for evaluating creditworthiness, while others would 
continue to refer to NRSRO ratings as the basis of their 
creditworthiness decisions.
    We further estimate that, on average, each broker-dealer will spend 
an additional ten hours a year reviewing, adjusting, and applying its 
own standards for evaluating creditworthiness, for a total of 5,500 
annual hours across the industry. Once again, this estimate reflects 
our belief that many of these broker-dealers already have their own 
criteria in place, while others would continue to refer to NRSRO 
ratings. We also estimate that firms would employ compliance attorneys, 
in many cases relying on outside counsel, to review these standards, 
both initially and on an annual basis. We estimate the per-firm costs 
of outside counsel to be $2,700 initially and $1,350 on an annual 
basis, for an aggregate industry cost of $1,485,000 initially and 
$742,500 on an annual basis.\74\
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    \74\ For the purposes of this analysis, we are using salary data 
from the Securities Industry and Financial Markets Association 
(``SIFMA'') Report on Management and Professional Earnings in the 
Securities Industry 2007, which provides base salary and bonus 
information for middle management and professional positions within 
the securities industry, as modified by Commission staff to account 
for an 1800-hour work-year and multiplied by 5.35 to account for 
bonuses, firm size, employee benefits and overhead. We believe that 
the legal reviews required by the proposed amendments would be 
performed by compliance attorneys at an average rate of $270 per 
hour. Furthermore, we believe that the review process will entail 
ten hours of initial work and five hours on an annual basis of $270 
x 10 = $2,700 x 550 = $1,485,000; $270 x 5 = $1,350 x 550 = 
$742,500.

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[[Page 40098]]

    We generally request comment on all aspects of these proposed 
estimates. In addition, we request specific comment on the following 
items related to these estimates:
     Are we correct in our hours estimates and our belief that 
many broker-dealers already have their own criteria in place for 
evaluating creditworthiness?
     Are we correct in our belief that some broker-dealers 
would continue to refer to NRSRO ratings as the basis of their 
creditworthiness decisions?
     Are we correct in our estimation that broker-dealers would 
engage outside counsel to review their internally generated standards 
for creditworthiness? If not, how would firms review such standards and 
what would be the effect of such differing approaches on our burden 
estimates?
    The proposed amendments to the appendices of Rule 15c3-1 include 
amendments to certain recordkeeping and disclosure requirements that 
are subject to the PRA. Specifically, the proposed amendments to 
Appendices E and F of Rule 15c3-1 and conforming amendments to Appendix 
G would remove the provisions permitting reliance on NRSRO ratings for 
the purposes of determining counterparty risk. As a result of these 
deletions, an entity that wished to use the approach set forth in these 
appendices to determine counterparty risks would be required, as part 
of its initial application to use the alternative approach or in an 
amendment, to request Commission approval to determine credit risk 
weights based on internal calculations and make and keep current a 
record of the basis for the credit risk weight of each counterparty.
    We do not believe that the removal of the option permitting 
reliance on NRSRO ratings would affect the small number of entities 
that currently elect to compute their net capital deductions pursuant 
to the alternative methods set forth in Appendix E or F. Although the 
collection of information obligations imposed by the proposed 
amendments are mandatory, applying for approval to use the alternative 
capital calculation is voluntary. To date, a total of seven entities 
have applied for and been granted permission to use the methods set 
forth in Appendix E, while five have applied for and been granted 
permission to use the methods set forth in Appendix F. We do not 
currently anticipate that any additional firms will apply for 
permission to use either Appendix E or Appendix F. All of the approved 
firms have already developed models to calculate market and credit risk 
under the alternative net capital calculation methods set forth in the 
appendices as well as internal risk management control systems.\75\ As 
such, each firm already employs the non-NRSRO ratings-based method that 
would, under the proposed amendments, become the only option for 
determining counterparty credit risk under Appendices E and F. Since 
each entity already employs its own models to calculate market and 
credit risk and keeps current a record of the basis for the credit risk 
weight of each counterparty, the proposed amendments would therefore 
not alter the paperwork burden currently imposed by Appendices E and F.
---------------------------------------------------------------------------

    \75\ See, e.g., Alternative Net Capital Requirements for Broker-
Dealers That Are Part of Consolidated Supervised Entities, 
Securities Exchange Act Release No. 49830 (June 8, 2004), 69 FR 
33428 at 33456 (June 21, 2004).
---------------------------------------------------------------------------

    The proposed amendment to Note G of Exhibit A to Rule 15c3-3 would 
potentially modify broker-dealers' existing practices to impose 
additional recordkeeping burdens. Currently, Note G to Exhibit A of 
Rule 15c3-3 allows a broker-dealer to include, as a debit in the 
formula for determining its reserve requirements, the amount of 
customer margin related to customers' positions in security futures 
products posted to a registered clearing or derivatives organization 
that meets one of four standards, including maintaining the highest 
investment grade rating from an NRSRO.\76\ The proposed amendment would 
replace the NRSRO ratings-based standard with a requirement that the 
registered clearing or derivatives organization has the highest 
capacity to meet its financial obligations and is subject to no greater 
than minimal credit risk. As such, we believe that firms that 
previously relied on NRSRO ratings for the purposes of Note G would be 
required to develop criteria for assessing the creditworthiness of 
registered clearing or derivatives organizations and apply those 
criteria to such securities, although one means of complying with the 
proposed amendment would be for broker-dealers to refer to NRSRO 
ratings. In addition, the expectation that the broker-dealer be able to 
explain that any such clearing or derivatives organizations meets the 
standard set forth in the proposed amendment would result in the 
creation and maintenance of records of those assessments.
---------------------------------------------------------------------------

    \76\ See 17 CFR 240.15c3-3a, Note G, (b)(1)(i). A broker-dealer 
may also include customer margin related to customers' positions in 
security futures products posted to a registered clearing or 
derivatives organization (1) that maintains security deposits from 
clearing members in connection with regulated options or futures 
transactions and assessment power over member firms that equal a 
combined total of at least $2 billion, at least $500 million of 
which must be in the form of security deposits; (2) that maintains 
at least $3 billion in margin deposits; or (3) which does not meet 
any of the other criteria but which the Commission has agreed, upon 
a written request from the broker-dealer, that the broker-dealer may 
utilize. 17 CFR 240.15c3-3a, Note G, (b)(1)(ii)--(iv).
---------------------------------------------------------------------------

    In the final release adding Note G to Exhibit A of Rule 15c3-3, we 
estimated that approximately 102 firms would be required to comply with 
the provisions of the Note.\77\ In addition, we estimated in that 
release that under subparagraph (c) to Note G, each broker-dealer would 
spend approximately 0.25 hours to verify that the clearing 
organizations they used met the conditions of Note G, for an aggregate 
one-time total of 25.5 hours; \78\ we believe that this estimate would 
apply to the verification of that status under the proposed amendment 
as well. We believe that the proposed amendment would impose an 
additional one-time burden for broker-dealers that chose to rely on the 
new standard of proposed Rule 15c3-3a(b)(1)(i). Given the additional 
options set forth in Note G, we estimate that only half, or 51, of the 
broker-dealers would choose this option, which we believe would result 
in the broker-dealer spending, on average, ten hours developing a 
system of standards for evaluating creditworthiness for the purposes of 
Note G, resulting in an aggregate initial burden of 510 hours.\79\ We 
also estimate that firms would employ compliance attorneys, in many 
cases relying on outside counsel, to review these standards. We 
estimate the one-time costs of outside counsel to be $1,350 per firm, 
resulting in an aggregate industry cost of $68,850.\80\
---------------------------------------------------------------------------

    \77\ See Reserve Requirements for Margin Related to Security 
Futures Products, Exchange Act Release No. 34-50295 (August 31, 
2004), 69 FR 54182 at 54188 (September 7, 2004).
    \78\ 0.25 x 102 = 25.5.
    \79\ 10 x 51 = 510.
    \80\ For the purposes of this analysis, we are using salary data 
from the SIFMA Report on Management and Professional Earnings in the 
Securities Industry 2007. We believe that the legal reviews required 
by the proposed amendments would be performed by compliance 
attorneys at an average rate of $270 per hour. Furthermore, we 
believe that the review process will entail five hours of initial 
work. $270 x 5 = $1,350 x 51 = $68,850.
---------------------------------------------------------------------------

    We generally request comment on all aspects of these proposed 
estimates. In addition, we request specific comment on the following 
items related to these estimates:

[[Page 40099]]

     Are we correct in our estimate of the number of broker-
dealers that would be affected by the proposed amendment to Note G?
     Are we correct in our estimate of the percentage of such 
broker-dealers that choose to rely on proposed Rule 15c3-3a(b)(1)(i)?
     Are we correct in our belief that broker-dealers would 
engage outside counsel to review their internally generated standards 
for creditworthiness? If not, how would firms review such standards and 
what would be the effect of such differing approaches on our burden 
estimates?
    The instructions to Form X-17A-5 Part IIB currently include a 
summary of the credit risk calculation in paragraph (d) of Rule 15c3-
1f. Paragraph (d) of Rule 15c3-1f is proposed to be amended to remove 
that part of the credit risk calculation that is summarized in Form X-
17A-5 Part IIB. Accordingly, we have proposed a conforming amendment to 
the form that would remove the summary of the credit risk calculation. 
The summary in the instructions provides additional information for the 
benefit of the filer and is not related to the information reported on 
the forms. Accordingly, we do not believe the proposed amendment would 
result in a substantive revision to these collections of information if 
adopted.
    Pursuant to 44 U.S.C. 3506(c)(2)(B), we solicit comments to:
    (1) Evaluate whether the proposed collection of information is 
necessary for the performance of the functions of the agency, including 
whether the information shall have practical utility;
    (2) Evaluate and provide relevant data regarding the agency's 
estimate of the burden of the proposed collection of information, 
including the validity of the methodology and assumptions used;
    (3) Enhance the quality, utility and clarity of the information to 
be collected; and
    (4) Minimize the burden of collection of information on those who 
are to respond, including through the use of automated collection 
techniques or other forms of information technology.
    Persons wishing to submit comments on the collection of information 
requirements should direct them to the following persons: (1) Desk 
Officer for the Securities and Exchange Commission, Office of 
Information and Budget (``OMB''), Room 3208, New Executive Office 
Building, Washington, DC 20503; and (2) Florence E. Harmon, Acting 
Secretary, Securities and Exchange Commission, 100 F Street, NE., 
Washington, DC 20549-1090 with reference to File No. S7-17-08. OMB is 
required to make a decision concerning the collection of information 
between 30 and 60 days after publication, so a comment to OMB is best 
assured of having its full effect if OMB receives it within 30 days of 
publication. The Commission has submitted the proposed collection of 
information to OMB for approval. Requests for the materials submitted 
to OMB by the Commission with regard to this collection of information 
should be in writing, refer to File No. S7-17-08, and be submitted to 
the Securities and Exchange Commission, Records Management Office, 100 
F Street, NE., Washington, DC 20549-1110.

VI. Costs and Benefits of the Proposed Rulemaking

    The Commission is sensitive to the costs and benefits imposed by 
its rules. We have identified certain costs and benefits of the 
proposed amendments and request comment on all aspects of this cost-
benefit analysis, including identification and assessment of any costs 
and benefits not discussed in this analysis. We seek comment and data 
on the value of the benefits identified. We also welcome comments on 
the accuracy of the cost estimates in each section of this analysis, 
and request that commenters provide data that may be relevant to these 
cost estimates. In addition, we seek estimates and views regarding 
these costs and benefits for particular covered institutions, including 
small institutions, as well as any other costs or benefits that may 
result from the adoption of these proposed amendments.
    As discussed above, the proposed rule amendments are designed to 
address the risk that the reference to and use of NRSRO ratings in our 
rules is interpreted by investors as an endorsement of the quality of 
the credit ratings issued by NRSROs, and may encourage investors to 
place undue reliance on the NRSRO ratings. The proposed amendments to 
Rule 3a1-1, Rule 10b-10, Rule 15c3-1, Rule 15c3-3, Rules 101 and 102 of 
Regulation M, Rules 300 and 301 of Regulation ATS, and Form ATS-R, Form 
PILOT, and Form X-17A-5 Part IIB would eliminate the reference to and 
requirement for the use of NRSRO ratings in these rules.

A. Benefits

    The Commission anticipates that one of the primary benefits of the 
proposed amendments, if adopted, would be the benefit to investors of 
reducing their possible undue reliance on NRSRO ratings that could be 
caused by references to NRSROs in our rules. An over-reliance on 
ratings can inhibit independent analysis and could possibly lead to 
investment decisions that are based on incomplete information. The 
purpose of the proposed rule amendments is to encourage investors to 
examine more than a single source of information in making an 
investment decision. Eliminating reliance on ratings in the 
Commission's rules could also result in greater investor due diligence 
and investment analysis. In addition, the Commission believes that 
eliminating the reliance on ratings in its rules would remove any 
appearance that the Commission has placed its imprimatur on certain 
ratings.
    We expect that there would be little effect on broker-dealers or 
other market participants that are subject to the rules that are 
proposed to be amended. This is because the references to NRSROs in 
these rules would be no longer necessary, can be replaced with an 
alternative bright-line standard, or can be used as one possible 
interpretation of a subjective standard set forth in a proposed 
amendment to the rule.
    The proposed amendments to Rule 3a1-1, Rules 300 and 301 of 
Regulation ATS, Form ATS-R, and Form PILOT would eliminate the separate 
definitions of and references to investment grade corporate debt 
securities and non-investment grade corporate debt securities and would 
replace them with a single category ``corporate debt securities.'' For 
reasons discussed above, the Commission preliminarily believes that it 
is not necessary or appropriate to assess trading volumes in the 
narrower segments of investment grade and non-investment grade 
corporate debt securities to fulfill the purposes of those rules. The 
other classes of securities and the threshold levels themselves would 
remain unchanged. Therefore, the proposed amendments to Rule 3a1-1 and 
Regulation ATS are not expected to significantly affect the regulatory 
treatment of ATSs. With respect to the proposed changes to Form ATS-R 
and Form PILOT, we expect that combining investment grade and non-
investment grade corporate debt securities into a single class for 
purposes of those two forms would have only minimal impact, because the 
total units and total dollar volume of corporate debt securities 
transacted would still have to be reported.
    The proposed amendments to Rule 10b-10 to eliminate a requirement 
for transaction confirmations for debt securities (other than 
government securities) to inform customers if a security is unrated by 
an NRSRO. The other requirements of Rule 10b-10 would remain unchanged. 
Eliminating

[[Page 40100]]

this requirement would avoid giving credit ratings an imprimatur that 
may inadvertently suggest to investors that an unrated security is 
inherently riskier than a rated security. Accordingly, we anticipate 
that investors and the marketplace would benefit from the elimination 
of this requirement, in light of concerns about promoting over-reliance 
on securities ratings or creating confusion about the significance of 
those ratings. More generally, eliminating this requirement is 
consistent with the goal of promoting a dialogue between broker-dealers 
and their customers--prior to purchase--regarding the creditworthiness 
of issuers, and should help avoid promoting the use of credit ratings 
as an oversimplified shorthand that replaces a more complete discussion 
of credit quality issues.
    We preliminarily believe that the proposed amendments to the Net 
Capital Rule, its appendices, and Exhibit A to the Customer Protection 
Rule would result in a better overall assessment of the risks 
associated with securities held by broker-dealers for the purposes of 
net capital calculations as well as of the long-term financial strength 
and general creditworthiness of clearing organizations to which 
customers' positions in security futures products are posted. As the 
NRSROs themselves have stressed, the ratings they generate focus solely 
on credit risk, that is, the likelihood that an obligor or financial 
obligation will repay investors in accordance with the terms on which 
they made their investment.\81\ Many broker-dealers already conduct 
their own risk evaluation. However, for those broker-dealers that do 
not, developing their own means of evaluating risk--including, as would 
be required by the proposed amendments to the Net Capital Rule, an 
evaluation of the degree of liquidity--would allow them to better 
incorporate the overall levels of various categories of risk associated 
with the securities they hold into their net capital calculations.
---------------------------------------------------------------------------

    \81\ See, e.g., Inside the Ratings: What Credit Ratings Mean, 
Fitch, August 2007 (``Inside the Ratings''), p. 1; Testimony of 
Michael Kanef, Group Managing Director, Moody's Investors Service, 
Before the United States Senate Committee on Banking, Housing, and 
Urban Affairs (September 26, 2007), p. 2; Testimony of Vickie A. 
Tillman, Executive Vice President, Standard & Poor's Credit Market 
Services, Before the United States Senate Committee on Banking, 
Housing, and Urban Affairs (September 26, 2007), p. 3.
---------------------------------------------------------------------------

    A separate evaluation of risk by the broker-dealer should lead to a 
better understanding of the risks associated with those securities 
which would, we believe, lead to increased operational efficiency and 
potentially lowered net capital charges for those broker-dealers that 
currently do not conduct their own risk evaluation. We believe that 
allowing broker-dealers to employ their own criteria in determining 
credit risk for net capital purposes would, by reducing the reliance on 
NRSRO ratings and therefore more closely aligning a broker-dealer's net 
capital-related risk assessments with its general internal risk 
assessments, increase operational efficiency. Furthermore, we believe 
that the proposed amendments could result in more closely tailored 
capital charges, and thus lowered costs, for broker-dealers while still 
being designed to ensure net capital requirements sufficient to require 
maintenance of capital to achieve the goals of the Net Capital Rule.
    We believe that the same reasoning applies to the proposed 
amendment to Exhibit A of the Customer Protection Rule. Broker-dealers 
that utilize their own means of evaluating the long-term financial 
strength and general creditworthiness of clearing organizations to 
which customers' positions in security futures products are posted 
would better be positioned to incorporate the overall levels of various 
categories of risk associated with those organizations into their 
assessments.
    In the case of the amendments to Rules 101 and 102 of Regulation M, 
we believe the proposed rule amendments would have benefits that 
justify any costs, if adopted. Because the exceptions in Rules 101 and 
102 are narrowly-tailored, the proposed amendments should continue to 
promote investor confidence in the offering process and the market as a 
whole by only excepting those securities that are resistant to 
manipulation. Market integrity would also continue to be promoted, 
which benefits the market and all participants. Also, since the 
proposals would be a bright-line, compliance with the proposed 
amendments would be easy for issuers and other persons subject to the 
rules. In fact, this proposal may lower costs for these people by 
eliminating the need to obtain an investment grade rating from a 
nationally recognized statistical rating organization. We believe that 
replacing the NRSRO investment grade requirement with the proposed 
exceptions should not result in broker-dealers hiring new compliance 
staff or making extensive systems changes because the proposals utilize 
existing bright-line benchmarks.

B. Costs

    We anticipate that broker-dealers and other market participants 
could incur certain costs if the proposed amendments are adopted. 
Investors could incur additional costs if they perform a more detailed 
and comprehensive analysis before making an investment decision. 
Broker-dealers could incur additional costs if they perform their own 
risk evaluation, if they do not currently do so. Furthermore, the 
purpose of the proposal is to encourage investors not to place undue 
reliance on NRSRO ratings in making investment decisions. Investors 
could still choose to rely solely on NRSRO ratings without incurring 
additional costs.
    The proposed amendments to Rule 3a1-1, Rules 300 and 301 of 
Regulation ATS, Form ATS-R, and Form PILOT would eliminate the separate 
definitions of and references to investment grade corporate debt 
securities and non-investment grade debt securities and would replace 
them with a single category ``corporate debt securities.'' We 
preliminarily believe that these changes would not impose any 
significant costs on market participants.
    The proposed amendments to Rule 3a1-1 and Regulation ATS would 
marginally reduce the likelihood of an ATS meeting the thresholds in 
those rules. For example, under existing Rule 3a1-1, an ATS that 
currently has 40% of the average daily dollar trading volume in non-
investment grade corporate debt securities and 0% of the average daily 
dollar trading volume in investment grade corporate debt securities for 
at least four of the preceding six calendar months could be required to 
register as an exchange. Under the proposed amendment to Rule 3a1-1, 
the Commission would no longer be able to require the ATS to register 
as an exchange, because its average daily dollar trading volume in 
corporate debt securities combined would be less than 40%. A potential 
cost of the proposed amendments to Rule 3a1-1 and Regulation ATS is 
that an ATS that exceeds one of the existing thresholds and thus 
becomes subject to additional regulatory requirements (in the case of 
Regulation ATS) or must register as an exchange (in the case of Rule 
3a1-1) would no longer exceed the threshold and would not have to meet 
the attendant requirements. However, the Commission preliminarily 
believes that this possibility is remote, and that the proposed 
amendments are unlikely to impose any costs on investors, market 
participants, or the national market system generally.
    We believe that any costs associated with the proposed changes to 
Form ATS-R and Form PILOT would be minimal. Respondents already 
determine and report the total units and

[[Page 40101]]

total trading volume for investment grade and non-investment grade 
corporate debt securities separately. On the revised forms, respondents 
would report them together as a single item for ``corporate debt 
securities.'' The cost of the proposed changes to these forms would be 
the cost of adding these previously separate items together.
    We do not expect the proposed amendment to result in any 
significant changes in the costs associated with Rule 10b-10. Broker-
dealers will continue to generate transaction confirmations and send 
those confirmations to customers, and the proposed amendment if adopted 
would not be expected to change the cost of generating and sending 
confirmations. Moreover, we believe that broker-dealers may not need to 
incur significant costs if they choose not to input information that a 
debt security is unrated into their existing confirmation systems.
    We believe that the costs of compliance with the proposed 
amendments to the Net Capital Rule and its appendices as well as to 
Note G of Exhibit A of the Rule 15c3-3 would be minimal for entities 
that already employ their own criteria in determining credit risk for 
net capital purposes. In the event the broker-dealer inaccurately 
evaluates the creditworthiness and liquidity of its positions, a 
potential cost could be that the broker-dealer is required to take a 
larger haircut on its proprietary positions, and therefore reserve 
additional capital. This could affect its ability to hold its positions 
or to add to its positions. As for broker-dealers that do not currently 
employ such criteria, if the proposed amendments are adopted, after 
considering comment, we could take the view that securities rated by 
NRSROs would meet the standards in the rules as amended and this would 
provide a way for broker-dealers that do not determine credit risk on 
their own to avoid incurring any additional costs. If we were to adopt 
the view that NRSRO rated securities meet the standard in the proposed 
amendments, it would mean that any potential costs would be wholly 
voluntary. While we encourage broker-dealers that have not yet 
developed their own credit risk evaluation procedures to do so, such 
actions would proceed at the time and pace desired by the broker-
dealers.
    We expect the costs of the proposal to modify Rules 101 and 102 of 
Regulation M to be minimal to most persons subject to those rules who 
could rely on the proposed amendments as they relate to nonconvertible 
debt and preferred securities. The proposed exceptions are only 
triggered when the conditions in the exceptions are met which would 
only occur in a limited number of situations. It is only when there is 
an offering of nonconvertible debt or nonconvertible preferred 
securities which qualifies as a distribution under Regulation M where a 
covered person bids for, purchases or attempts to induce another person 
to bid for or purchase the covered security during the applicable 
restricted period. Thus, there may be offerings of nonconvertible debt 
or preferred securities that do not constitute a distribution for 
purposes of Regulation M. In such case, the prohibitions of Regulation 
M are not triggered and neither the current nor the proposed exceptions 
would be necessary. Additionally, even if a distribution of the 
nonconvertible debt or nonconvertible preferred securities exists, a 
person subject to Regulation M's prohibitions could structure buying 
activity before or after the applicable restricted period so as not to 
incur any costs, even if minimal, associated with relying on the 
proposed exceptions. This holds true for asset-backed securities as 
well.
    We believe that many of the issuers of these securities would 
already know if they are WKSI issuers based on the non-common equity 
standard because this analysis would have been already done as part of 
the offering process. Persons other than issuers who would be subject 
to Rules 101 and 102 should have access to the issuer's WKSI status as 
well via the issuer's 10K filings. Such persons should also be in a 
position with the issuer to obtain any other information needed to make 
a determination as to whether the proposed exception would apply to the 
security at issue. Thus, we believe that these persons should incur no 
significant costs under the proposal. There may be, however, costs to 
any person subject to Rules 101 or 102 to make minor system changes 
should the Commission adopt this proposal because of the proposed new 
standard.
    We do believe, however, that there may be increased costs for 
issuers and other persons subject to Rules 101 and 102 as they relate 
to nonconvertible debt and preferred securities if that issuer is WKSI 
based on the common equity standard.\82\ Since the issuer in that case 
would not need to determine the aggregate principal amount of their 
nonconvertible securities other than common equity for purposes of 
Securities Act disclosure, new analysis would need to be conducted and 
communicated to other persons subject to Rules 101 and 102 to rely on 
the exception. This could likely result in increased costs not 
completely offset by not needing to obtain an investment grade rating.
---------------------------------------------------------------------------

    \82\ 17 CFR 230.405. The common equity standard is at 
subparagraph (1)(i)(A) of the definition of ``well-known seasoned 
issuer.''
---------------------------------------------------------------------------

    With respect to asset-backed securities, we believe that there 
should not be any significant increased costs to persons subject to 
Rules 101 and 102. All persons who are subject to those rules should 
know what form the issuer is using to register the offering, including 
whether Form S-3 is being used. Thus, no new analysis would need to be 
conducted. We also expect that there could be a small number of 
securities taken out of this exception as a result of the proposed 
change. Costs for such issuers, selling shareholders, underwriters, 
brokers, dealers, any other distribution participants, or affiliated 
purchasers of any of these persons affected by this change would be 
more significant, but we do not expect there to be a significant number 
of these persons. There could also be minimal costs to train broker-
dealer and self-regulatory organization staff and to update broker-
dealer policies and procedures and make system changes regarding the 
new exceptions.

C. Request for Comment

    We request data to quantify the costs and the benefits above. We 
seek estimates of these costs and benefits, as well as any costs and 
benefits not already described, which could result from the adoption of 
the proposed amendments. Specifically, would the proposal result in 
lower costs associated with debt and preferred securities covered by 
the new exception? What new costs, if any, would be associated with the 
proposal for persons subject to Rules 101 and 102 where the 
nonconvertible debt and nonconvertible preferred securities are issued 
by issuers who are WKSI based on the common equity standard? What 
costs, if any, would be related to the change for asset-backed 
securities? For these issues, what is the cost of determining the 
aggregate principal amount of nonconvertible debt securities other than 
common equity and then communicating the exception to other persons 
subject to Rules 101 and 102? Would any securities that currently fall 
within the existing exceptions not meet the exceptions as proposed? 
Would the proposal affect the cost to broker dealers of generating 
transaction confirmations? Do investors benefit from the notification 
on the transaction confirmation? Does the confirmation help promote 
conversations about broker-dealers and their customers

[[Page 40102]]

regarding unrated securities? Are there alternative means to promote 
such conversations that would not create over-reliance on NRSRO 
ratings?

VII. Consideration of the Burden on Competition, Promotion of 
Efficiency, and Capital Formation

    Section 3(f) of the Exchange Act \83\ requires the Commission, 
whenever it engages in rulemaking and is required to consider or to 
determine whether an action is necessary or appropriate in the public 
interest, to consider whether the action will promote efficiency, 
competition, and capital formation. In addition, Section 23(a)(2) of 
the Exchange Act \84\ requires the Commission, when promulgating rules 
under the Exchange Act, to consider the impact any such rules would 
have on competition. Section 23(a)(2) further provides that the 
Commission may not adopt a rule that would impose a burden on 
competition not necessary or appropriate in furtherance of the purposes 
of the Exchange Act.
---------------------------------------------------------------------------

    \83\ 15 U.S.C. 78c(f).
    \84\ 15 U.S.C. 78w(a)(2).
---------------------------------------------------------------------------

    The proposed amendments would remove the reference to NRSRO ratings 
in several of our rules and forms. These include Rules 3a1-1, 10b-10, 
15c3-1, 15c3-3, Rules 101 and 102 of Regulation M, Rules 300 and 301 of 
Regulation ATS, and Forms ATS-R and PILOT. The purpose of the proposed 
amendments is to address concerns that the references to NRSRO ratings 
in our rules and forms contributed to any over-reliance on credit 
ratings by investors.
    We preliminarily believe that the proposed amendments to Rule 3a1-1 
and Rules 300 and 301 of Regulation ATS would be unlikely to create any 
adverse impact on efficiency, competition, or capital formation. The 
Commission preliminarily believes that combining investment grade and 
non-investment grade corporate debt securities into a single class of 
securities for purposes of the thresholds in those rules is unlikely to 
affect whether an ATS crosses one of those thresholds. Moreover, the 
other classes of securities for which the thresholds are applied--and 
the levels of the thresholds themselves--would remain unchanged.
    The proposed changes to Form ATS-R and Form PILOT would simplify 
reporting for ATSs and self-regulatory systems that operate pilot 
trading systems. Form ATS-R and Form PILOT respondents are already 
required to determine and report the volumes of corporate debt 
securities. A single reporting item for ``corporate debt securities'' 
would replace the existing separate entries for ``investment grade 
corporate debt securities'' and ``non-investment grade corporate debt 
securities.'' Therefore, we preliminarily believe that the changes to 
Form ATS-R and Form PILOT would be unlikely to have any significant 
impact on efficiency, competition, or capital formation.
    We do not believe that the proposed amendment to Rule 10b-10 would 
result in any burden on competition that is not necessary or 
appropriate in furtherance of the purposes of the Exchange Act. The 
proposed deletion of paragraph (a)(8) of that rule would not be 
expected to impose any significant additional costs upon broker-dealers 
(which in any event would not be prohibited from voluntarily including 
information that a particular debt security is unrated by an NRSRO). 
For similar reasons, we do not believe that this proposed amendment 
would impose any significant adverse effects on efficiency, competition 
or capital formation.
    We preliminarily believe that the proposed amendments to the Net 
Capital Rule and its appendices or to Note G of Exhibit A of the Rule 
15c3-3 would serve to promote efficiency and capital formation. As 
noted above, we believe that by relying on their own means of 
evaluating risk, broker-dealers would better incorporate the overall 
levels of risk associated with the securities they hold into their Net 
Capital Rule. In turn, we believe, this better understanding would more 
closely align a broker-dealer's net capital-related risk assessments 
with its general internal risk assessments and lead to increased 
operational efficiency, potentially lowered net capital charges, and a 
more efficient allocation of capital. In addition, broker-dealers that 
developed their own means of evaluating the long-term financial 
strength and general creditworthiness of clearing organizations to 
which customers' positions in security futures products are posted for 
purposes of Note G to Exhibit A of Rule 15c3-3 would better be 
positioned to incorporate the overall levels of various categories of 
risk associated with those organizations into their assessments, 
creating a more efficient means of evaluating those organizations for 
the sake of the Rule 15c3-3 than simply relying on NRSRO credit ratings 
alone. We do not anticipate that the proposed amendments to the Net 
Capital Rule and its appendices or to Note G of Exhibit A of Rule 15c3-
3 would have any impact on competition.
    We preliminarily believe that the proposed amendments to Rules 101 
and 102 of Regulation M are intended to promote capital formation. The 
proposed amendments should promote continued investor confidence in the 
offering process by proposing an exception from Regulation M's Rule 101 
and 102 prohibitions limited to those securities which are resistant to 
manipulation. Such investor confidence in our markets should promote 
continued capital formation. We believe that the proposals should 
foster continued market integrity which should also translate into 
capital formation by only allowing for non-manipulative buying activity 
during distributions. Issuers of nonconvertible debt, nonconvertible 
preferred securities and asset-backed securities who fall within the 
proposed exceptions may be encouraged to engage in capital formation 
knowing that the proposed exceptions are available for their buying 
activity as well as the buying activity of distribution participants. 
Because the proposal eliminates the need to obtain an investment grade 
rating by an NRSRO, a hurdle to both relying on the exception and 
capital formation would be eliminated, which would also promote capital 
formation.
    The proposal would provide an alternative to obtaining an 
investment grade rating but still would provide clear guidance to all 
persons subject to those rules. We preliminarily believe that the 
proposed Regulation M amendments would promote market efficiency by 
providing continued clarity to issuers, distribution participants, and 
their affiliated purchasers as to the scope of permissible activity by 
providing a bright line test for compliance with the proposed 
exceptions comparable to the existing exception. In addition, the 
proposals continue to utilize existing benchmarks so as not to trigger 
inefficiencies that might result from use of a new standard. The 
proposal would also eliminate the need to obtain an investment grade 
rating from an NRSRO to rely on the exception, which will eliminate a 
potential inefficiency in the capital raising process. For these 
reasons, the Commission preliminarily believes that the proposed 
exceptions will promote efficient capital formation and competition.
    We have considered the proposed amendments to Rules 101 and 102 of 
Regulation M in light of the standards cited in Section 23(a)(2) and 
believe preliminarily that, if adopted, they would not likely impose 
any significant burden on competition not necessary or appropriate in 
furtherance of the Exchange Act. We preliminary believe that the use of 
the existing WSKI and

[[Page 40103]]

Form S-3 standards would mean that any additional burdens the proposal 
may place on market participants should be minimal as market 
participants are already familiar with and utilize these benchmarks in 
other contexts. Additionally, the proposals would apply equally to all 
issuers, distribution participants, and their affiliated issuers. Thus, 
no person covered by Regulation M should be put at a competitive 
disadvantage, and the proposal would not impose a significant burden on 
competition not necessary or appropriate in furtherance of the Act.
    We generally request comment on the effects of the proposed 
amendments to Rules 3a1-1, 10b-10, 15c3-1, 15c3-3, Rules 101 and 102 of 
Regulation M, Rules 300 and 301 of Regulation ATS, and Forms ATS-R and 
PILOT on efficiency, competition, and capital formation. Commenters 
should provide analysis and empirical data to support their views.

VIII. Regulatory Flexibility Act Certification

    Section 3(a) of the Regulatory Flexibility Act of 1980 \85\ 
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.\86\ Pursuant 
to Section 605(b) of the Regulatory Flexibility Act (``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.
---------------------------------------------------------------------------

    \85\ 5 U.S.C. 603(a).
    \86\ 5 U.S.C. 605(b).
---------------------------------------------------------------------------

    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,\87\ 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.\88\
---------------------------------------------------------------------------

    \87\ See 17 CFR 240.17a-5(d).
    \88\ See 17 CFR 240.0-10(c).
---------------------------------------------------------------------------

    An alternative trading system that complies with Regulation ATS 
must, among other things, register as a broker-dealer.\89\ Thus, the 
Commission's definition of small entity as it relates to broker-dealers 
also would apply to ATSs. An ATS that approaches the volume thresholds 
for investment grade or non-investment grade corporate debt securities 
in Rule 3a1-1 or Regulation ATS would be very large and thus unlikely 
to be a small entity or small organization. With respect to the 
proposed changes to Form ATS-R, even if an ATS is a ``small entity'' or 
``small organization'' for purposes of the RFA, the only change being 
proposed to the form is to eliminate the distinction between investment 
grade and non-investment grade corporate debt securities and to require 
reporting for the combined class of corporate debt securities. We 
believe this would impose only negligible costs on ATSs, even if they 
were small entities or small organizations.
---------------------------------------------------------------------------

    \89\ See 17 CFR 242.301(b)(1).
---------------------------------------------------------------------------

    Similarly, SROs are the only respondents to Form PILOT and are not 
``small entities'' for purposes of the RFA. Accordingly, no small 
entities would be affected by the proposed amendments to Form PILOT.
    We believe that the proposed amendment to Rule 10b-10 will not have 
a significant economic impact on a substantial number of small 
entities. While some broker-dealers that effect transactions in the 
debt securities currently subject to paragraph (a)(8) of that rule may 
be small entities, the proposed amendment should not result in any 
significant change to the cost of providing confirmations to customers 
in connection with those transactions.
    The proposed amendments to the securities haircut provisions in 
paragraphs (E), (F), and (H) of Rules 15c3-1(c)(2)(vi), if adopted, 
would not have a significant economic impact on a small number of 
entities. If the Commission adopts the proposed amendments, we would 
take the view in the adopting release that securities rated by NRSROs 
as currently required would meet the amended standards. Thus, the 
proposed amendments would allow for compliance without reference to the 
standards that are currently in the rule (i.e., NRSRO ratings), but 
broker-dealers that wish to use them would still be accommodated. 
Accordingly, the rule would not have any economic impact on small 
entities because they would not have to change their current practices.
    The proposed amendments to the Appendices E and F to Rule 15c3-1 
(which include conforming amendments to Appendix G of Rule 15c3-1 and 
the General Instructions to Form X-17A-5, Part IIB), if adopted, would 
not apply to small entities. Appendices E and G apply to broker-dealers 
that are part of a consolidated supervised entity and Appendix F and 
Form X-17A-5, Part IIB apply to OTC Derivatives Dealers that have 
applied to the Commission for authorization to compute capital charges 
as set forth in Appendix F in lieu of computing securities haircuts 
pursuant to Rule 15c3-1(c)(2)(vi). All of these brokers or dealers 
would be larger than the definition of a small broker dealer in Rule 0-
10.
    The proposed amendments to Rule 15c3-3a, if adopted, would not have 
a significant economic impact on a substantial number of small 
entities. The proposed amendments to Rule 15c3-3a would apply only to 
broker-dealers that clear and carry positions in security futures 
products in securities accounts for the benefit of customers. None of 
those broker-dealers affected by the rule is a small entity as defined 
in Rule 0-10 (confirming this with OEA).
    With respect to the amendments to Rules 101 and 102 of Regulation 
M, it is unlikely that any broker-dealer that is defined as a ``small 
business'' or ``small organization'' as defined in Rule 0-10 \90\ could 
be an underwriter or other distribution participant as they 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.\91\ 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.
---------------------------------------------------------------------------

    \90\ 17 CFR 240.0-10.
    \91\ 17 CFR 240.0-10(a).
---------------------------------------------------------------------------

    We encourage written comments regarding this certification. The 
Commission solicits comment as to whether the proposed amendments to 
Rules 3a1-1, 10b-10, 15c3-1, 15c3-3, Rules 101 and 102 of Regulation M, 
Rules 300 and 301 of Regulation ATS, and Forms ATS-R and PILOT could 
have an effect on small entities that has not been considered. We 
request that commenters describe the nature of any

[[Page 40104]]

impact on small entities and provide empirical data to support the 
extent of such impact.

IX. Statutory Basis and Text of the Proposed Amendments

    The amendments to Rules 3a1-1, 10b-10, 15c3-1, 15c3-3, Rules 101 
and 102 of Regulation M, Rules 300 and 301 of Regulation ATS, and Forms 
ATS-R, Pilot, 17-H, and X-17A-5 Part IIB under the Act are being 
proposed pursuant to the Sections 7,\92\ 17(a),\93\ 19(a) \94\ of the 
Securities Act, Sections 2,\95\ 3,\96\ 9(a),\97\ 10,\98\ 11,\99\ 
11A(c),\100\ 12,\101\ 13,\102\ 14,\103\ 15,\104\ 15(c),\105\ 
15(g),\106\ 17,\107\ 17(a),\108\ 23(a),\109\ 30,\110\ and 36(a)(1) 
\111\ of the Exchange Act, and Sections 23,\112\ 30,\113\ and 38 \114\ 
of the Investment Company Act of 1940.
---------------------------------------------------------------------------

    \92\ 15 U.S.C. 77g.
    \93\ 15 U.S.C. 77q(a).
    \94\ 15 U.S.C. 77s(a).
    \95\ 15 U.S.C. 78b.
    \96\ 15 U.S.C. 78c.
    \97\ 15 U.S.C. 78i(a).
    \98\ 15 U.S.C. 78j.
    \99\ 15 U.S.C. 78k.
    \100\ 15 U.S.C. 78k-1(c).
    \101\ 15 U.S.C. 78l.
    \102\ 15 U.S.C. 78m.
    \103\ 15 U.S.C. 78n.
    \104\ 15 U.S.C. 78o.
    \105\ 15 U.S.C. 78o(c).
    \106\ 15 U.S.C. 78o(g).
    \107\ 15 U.S.C. 78q.
    \108\ 15 U.S.C. 78q(a).
    \109\ 15 U.S.C. 78w(a).
    \110\ 15 U.S.C. 78dd.
    \111\ 15 U.S.C. 78mm(a)(1).
    \112\ 15 U.S.C. 80a-23.
    \113\ 15 U.S.C. 80a-29.
    \114\ 15 U.S.C. 80a-37.
---------------------------------------------------------------------------

List of Subjects in 17 CFR Parts 240, 242, and 249

    Broker, Reporting and recordkeeping requirements, Securities.

Text of Amendment

    In accordance with the foregoing, 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, 78d, 78e, 78f, 78g, 78i, 
78j, 78j-1, 78k, 78k-1, 78l, 78m, 78n, 78o, 78p, 78q, 78s, 78u-5, 
78w, 78x, 78ll, 78mm, 80a-20, 80a-23, 80a-29, 80a-37, 80b-3, 80b-4, 
80b-11, and 7201 et seq.; and 18 U.S.C. 1350, unless otherwise 
noted.
* * * * *
    2. Amend Sec.  240.3a1-1 by revising paragraphs (b)(3)(v), 
(b)(3)(vi), and (b)(3)(vii) and by removing (b)(3)(viii) to read as 
follows:


Sec.  240.3a1-1  Exemption from the definition of ``Exchange'' under 
Section 3(a)(1) of the Act.

* * * * *
    (b) * * *
    (3) * * *
    (v) Corporate debt securities, which shall mean any securities 
that:
    (A) Evidence a liability of the issuer of such securities;
    (B) Have a fixed maturity date that is at least one year following 
the date of issuance; and
    (C) Are not exempted securities, as defined in section 3(a)(12) of 
the Act, (15 U.S.C. 78c(a)(12));
    (vi) Foreign corporate debt securities, which shall mean any 
securities that:
    (A) Evidence a liability of the issuer of such debt securities;
    (B) Are issued by a corporation or other organization incorporated 
or organized under the laws of any foreign country; and
    (C) Have a fixed maturity date that is at least one year following 
the date of issuance; and
    (vii) Foreign sovereign debt securities, which shall mean any 
securities that:
    (A) Evidence a liability of the issuer of such debt securities;
    (B) Are issued or guaranteed by the government of a foreign 
country, any political subdivision of a foreign country, or any 
supranational entity; and
    (C) Do not have a maturity date of a year or less following the 
date of issuance.
    3. Section 240.10b-10 is amended by removing paragraph (a)(8) and 
redesignating paragraph (a)(9) as paragraph (a)(8).
    4. Section 240.15c3-1 is amended by revising the introductory text 
of paragraphs (c)(2)(vi)(E), (c)(2)(vi)(F)(1), and (c)(2)(vi)(F)(2), 
and by revising paragraph (c)(2)(vi)(H) to read as follows:


Sec.  240.15c3-1  Net capital requirements for brokers or dealers.

* * * * *
    (c) * * *
    (2) * * *
    (vi) * * *
    (E) Commercial paper, bankers acceptances and certificates of 
deposit. In the case of any short term promissory note or evidence of 
indebtedness which has a fixed rate of interest or is sold at a 
discount, which has a maturity date at date of issuance not exceeding 
nine months exclusive of days of grace, or any renewal thereof, the 
maturity of which is likewise limited, and is subject to a minimal 
amount of credit risk and has sufficient liquidity such that it can be 
sold at or near its carrying value almost immediately, or in the case 
of any negotiable certificates of deposit or bankers acceptance or 
similar type of instrument issued or guaranteed by any bank as defined 
in section 3(a)(6) of the Securities Exchange Act of 1934, the 
applicable percentage of the market value of the greater of the long or 
short position in each of the categories specified below are:
* * * * *
    (F) (1) Nonconvertible debt securities. In the case of 
nonconvertible debt securities having a fixed interest rate and a fixed 
maturity date, which are not traded flat or in default as to principal 
or interest and which are subject to no greater than moderate credit 
risk and have sufficient liquidity such that they can be sold at or 
near their carrying value within a reasonably short period of time, the 
applicable percentages of the market value of the greater of the long 
or short position in each of the categories specified below are:
* * * * *
    (2) A broker or dealer may elect to exclude from the above 
categories long or short positions that are hedged with short or long 
positions in securities issued by the United States or any agency 
thereof or nonconvertible debt securities having a fixed interest rate 
and a fixed maturity date and which are not traded flat or in default 
as to principal or interest, and which are subject to no greater than 
moderate credit risk and have sufficient liquidity such that they can 
be sold at or near their carrying value within a reasonably short 
period of time, if such securities have maturity dates:
* * * * *
    (H) In the case of cumulative, non-convertible preferred stock 
ranking prior to all other classes of stock of the same issuer, which 
is subject to no greater than moderate credit risk and has sufficient 
liquidity such that it can be sold at or near its carrying value within 
a reasonably short period of time and which are not in arrears as to 
dividends, the deduction shall be 10% of the market value of the 
greater of the long or short position.
* * * * *
    5. Section 240.15c3-1e is amended by removing paragraphs 
(c)(4)(vi)(A) through (c)(4)(vi)(D) and redesignating paragraphs 
(c)(4)(vi)(E), (F), and (G) as paragraphs (c)(4)(vi)(A), (B), and (C).
    6. Section 240.15c3-1f is amended by:
    a. Removing the phrase ``by a nationally recognized statistical 
rating

[[Page 40105]]

organization (``NRSRO'')'' in paragraph (d)(2)(i);
    b. Removing the phrase ``by an NRSRO'' in paragraphs (d)(2)(ii), 
(d)(3)(i), and (d)(3)(ii); and
    c. Revising the first and second sentences of paragraph (d)(4).
    The revision reads as follows:


Sec.  240.15c3-1f  Optional market and credit risk requirements for OTC 
derivatives dealers (Appendix F to 17 CFR 240.15c3-1).

* * * * *
    (d) * * *
    (4) Counterparties may be rated by the OTC derivatives dealer, or 
by an affiliated bank or affiliated broker-dealer of the OTC 
derivatives dealer, upon approval by the Commission on application by 
the OTC derivatives dealer. Based on the strength of the OTC 
derivatives dealer's internal credit risk management system, the 
Commission may approve the application. * * *
* * * * *
    7. Section 240.15c3-1g is amended by revising paragraph 
(a)(3)(i)(F) to read as follows:


Sec.  240.15c3-1g  Conditions for ultimate holding companies of certain 
brokers or dealers (Appendix G to 17 CFR 240.15c3-1).

* * * * *
    (a) * * *
    (3) * * *
    (i) * * *
    (F) Credit risk weights shall be determined according to the 
provisions of paragraphs (c)(4)(vi)(A) of Sec.  240.15c3-1e.
* * * * *
    8. Section 15c3-3a is amended by revising Note G paragraph 
(b)(1)(i) to read as follows:


Sec.  240.15c3-3a  Exhibit A--formula for determination reserve 
requirement of brokers and dealers under Sec.  240.15c3-3.

* * * * *
    Note G. * * *
    (b) * * *
    (1) * * *
    (i) Has the highest capacity to meet its financial obligations and 
is subject to no greater than minimal credit risk; or
* * * * *

PART 242--REGULATIONS M, SHO, ATS, AC, AND NMS AND CUSTOMER MARGIN 
REQUIREMENTS FOR SECURITY FUTURES

    9. 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.

    10. Section 242.101 is amended by revising paragraph (c)(2) to read 
as follows:


Sec.  242.101  Activities by distribution participants.

* * * * *
    (c) * * *
    (2) Nonconvertible and asset-backed securities. Nonconvertible debt 
securities, nonconvertible preferred securities, and asset-backed 
securities, if:
    (i) For nonconvertible debt securities and nonconvertible preferred 
securities, the issuer of such securities meets the requirements of 
``well-known seasoned issuer'' as that term is used in Sec.  230.405 of 
this chapter, but only if such issuer also meets the requirements of 
paragraph (1)(i)(B)(1) of that definition; or
    (ii) For asset-backed securities, the offer and sale of the 
security is registered using Form S-3 (Sec.  239.13 of this chapter); 
or
* * * * *
    11. Section 242.102 is amended by revising paragraph (d)(2) to read 
as follows:


Sec.  242.102  Activities by issuers and selling security holders 
during a distribution.

* * * * *
    (d) * * *
    (2) Nonconvertible and asset-backed securities. Nonconvertible debt 
securities, nonconvertible preferred securities, and asset-backed 
securities, if:
    (i) For nonconvertible debt securities and nonconvertible preferred 
securities, the issuer of such securities meets the requirements of 
``well-known seasoned issuer'' as that term is used in Sec.  230.405 of 
this chapter, but only if such issuer also meets the requirements of 
paragraph (1)(i)(B)(1) of that definition; or
    (ii) For asset-backed securities, the offer and sale of the 
security is registered using Form S-3 (Sec.  239.13 of this chapter); 
or
* * * * *
    12. Section 242.300 is amended by revising paragraph (i), removing 
paragraph (j), and redesignating paragraph (k) as paragraph (j).
    The revision reads as follows:


Sec.  242.300  Definitions.

* * * * *
    (i) Corporate debt security shall mean any security that:
    (1) Evidences a liability of the issuer of such security;
    (2) Has a fixed maturity date that is at least one year following 
the date of issuance; and
    (3) Is not an exempted security, as defined in section 3(a)(12) of 
the Act (15 U.S.C. 78c(a)(12)).
* * * * *
    13. Section 242.301 is amended by:
    a. Adding the word ``or'' to the end of paragraph (b)(5)(i)(C);
    b. Revising paragraph (b)(5)(i)(D);
    c. Removing paragraph (b)(5)(i)(E);
    d. Adding the word ``or'' to the end of paragraph (b)(6)(i)(C);
    e. Revising paragraph (b)(6)(i)(D); and
    f. Removing paragraph (b)(6)(i)(E).
    The revisions read as follows:


Sec.  242.301  Requirements for alternative trading systems.

* * * * *
    (b) * * *
    (5) * * *
    (i) * * *
    (D) With respect to corporate debt securities, 5 percent or more of 
the average daily volume traded in the United States.
* * * * *
    (6) * * *
    (i) * * *
    (D) With respect to corporate debt securities, 20 percent or more 
of the average daily volume traded in the United States.
* * * * *

PART 249--FORMS, SECURITIES EXCHANGE ACT OF 1934

    14. The authority citation for part 249 continues to read in part 
as follows:

    Authority: 15 U.S.C. 78a et seq., 7202, 7233, 7241, 7262, 7264, 
and 7265; and 18 U.S.C. 1350, unless otherwise noted.
* * * * *
    15. Amend Form X-17A-5 Part IIB General Instructions (referenced in 
Sec.  249.617) by removing the phrase ``by a nationally recognized 
statistical rating organization (`NRSRO')'' and the phrase ``by an 
NRSRO'' wherever it appears in the section ``Credit risk exposure'' 
under the heading ``Computation of Net Capital and Required Net 
Capital'' and before the heading ``Aggregate Securities and OTC 
Derivatives Positions.''

    Note: The text of Form X-17A-5 Part IIB does not and this 
amendment will not appear in the Code of Federal Regulations.

    16. Form ATS-R (referenced in Sec.  249.638) is amended by:
    a. In the instructions to the form, Section B, revising the second 
term and removing the third term; and
    b. In Section 4 of the form, revising Line L, to read ``Corporate 
debt securities,'' removing Line M, and redesignating Lines N and O as 
Lines M and N.


[[Page 40106]]


    Note: The text of Form ATS-R does not and this amendment will 
not appear in the Code of Federal Regulations.

    The revision reads as follows:

Form ATS-R, Quarterly Report of Alternative Trading System Activities

Form ATS-R Instructions

    B. * * *
    Corporate Debt Securities--shall mean any securities that (1) 
evidence a liability of the issuer of such securities; (2) have a fixed 
maturity date that is at least one year following the date of issuance; 
and (3) are not exempted securities, as defined in section 3(a)(12) of 
the Act (15 U.S.C. 78c(a)(12)).
* * * * *
    17. Form PILOT (referenced in Sec.  249.821) is amended by:
    a. In the instructions to the form, Section B, revising the second 
term and removing the third term; and
    b. In Section 9 of the form, revising Line J, to read ``Corporate 
debt securities,'' removing Line K, and redesignating Lines L, M, N and 
O as Lines K, L, M and N.

    Note: The text of Form PILOT does not and this amendment will 
not appear in the Code of Federal Regulations.

    The revision reads as follows:

Form PILOT, Initial Operation Report, Amendment to Initial Operation 
Report and Quarterly Report for Pilot Trading Systems Operated by Self-
Regulatory Organizations

Form PILOT Instructions

    B. * * *
    Corporate Debt Securities--shall mean any securities that (1) 
evidence a liability of the issuer of such securities; (2) have a fixed 
maturity date that is at least one year following the date of issuance; 
and (3) are not exempted securities, as defined in section 3(a)(12) of 
the Act (15 U.S.C. 78c(a)(12)).

    By the Commission.
    Dated: July 1, 2008.
Florence E. Harmon,
Acting Secretary.
[FR Doc. E8-15280 Filed 7-10-08; 8:45 am]

BILLING CODE 8010-01-P


[Federal Register: July 11, 2008 (Volume 73, Number 134)]
[Proposed Rules]               
[Page 40106-40124]
From the Federal Register Online via GPO Access [wais.access.gpo.gov]
[DOCID:fr11jy08-17]                         

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SECURITIES AND EXCHANGE COMMISSION

17 CFR Parts 229, 230, 239, and 240

[Release No. 33-8940; 34-58071; File No. S7-18-08]
RIN 3235-AK18

 
Security Ratings

AGENCY: Securities and Exchange Commission.

ACTION: Proposed rule.

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SUMMARY: This is one of three releases that the Commission is 
publishing simultaneously relating to the use of security ratings by 
nationally recognized statistical rating organizations in its rules and 
forms. In this release, the Commission proposes to replace rule and 
form requirements under the Securities Act of 1933 and the Securities 
Exchange Act of 1934 that rely on security ratings (for example, Forms 
S-3 and F-3 eligibility criteria) with alternative requirements. In 
addition, the Commission requests comment on its rules relating to the 
disclosure of security ratings.

DATES: Comments should be received on or before September 5, 2008.

ADDRESSES: Comments may be submitted by any of the following methods:

Electronic Comments

     Use the Commission's Internet comment form (http://
www.sec.gov/rules/proposed.shtml); or
     Send an e-mail to rule-comments@sec.gov. Please include 
File Number S7-18-08 on the subject line; or
     Use the Federal eRulemaking Portal (http://
www.regulations.gov). Follow the instructions for submitting comments.

Paper Comments

     Send paper comments in triplicate to Secretary, Securities 
and Exchange Commission, 100 F Street NE., Washington, DC 20549-1090.

All submissions should refer to File Number S7-18-08. This file number 
should be included on the subject line if e-mail is used. To help us 
process and review your comments more efficiently, please use only one 
method. The Commission will post all comments on the Commission's Web 
site (http://www.sec.gov/rules/proposed.shtml). Comments are also 
available for public inspection and copying in the Commission's Public 
Reference Room, 100 F Street, NE., Washington, DC 20549, on official 
business days between the hours of 10 a.m. and 3 p.m. All comments 
received will be posted without change; we do not edit personal 
identifying information from submissions. You should submit only 
information that you wish to make available publicly.

FOR FURTHER INFORMATION CONTACT: Steven Hearne, Eduardo Aleman, or 
Katherine Hsu, Special Counsels in the Office of Rulemaking, Division 
of Corporation Finance, at (202) 551-3430, 100 F Street NE., 
Washington, DC 20549.

SUPPLEMENTARY INFORMATION: The Commission is proposing amendments to 
Regulation S-K,\1\ and rules and forms under the Securities Act of 1933 
(Securities Act),\2\ and the Securities Exchange Act of 1934 (Exchange 
Act).\3\ In Regulation S-K, the Commission is proposing to amend Items 
10,\4\ 1100,\5\ 1112,\6\ and 1114.\7\ Under the Securities Act, the 
Commission is proposing to amend Rules 134,\8\ 138,\9\ 139,\10\ 
168,\11\ 415,\12\ 436,\13\ Form S-3,\14\ Form S-4,\15\ Form F-1,\16\ 
Form F-3,\17\ Form F-4,\18\ and Form F-9.\19\ The Commission is also 
proposing to amend Schedule 14A \20\ under the Exchange Act.
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    \1\ 17 CFR 229.10 through 1123.
    \2\ 15 U.S.C. 77a et seq.
    \3\ 15 U.S.C. 78a et seq.
    \4\ 17 CFR 229.10.
    \5\ 17 CFR 229.1100.
    \6\ 17 CFR 229.1112.
    \7\ 17 CFR 229.1114.
    \8\ 17 CFR 230.134.
    \9\ 17 CFR 230.138.
    \10\ 17 CFR 230.139.
    \11\ 17 CFR 230.168.
    \12\ 17 CFR 230.415.
    \13\ 17 CFR 230.436.
    \14\ 17 CFR 239.13.
    \15\ 17 CFR 239.25.
    \16\ 17 CFR 239.31.
    \17\ 17 CFR 239.33.
    \18\ 17 CFR 239.34.
    \19\ 17 CFR 239.39.
    \20\ 17 CFR 240.14a-101.
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I. Background

    On June 16, 2008, in furtherance of the Credit Rating Agency Reform 
Act of 2006,\21\ the Commission published for notice and public comment 
two rulemaking initiatives.\22\ The first proposes additional 
requirements for nationally recognized statistical rating organizations 
(NRSROs) that were directed at reducing conflicts of interest in the 
credit rating process, fostering competition and comparability among 
credit rating agencies, and increasing transparency of the credit 
rating

[[Page 40107]]

process.\23\ The second is designed to improve investor understanding 
of the risk characteristics of structured finance products. These 
proposals address concerns about the integrity of the credit rating 
procedures and methodologies of NRSROs in light of the role they played 
in determining the security ratings for securities that were the 
subject of the recent turmoil in the credit markets.
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    \21\ Pub. L. No. 109-291, 120 Stat. 1327 (2006).
    \22\ Proposed Rules for Nationally Recognized Statistical Rating 
Organizations, Release No. 34-57967 (Jun. 16, 2008).
    \23\ See Press Release No. 2008-110 (Jun. 11, 2008). As 
described in more detail below, an NRSRO is an organization that 
issues ratings that assess the creditworthiness of an obligor itself 
or with regard to specific securities or money market instruments, 
has been in existence as a credit rating agency for at least three 
years, and meets certain other criteria. The term is defined in 
section 3(a)(62) of the Exchange Act (15 U.S.C. 78c(a)(62)). A 
credit rating agency must apply with the Commission to register as 
an NRSRO, and currently there are nine registered NRSROs.
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    Today's proposals comprise the third of these three rulemaking 
initiatives relating to security ratings by an NRSRO that the 
Commission is proposing. This release, together with two companion 
releases, sets forth the results of the Commission's review of the 
requirements in its rules and forms that rely on security ratings by an 
NRSRO. The proposals also address recent recommendations issued by the 
President's Working Group on Financial Markets, the Financial Stability 
Forum on Enhancing Market and Institutional Resilience, and the 
Technical Committee of the International Organization of Securities 
Commissions.\24\ Consistent with these recommendations, the Commission 
is considering whether the inclusion of requirements related to 
security ratings in its rules and forms has, in effect, placed an 
``official seal of approval'' on ratings that could adversely affect 
the quality of due diligence and investment analysis. The Commission 
believes that today's proposals could reduce undue reliance on ratings 
and result in improvements in the analysis that underlies investment 
decisions.
---------------------------------------------------------------------------

    \24\ See President's Working Group on Financial Markets, Policy 
Statement on Financial Market Developments (March 2008), available 
at www.ustreas.gov; The Report of the Financial Stability Forum on 
Enhancing Market and Institutional Resilience (April 2008), 
available at www.fsforum.org; Technical Committee of the 
International Organization of Securities Commissions, Consultation 
Report: The Role of Credit Rating Agencies in Structured Finance 
Markets (March 2008), page 9, available at www.iosco.org.
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    In 1981, the Commission issued a statement of policy regarding its 
view of disclosure of security ratings in registration statements under 
the Securities Act.\25\ This statement marked a clear delineation 
between the Commission's historic practice of precluding the disclosure 
of security ratings in these filings and the Commission's then-
developing acknowledgement of the growing importance of ratings in the 
securities markets and in the regulation of those markets. Soon 
thereafter, the Commission adopted rules that not only set forth its 
new policy of permitting the voluntary disclosure of security ratings 
in registration statements but that also encouraged such disclosure by 
the issuer.\26\ The rules permitted the voluntary disclosure of 
security ratings in a communication deemed not to be a prospectus and 
provided that a security rating by an NRSRO is generally not part of a 
registration statement or report prepared or certified by a person 
within the meaning of Sections 7 \27\ and 11 \28\ of the Securities 
Act.
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    \25\ See Disclosure of Ratings in Registration Statements, 
Release No. 33-6336 (Aug. 6, 1981) [46 FR 42024]. The Commission 
first began using ratings by an NRSRO in 1975 for purposes of 
determining capital charges on different grades of debt securities 
under Rule 15c3-1 under the Exchange Act (Net Capital Rule). See 17 
CFR 240.15c-31(c)(2)(vi)(E) and Adoption of Amendments to Rule 15c3-
1 and Adoption of Alternative Net Capital Requirement for Certain 
Brokers and Dealers, Release No. 34-11497 (Jun. 26, 1975) [40 FR 
29795].
    \26\ See Adoption of Integrated Disclosure System, Release No. 
33-6383 (Mar. 3, 1982) [47 FR 11380] (``Integrated Disclosure 
Release'').
    \27\ 15 U.S.C. 77g.
    \28\ 15 U.S.C. 77k.
---------------------------------------------------------------------------

    Concurrent with the adoption of these rules regarding security 
ratings, the Commission adopted Securities Act Form S-3, the short-form 
Securities Act registration statement for eligible domestic 
issuers.\29\ The Commission adopted a provision in Form S-3 that a 
primary offering of non-convertible debt securities may be eligible for 
registration on the form if rated investment grade.\30\ This provision 
provided debt securities issuers whose public float did not reach the 
required threshold, or that did not have a public float, with an 
alternate means of becoming eligible to register offerings on Form S-
3.\31\ In adopting this requirement, the Commission specifically noted 
that commenters believed that the component relating to investment 
grade ratings was appropriate because nonconvertible debt securities 
are generally purchased on the basis of interest rates and security 
ratings.\32\ Consistent with Form S-3, the Commission adopted a 
provision in Form F-3 providing for the eligibility of a primary 
offering of investment grade non-convertible debt securities by 
eligible foreign private issuers.\33\
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    \29\ 17 CFR 239.13 and the Integrated Disclosure Release.
    \30\ See General Instruction I.B.2 of Form S-3. A non-
convertible security is an ``investment grade security'' for 
purposes of form eligibility if at the time of sale, at least one 
NRSRO has rated the security in one of its generic rating categories 
which signifies investment grade, typically one of the four highest 
rating categories. See id.
    \31\ Pursuant to the recently adopted revisions to Form S-3 and 
Form F-3, issuers also may conduct primary securities offerings on 
these forms without regard to the size of their public float or the 
rating of debt securities being offered, so long as they satisfy the 
other eligibility conditions of the respective forms, have a class 
of common equity securities listed and registered on a national 
securities exchange, and the issuers do not sell more than the 
equivalent of one-third of their public float in primary offerings 
over any period of 12 calendar months. See Revisions to Eligibility 
Requirements for Primary Offerings on Forms S-3 and F-3, Release No. 
33-8878 (Dec. 19, 2007) [72 FR 73534].
    \32\ See Section III.A.1 of the Integrated Disclosure Release. 
Later, in 1992, the Commission expanded the eligibility requirement 
to delete references to debt or preferred securities and provide 
Form S-3 eligibility for other investment grade securities (such as 
foreign currency or other cash settled derivative securities). See 
Simplification of Registration Procedures for Primary Securities 
Offerings, Release No. 33-6964 (Oct. 22, 1992) [57 FR 48970].
    \33\ General Instruction I.B.2 of Form F-3. See Adoption of 
Foreign Issuer Integrated Disclosure System, Release No. 33-6437 
(Nov. 19, 1982) [47 FR 54764]. In 1994, the Commission expanded the 
eligibility requirement to delete references to debt or preferred 
securities and provide Form F-3 eligibility for other investment 
grade securities (such as foreign currency or other cash settled 
derivative securities). See Simplification of Registration of 
Reporting Requirements for Foreign Companies, Release No. 33-7053A 
(May 12, 1994) [59 FR 25810].
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    Since the adoption of those rules relating to security ratings and 
Form S-3 and Form F-3, other Commission forms and rules have included 
requirements that likewise rely on the ratings issued to a 
security.\34\ Among them are Form F-9,\35\ Forms S-4 and F-4,\36\ and 
Exchange Act Schedule 14A.\37\ Shelf registration requirements for 
asset-backed securities also depend on a security ratings 
component.\38\ In 1983, the Commission adopted Securities Act Rule 415 
which permits certain mortgage related securities, among others, to be 
offered on a delayed basis.\39\ A mortgage related security is defined 
in section 3(a)(41) of the Exchange Act,\40\ as, among other things, 
``a security that is rated in one of the two highest rating categories 
by at least one nationally recognized statistical

[[Page 40108]]

rating organization.'' \41\ In 1992, the Commission expanded the Form 
S-3 eligibility provisions to provide for the registration of 
investment grade asset-backed securities offerings, regardless of the 
issuer's reporting history or public float.\42\ In addition, if they 
are related to investment grade rated securities, certain registration 
statements and other requirements afford foreign private issuers with 
an option to comply with less extensive U.S. GAAP reconciliation 
requirements.\43\
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    \34\ This release addresses rules and forms filed by issuers 
under the Securities Act and Exchange Act. In separate releases, the 
Commission is proposing to address other rules and forms that rely 
on an investment grade ratings component.
    \35\ See General Instruction I. of Form F-9.
    \36\ See General Instruction B.1 of Form S-4 and General 
Instruction B.1(a) of Form F-4.
    \37\ See Note E and Item 13 of Schedule 14A.
    \38\ General Instruction I.B.5 of Form S-3.
    \39\ 17 CFR 230.415(a)(1)(vii). See Shelf Registration, Release 
No. 33-6499 (Nov. 17, 1983) [48 FR 5289].
    \40\ 15 U.S.C. 78c(a)(41).
    \41\ See discussion of mortgage related securities in Section 
II.A.2. below.
    \42\ See Simplification of Registration Procedures for Primary 
Securities Offerings, Release No. 33-6964 (Oct. 22, 1992) [57 FR 
32461].
    \43\ See Exchange Act Forms 20-F (17 CFR 249.220f) and 40-F (17 
CFR 249.240f), Securities Act Forms F-1 (17 CFR 239.31), F-3 (17 CFR 
239.33), and F-4 (17 CFR 239.34), and Form F-9 (17 CFR 239.39) and 
Rule 502(b)(2)(i)(C) of Regulation D (17 CFR 230.502(b)(2)(i)(C)).
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    At various times since the adoption of these form requirements and 
rules, however, the Commission has reviewed and reconsidered its 
permissive views toward the disclosure of ratings in filings and the 
reliance on ratings in the Commission's form requirements. For example, 
in 1994, the Commission published a proposing release that would have 
mandated disclosure in Securities Act prospectuses of a rating given by 
an NRSRO whenever a rating with respect to the securities being offered 
is ``obtained by or on behalf of an issuer.'' \44\ The proposals would 
have required disclosure of specified information with respect to 
security ratings, whether or not disclosed voluntarily or mandated by 
the proposed new rules. In addition, the 1994 Ratings Release sought 
comment on various areas relating to the disclosure of security 
ratings.
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    \44\ See Disclosure of Security Ratings, Release No. 33-7086 
(Aug. 31, 1994) [59 FR 46304] (the ``1994 Ratings Release''). A 
concept release on this subject was published in Disclosure of 
Security Ratings, Release No. 33-5882 (Nov. 3, 1977) [42 FR 58414].
---------------------------------------------------------------------------

    The 1994 Ratings Release also proposed to require the disclosure on 
a Form 8-K current report of any material change in the security rating 
assigned to the registrant's securities by an NRSRO.\45\ Later, in 
2002, the Commission again proposed to require an issuer to file a Form 
8-K current report when it received a notice or other communication 
from any rating agency regarding, for example, a change or withdrawal 
of a particular rating.\46\ The Commission did not adopt this proposal, 
noting that it would continue to consider the appropriate regulatory 
approach for rating agencies.\47\
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    \45\ See the 1994 Ratings Release.
    \46\ See Additional Form 8-K Disclosure Requirements and 
Acceleration of Filing Date, Release No. 33-8106 (Jun. 17, 2002) [67 
FR 42914].
    \47\ See Additional Form 8-K Filing Requirements and 
Acceleration of Filing Date, Release No. 33-8400 (Mar. 16, 2004) [69 
FR 15594], amended by Release No. 33-8400A (Aug. 4, 2004) [69 FR 
48370].
---------------------------------------------------------------------------

    In 2003, the Commission issued a concept release requesting comment 
on whether it should cease using the NRSRO designation and, as an 
alternative to the ratings criteria, provide for Form S-3 eligibility 
where investor sophistication or large size denomination criteria are 
met.\48\ The Commission also requested comment on alternatives to Form 
S-3 ratings reliance with regard to offerings of asset-backed 
securities. In the 2004 adopting release for Regulation AB,\49\ while 
retaining the eligibility provision for investment grade rated asset-
backed securities, the Commission noted that it was engaged in a broad 
review of the role of credit rating agencies in the securities markets, 
including whether security ratings should continue to be used for 
regulatory purposes under the securities laws.\50\ The release made 
note of the 2003 concept release and the comments received on possible 
alternatives to using the investment grade requirement for determining 
Form S-3 eligibility for asset-backed securities.
---------------------------------------------------------------------------

    \48\ See Rating Agencies and the Use of Credit Ratings under the 
Federal Securities Laws, Release No. 33-8236 (Jun. 4, 2003) [68 FR 
35258]. Comments on the concept release are available at: http://
www.sec.gov/rules/concept/s71203.shtml. As discussed above, recent 
events have highlighted the need to revisit our reliance on NRSRO 
ratings in the context of these developments. See also the extensive 
discussion of market developments in Release No. 34-57967.
    \49\ 17 CFR 229.1100 through 1123.
    \50\ See Section III.A.3.c of Asset-Backed Securities, Release 
No. 33-8518 (Dec. 22, 2004) [70 FR 1506, 1524].
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    In 2005, the Commission adopted rules and form amendments to modify 
the framework for the registration, communications, and offerings 
processes, relaxing restrictions and requirements on the largest 
issuers.\51\ These large issuers, defined as well-known seasoned 
issuers, include issuers that have issued for cash more than an 
aggregate of $1 billion in non-convertible securities, other than 
common equity, through registered primary offerings over the prior 
three years.\52\ In adopting this definition, the Commission did not 
rely on investment grade ratings, noting in the adopting release that 
the securities included in the calculation for determining whether the 
$1 billion threshold has been met need not be investment grade 
securities.\53\
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    \51\ See Securities Offering Reform, Release No. 33-8591 (July 
19, 2005) [70 FR 44722].
    \52\ See definition of well-known seasoned issuer in Rule 405. 
17 CFR 230.405.
    \53\ See Section II.A.1.b of Release No. 33-8591.
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II. Proposed Amendments

A. Shelf Registration for Issuers of Asset-Backed Securities

1. Form S-3 Eligibility for Offerings of Asset-Backed Securities
    Under the existing requirements, an offering of asset-backed 
securities, or ABS, as defined in Item 1101 of Regulation AB,\54\ may 
be eligible for registration on Form S-3 and may therefore be offered 
on a delayed or continuous basis \55\ if they are rated investment 
grade by an NRSRO and meet certain other conditions.\56\ The Commission 
now proposes to amend this requirement in Form S-3 for ABS to replace 
the component that relies on investment grade ratings with an alternate 
provision.
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    \54\ 17 CFR 229.1101.
    \55\ General Instruction I.B.5 of Form S-3. The Commission 
expanded the use of Form S-3 to all types of asset-backed securities 
in 1992. See Simplification of Registration Procedures for Primary 
Securities Offerings, Release No. 33-6964 (Oct. 22, 1992) [57 FR 
48970].
    \56\ As discussed below, two additional conditions also apply in 
order for ABS offered for cash to be Form S-3 eligible: (1) 
delinquent assets do not constitute 20% or more, as measured by 
dollar volume, of the asset pool as of the measurement date; and (2) 
with respect to securities that are backed by leases other than 
motor vehicle leases, the portion of the securitized pool balance 
attributable to the residual value of the physical property 
underlying the leases, as determined in accordance with the 
transaction agreements for the securities, does not constitute 20% 
or more, as measured by dollar volume, of the securitized pool 
balance as of the measurement date. General Instruction I.B.5(a) of 
Form S-3.
---------------------------------------------------------------------------

    In the 2004 proposing release for Regulation AB, the Commission 
requested comment on whether the investment grade reliance component of 
the Form S-3 eligibility requirements for ABS offerings was appropriate 
and whether alternative criteria such as investor sophistication, 
minimum denomination, or experience criteria were more appropriate.\57\ 
The Commission received four comment letters in response that provided 
suggestions on possible alternatives to the investment grade 
requirement for Form S-3 eligibility purposes for ABS offerings.\58\ 
One commenter

[[Page 40109]]

recommended that the Commission replace the investment grade ratings 
requirement with a sponsor \59\ experience requirement (e.g., Exchange 
Act reporting).\60\ Another commenter suggested that the Commission 
either (1) eliminate the use of the ratings as a bright line test for 
the Form S-3 eligibility criteria, thereby eliminating the incentive to 
shop for ratings simply to satisfy a regulatory requirement; or (2) 
reflective of developing market practice, require an investment grade 
rating which is the lower of two ratings.\61\
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    \57\ See Section III.A.3.c of Asset-Backed Securities, Release 
No. 33-8419 (May 3, 2004) [69 FR 16650]. In the 2003 concept release 
where the Commission requested comment on alternatives to the 
ratings reliance requirement in Form S-3 for corporate debt, the 
Commission requested comment on alternatives to ratings reliance 
with respect to ABS offerings. No comment letters submitted in 
response to the concept release provided specific suggestions on 
alternatives for ABS offerings. See Release No. 33-8236.
    \58\ See letters commenting on Release No. 33-8419 from the 
American Bar Association (ABA), Kutak Rock, LLP (Kutak), State 
Street Global Advisors (State Street), and Moody's Investor Service 
(Moody's). The public comments received are available for inspection 
in our Public Reference Room at 100 F Street, NE., Washington, DC 
20549 in File No. S7-21-04, or may be viewed at http://www.sec.gov/
rules/proposed/s72104.shtml.
    \59\ While ``sponsor'' is a commonly used term for the entity 
that initiates the asset-backed securities transaction, the terms 
``seller'' or ``originator'' also are often used in the market. In 
some instances the sponsor is not the originator of the financial 
assets but has purchased them in the secondary market. See footnote 
46 of Release No. 33-8518.
    \60\ See letter from State Street.
    \61\ See letter from Moody's.
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    Two commenters recommended that the Commission adopt a minimum 
denomination requirement (e.g., $100,000 or $250,000) that would 
determine form eligibility, limiting investment in the offering to 
investors who had such capital.\62\ One of these commenters recommended 
that the Commission make short-form registration available to otherwise 
eligible non-investment grade rated or unrated classes of asset-backed 
securities provided that sales are made in minimum denominations and 
initial sales of classes of securities are made only to qualified 
institutional buyers (as defined in Securities Act Rule 144A(a)(1)) 
\63\ and institutional accredited investors (as defined in Rule 501 
\64\ of Regulation D).\65\ The commenter reasoned that such 
restrictions should ensure that securities are sold and subsequently 
resold only to investors who are capable of undertaking their own 
analysis of the merits and risks of their investment.\66\
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    \62\ See letters from ABA and Kutak.
    \63\ 17 CFR 230.144A(a)(1).
    \64\ 17 CFR 230.501.
    \65\ See letter from ABA.
    \66\ Id.
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    In light of our effort to reduce regulatory reliance on security 
ratings, the Commission has revisited the comments in 2004 and now 
proposes to replace the investment grade component in the Form S-3 
eligibility requirement for ABS offerings with a minimum denomination 
requirement for initial and subsequent sales and a requirement that 
initial sales of classes of securities be made only to qualified 
institutional buyers. The eligibility requirement, as proposed to be 
revised, would retain the other provisions relating to delinquency 
concentration and residual value percentages for offerings of 
securities backed by leases other than motor vehicle leases.\67\ Thus, 
as proposed, asset-backed securities offered for cash may be Form S-3 
eligible provided:
---------------------------------------------------------------------------

    \67\ See proposed General Instruction I.B.5(a)(iii) and (iv) of 
Form S-3.
---------------------------------------------------------------------------

     Initial and subsequent resales are made in minimum 
denominations of $250,000;
     Initial sales are made only to qualified institutional 
buyers (as defined in Rule 144A(a)(1));
     Delinquent assets do not constitute 20% or more, as 
measured by dollar volume, of the asset pool as of the measurement 
date; and
     With respect to securities that are backed by leases other 
than motor vehicle leases, the portion of the securitized pool balance 
attributable to the residual value of the physical property underlying 
the leases, as determined in accordance with the transaction agreements 
for the securities, does not constitute 20% or more, as measured by 
dollar volume, of the securitized pool balance as of the measurement 
date.\68\
---------------------------------------------------------------------------

    \68\ See proposed General Instruction I.B.5(a) of Form S-3.
---------------------------------------------------------------------------

    This proposed amendment would limit use of a short-form shelf 
registration statement for asset-backed securities to offerings to 
large sophisticated and experienced investors without, we believe, 
causing undue detriment to the liquidity of the asset-backed securities 
market.\69\ In keeping with that purpose and given the unique nature 
and structure of asset-backed securities, we are proposing at this time 
only to include qualified institutional buyers rather than also 
including institutional accredited investors as suggested by the 
commenter in 2004.
---------------------------------------------------------------------------

    \69\ We are aware of two types of asset-backed offerings that 
may not meet these new criteria, unit repackaging and securitization 
of insurance funding agreements but believe that they can be 
effectively registered using Form S-1 instead of Form S-3.
---------------------------------------------------------------------------

2. Mortgage Related Securities and Securities Act Rule 415
    In addition to being shelf eligible by meeting the requirements of 
Form S-3, a particular subset of ABS may also be shelf eligible by 
meeting the requirements in Securities Act Rule 415,\70\ which 
enumerates the securities which are permitted to be offered on a 
continuous or delayed basis. Among those securities are ``mortgage 
related securities, including such securities as mortgage-backed debt 
and mortgage participation or pass through certificates.'' \71\ By 
specifically referring to mortgage related securities, Rule 415 has 
permitted such securities to be offered on a delayed basis, even if the 
offering cannot be registered on the Form S-3 short form registration 
statement because it does not meet the eligibility requirements of Form 
S-3.
---------------------------------------------------------------------------

    \70\ 17 CFR 230.415.
    \71\ 17 CFR 230.415(a)(vii).
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    Currently, the term ``mortgage related securities'' is defined by 
Section 3(a)(41) of the Exchange Act \72\ as, among other things, ``a 
security that is rated in one of the two highest rating categories by 
at least one nationally recognized statistical rating organization.'' 
Given that the term mortgage related securities also depends on a 
ratings component, it would be a logical extension of our amendments 
here to amend the Rule 415 reference to a mortgage related security to 
add that the sale of such security must be in compliance with the 
additional requirements that initial sales are made to qualified 
institutional buyers and initial and subsequent sales are made in 
certain minimum denominations. Given that reliance on security ratings 
could just as easily impact an investor's investment decision in 
mortgage-backed securities as it could for other asset-backed 
securities,\73\ we believe it is appropriate that mortgage-backed 
securities be treated the same as all asset-backed securities.\74\
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    \72\ 15 U.S.C. 78c(a)(41). Section 3(a)(41) was added by the 
Secondary Mortgage Market Enhancement Act of 1984 (SMMEA) (Pub. L. 
98-440-98 Stat. 1690). In 1984, contemporaneous with the enactment 
of SMMEA, the Commission amended Rule 415, which is known as the 
shelf rule, to allow SMMEA-eligible mortgage related securities to 
use the shelf offering process. See Shelf Registration, Release No. 
33-6499 (Nov. 17, 1983) [48 FR 5289].
    \73\ The President's Working Group has noted that one of the 
principal underlying causes of the current global market turmoil 
relating to the mortgage-backed securities industry was the credit 
rating agencies' assessments of subprime residential mortgage-backed 
securities and other complex structured credit products that held 
residential mortgage-backed and other asset-backed securities. See 
Section I of the Policy Statement on Financial Market Developments. 
See n. 24 above.
    \74\ Indeed, mortgage-backed securities are merely a type of, or 
subset of, asset-backed securities. We believe that there have not 
been any recent offerings that have relied on Rule 415(a)(vii) for 
shelf eligibility rather than through meeting the requirements of 
Form S-3.
---------------------------------------------------------------------------

    Therefore, under the proposed revision to Rule 415, mortgage-backed 
securities, having the same characteristics as mortgage related 
securities under the Section 3(a)(41) definition, regardless of the 
security

[[Page 40110]]

rating, could be offered on a delayed basis provided that:
     Initial sales and any resales of the securities are made 
in minimum denominations of $250,000; \75\ and
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    \75\ Denominations of any amounts above $250,000 would meet this 
requirement.
---------------------------------------------------------------------------

     initial sales of the securities are made only to qualified 
institutional buyers (as defined in Rule 144A(a)(1)).
Request for Comment
     Is the proposed amendment to the Form S-3 eligibility 
requirement for asset-backed securities appropriate? Is there a better 
alternative to the investment grade ratings component? If so, what is 
that alternative and why is it better?
     Is the proposed amendment requiring that initial and 
subsequent sales be made in a minimum denomination appropriate? Should 
the denomination level be higher or lower (e.g., $400,000 or $100,000)?
     We understand that non-convertible securities may 
typically be held in book entry form with a depository. Are there any 
system issues or processes at the depository that may affect the 
ability to limit transferability based on a minimum denomination? If 
yes, what are those issues or processes and how should the rule 
provisions be revised to prohibit subsequent transfers below the 
minimum denominations?
     Should there be any restriction on permitting purchasers 
from allocating securities in denominations lower than $250,000 if the 
purchasers are acquiring the nonconvertible securities for more than 
one account? For example, if an investment advisor acquires the 
securities for more than one qualified institutional buyer, should it 
be allowed to allocate securities to the accounts of the qualified 
institutional buyers in denominations lower than $250,000?
     Should Form S-3 limit initial sales of eligible asset-
backed securities to qualified institutional buyers? Should the 
requirement include sales to an additional group of investors (e.g., 
institutional accredited investors)? If so, why? Should subsequent 
sales be limited as well? Would it be appropriate to eliminate the 
minimum denomination requirements after some period of time, such as 
after six months or one year from the date of issuance? Are there 
particular kinds of ABS offerings that are sold to investors other than 
qualified institutional buyers?
     What would be the impact on liquidity in the ABS secondary 
market if Form S-3 registration required that initial sales be limited 
to qualified institutional buyers, institutional accredited investors, 
or other groups of sophisticated investors? What would be the impact on 
liquidity in the secondary market if resales of securities that were 
originally offered and sold off of the Form S-3 were so limited? What 
would be the impact on the cost of capital for ABS sponsors if Form S-3 
registration required that initial sales or resales were limited to 
qualified institutional buyers or other groups of sophisticated 
investors?
     Would a better standard than qualified institutional buyer 
be any purchaser that owns and invests on a discretionary basis not 
less than $25,000,000? Would a threshold like this that does not limit 
the purchasers to institutions be appropriate, particularly in light of 
recent market events? Should there be other thresholds for particular 
investors, such as owning and investing on a discretionary basis not 
less than $50,000,000 for government or political subdivisions, 
agencies or instrumentalities of a government? Should we use Qualified 
Investor as defined in Exchange Act Section 3(a)(54) \76\ rather than 
qualified institutional buyer?
---------------------------------------------------------------------------

    \76\ 15 U.S.C. 78c(a)(54).
---------------------------------------------------------------------------

     We note that there are two types of ABS offerings that may 
not meet this new criteria, unit repackagings, and securitizations of 
insurance funding agreements. Can the offer and sale of these 
securities be effectively registered on Form S-1? We note that these 
securities are typically listed on a national securities exchange. 
Should we instead add an alternative eligibility requirement that would 
provide eligibility to use Form S-3 for securities listed on a national 
securities exchange?
     Should we instead assess Form S-3 and shelf eligibility in 
a manner similar to what we are proposing for corporate debt that is 
discussed in the next section? If so, what would be the appropriate 
amount of required issuance? Should the issuance amount be measured 
only for the same sponsor, same asset class, and same structure? Should 
it matter if the assets are purchased by the sponsor rather than 
originated by the sponsor or an affiliate?
     Is the proposed revision to Securities Act Rule 415 
appropriate? Is there any reason why mortgage related securities should 
be treated differently from other asset-backed securities for purposes 
of delayed offerings?
     Are there SMMEA eligible loans that could not be 
securitized in circumstances meeting the proposed threshold for S-3 
eligibility?
     Should Rule 415 be amended as proposed? In the 
alternative, should the reference to mortgage related securities in 
Rule 415 be deleted (i.e., so that mortgage-backed securities could 
only be offered on a delayed basis if eligible for registration on Form 
S-3)? Are there securities that are currently offered pursuant to Rule 
415(a)(1)(vii) that do not meet the current requirements of Form S-3 
and would not meet the requirements of the proposal?

B. Primary Offerings of Non-convertible Securities

1. Form S-3 and Form F-3
    Forms S-3 and F-3 are the ``short forms'' used by eligible issuers 
to register securities offerings under the Securities Act. These forms 
allow eligible issuers to rely on reports they have filed under the 
Exchange Act to satisfy many of the disclosure requirements under the 
Securities Act. Form S-3 eligibility for primary offerings also enables 
form eligible issuers to conduct primary offerings ``off the shelf'' 
under Securities Act Rule 415. Rule 415 provides considerable 
flexibility in accessing the public securities markets in response to 
changes in the market and other factors. Issuers that are eligible to 
register these primary ``shelf'' offerings under Rule 415 are permitted 
to register securities offerings prior to planning any specific 
offering and, once the registration statement is effective, offer 
securities in one or more tranches without waiting for further 
Commission action. To be eligible to use Form S-3 or F-3, an issuer 
must meet the form's eligibility requirements as to registrants, which 
generally pertain to reporting history under the Exchange Act,\77\ and 
at least one of the form's transaction requirements.\78\ One such 
transaction requirement permits registrants to register primary 
offerings of non-convertible securities if they are rated investment 
grade by at least one NRSRO.\79\ Instruction I.B.2 provides that a 
security is ``investment grade'' if, at the time of sale, at least one 
NRSRO has rated the security in one of its generic rating categories, 
typically the four highest, which signifies investment grade.
---------------------------------------------------------------------------

    \77\ See General Instruction I.A to Forms S-3 and F-3.
    \78\ See General Instruction I.B to Forms S-3 and F-3.
    \79\ See General Instruction I.B.2 to Forms S-3 and F-3.
---------------------------------------------------------------------------

    The Form S-3 investment grade requirement was originally proposed 
by

[[Page 40111]]

the Commission in a 1982 release.\80\ Prior to adopting Form S-3, the 
Commission had previously provided a short form registration statement 
on Form S-9, which permitted the registration of issuances of certain 
high quality debt securities.\81\ The criteria for use of Form S-9 
related primarily to the quality of the issuer.\82\ While these 
eligibility criteria delineated the type of issuer of high quality debt 
for which Form S-9 was intended, the Commission believed that certain 
of its requirements may have overly restricted the availability of the 
form.\83\ The Commission believed that security ratings were a more 
appropriate standard on which to base Form S-3 eligibility than 
specified quality of the issuer criteria, citing letters from 
commenters indicating that short form prospectuses are appropriate for 
investment grade debt because such securities are generally purchased 
on the basis of interest rates and security ratings.\84\
---------------------------------------------------------------------------

    \80\ See Reproposal of Comprehensive Revision to System for 
Registration of Securities Offerings, Release No. 33-6331 (Aug. 6, 
1981) [46 FR 41902] (``the S-3 Proposing Release'').
    \81\ Form S-9 was rescinded on December 20, 1976, because it was 
being used by only a very small number of registrants. The 
Commission believed the lack of usage was due in part to interest 
rate increases which made it difficult for many registrants to meet 
the minimum fixed charges coverage standards required by the form. 
Adoption of Amendments to Registration Forms and Guide and 
Rescission of Registration Form, Release No. 33-5791 (Dec. 20, 1976) 
[41 FR 56301].
    \82\ The criteria included net income during each of the 
registrant's last five fiscal years, no defaults in the payment of 
principal, interest, or sinking funds on debt or of rental payments 
for leases, and various fixed charge coverages. The use of fixed 
charges coverage ratios, typically 1.5, was common in state statutes 
defining suitable debt investments for banks and other fiduciaries.
    \83\ See the S-3 Proposing Release.
    \84\ See the Integrated Disclosure Release.
---------------------------------------------------------------------------

    Today we are proposing to revise the transaction eligibility 
criteria for registering primary offerings of non-convertible 
securities on Forms S-3 and F-3. As proposed, the instructions to these 
forms would no longer refer to security ratings by an NRSRO as a 
transaction requirement to permit issuers to register primary offerings 
of non-convertible securities for cash. Instead, these forms would be 
available to register primary offerings of non-convertible securities 
if the issuer has issued (as of a date within 60 days prior to the 
filing of the registration statement) for cash more than $1 billion in 
non-convertible securities, other than common equity, through 
registered primary offerings over the prior three years.\85\
---------------------------------------------------------------------------

    \85\ See proposed General Instruction I.B.2 of Forms S-3 and F-
3. We are also proposing to delete Instruction 3 to the signature 
block of Forms S-3 and F-3.
---------------------------------------------------------------------------

    We are proposing to revise the form criteria using the same method 
and threshold by which the Commission defined an issuer of non-
convertible securities, other than common equity, that does not meet 
the public equity float test as a ``well-known seasoned issuer.'' \86\ 
Similar to our approach with well-known seasoned issuers, we believe 
that having issued $1 billion of registered non-convertible securities 
over the prior three years would lead to a wide following in the 
marketplace. These issuers generally have their Exchange Act filings 
broadly followed and scrutinized by investors and the markets.\87\ The 
Commission intends for the number of issuers eligible under the 
proposed criteria to register primary offerings of non-convertible 
securities on Forms S-3 and F-3 to not be significantly reduced, or to 
differ significantly from, the number of those eligible under the 
current form requirements.\88\ Using the $1 billion threshold, we 
preliminarily believe that for issuances that have occurred thus far 
this year, the proposed change would result in approximately six 
issuers filing on Form S-1 instead of on a short-form registration 
statement. This approach is designed to provide assurance that eligible 
issuers are followed by the markets such that it is appropriate to 
allow forward incorporation by reference and delayed offering. We 
realize that it is now possible that some offerings of non-investment 
grade securities, such as high-yield bonds (also known as ``junk 
bonds'') may be registered for sale on Form S-3.
---------------------------------------------------------------------------

    \86\ See Securities Offering Reform, Release No. 33-8591 (Jul. 
19, 2005) [70 FR 44722]. Rule 405 under the Securities Act defines a 
``well-known seasoned issuer'' as an issuer that meets the 
registrant requirements of Form S-3 or F-3, and either has a 
worldwide market value of its outstanding voting and non-voting 
common equity held by non-affiliates of $700 million or more, or has 
issued in the last three years, in registered offerings, at least $1 
billion aggregate principal amount of non-convertible securities in 
primary offerings for cash. 17 CFR 230.405.
    \87\ See Securities Offering Reform, Release No. 33-8501 (Nov. 
3, 2004) [69 FR 67392].
    \88\ We preliminarily anticipate that under the proposed 
threshold some additional high yield debt issuers would be eligible 
to use the Forms.
---------------------------------------------------------------------------

    These issuers also would have to satisfy the other conditions of 
the form eligibility requirement. In determining compliance with this 
threshold:
     Issuers may aggregate the amount of non-convertible 
securities, other than common equity, issued in registered primary 
offerings during the prior three years;
     issuers may include only such non-convertible securities 
that were issued in registered primary offerings for cash--they may not 
include registered exchange offers; \89\ and
---------------------------------------------------------------------------

    \89\ Issuers may not include the principal amount of securities 
that were offered in registered exchange offers by the issuer when 
determining compliance with the $1 billion non-convertible 
securities threshold. A substantial portion of these offerings 
involve registered exchange offers of substantially identical 
securities for securities that were sold in private offerings. In 
those cases, the original sale to investors in the private offering, 
relying upon, for example, the exemptions of Securities Act Section 
4(2) and Rule 144A, is not registered and is not carried out under 
the Securities Act's disclosure or liability standards. Moreover, in 
the subsequent registered exchange offers purchasers may not be 
able, in certain cases, to avail themselves effectively of the 
remedies otherwise available to purchasers in registered offerings 
for cash.
---------------------------------------------------------------------------

     parent company issuers only may include in their 
calculation the principal amount of their full and unconditional 
guarantees, within the meaning of Rule 3-10 of Regulation S-X,\90\ of 
non-convertible securities, other than common equity, of their 
majority-owned subsidiaries issued in registered primary offerings for 
cash during the three-year period.
---------------------------------------------------------------------------

    \90\ 17 CFR 210.3-10.
---------------------------------------------------------------------------

The aggregate principal amount of non-convertible securities that may 
be counted toward the $1 billion issuance threshold may have been 
issued in any registered primary offering for cash, on any form (other 
than Form S-4 or Form F-4). Non-convertible securities need not be 
investment grade securities to be included in the calculation. In 
calculating the $1 billion amount, issuers generally may include the 
principal amount of any debt and the greater of liquidation preference 
or par value of any non-convertible preferred stock that were issued in 
primary registered offerings for cash.\91\
---------------------------------------------------------------------------

    \91\ In determining the dollar amount of securities that have 
been registered during the preceding three years, issuers should use 
the same calculation that they use to determine the dollar amount of 
securities they are registering for purposes of determining fees 
under Rule 457. 17 CFR 230.457.
---------------------------------------------------------------------------

Request for Comment
     The recent turmoil in the credit markets, particularly in 
the structured finance market, strongly suggests that there has been 
undue reliance on security ratings and that the ratings for many 
issuers did not reflect the risks of the investment. We are proposing 
thresholds on the amount of issuance in order to move away from 
reliance on security ratings in the Commission's rules. Does the 
proposed eligibility based on the amount of prior registered non-
convertible securities issued serve as an adequate replacement for the 
investment grade eligibility condition? Would the cumulative offering 
amount

[[Page 40112]]

for the most recent three-year period reflect market following? Since 
most of the problems in the market have occurred with respect to asset-
backed securities, should we retain the current eligibility requirement 
for investment grade non-convertible securities?
     Would the specific issuers eligible under the investment 
grade condition be different from the issuers eligible under the 
proposal? Would certain investors, such as pension funds, be impacted 
if investment grade securities could not be offered on Form S-3?
     If the Commission adopts a Form S-3 eligibility 
requirement designed to reflect the market following of a debt issuer, 
should the condition be sensitive to the number of debt holders? Is it 
reasonable to expect that analysts would be more likely to follow 
issuers with a larger number of debt holders insofar as such holders 
are potential customers of the analysts' products? If so, how should we 
determine the number of holders?
     Should there be an eligibility requirement based on a 
minimum number of holders of record of non-convertible securities 
offered for cash? If so, should this number be 300 or 500, by analogy 
to our registration and deregistration rules relating to equity 
securities? Would linking the eligibility requirement to the number of 
holders of record help to assure market following?
     Is the cumulative offering amount for the most recent 
three-year period the appropriate threshold at which to differentiate 
issuers? Should the threshold be higher (e.g., $1.25 billion) or lower 
(e.g., $800 million), and, if so, at what level should it be set? Are 
there any transactions that currently meet the requirements of current 
General Instruction I.B.2. that would not be eligible to use the form 
under the proposed revision? Are there any transactions that do not 
meet the current Form S-3 or Form F-3 eligibility requirements for 
investment grade securities but now would be eligible under the 
proposed revision that should not be eligible? If practicable, provide 
information on the frequency such offerings are made.
     Would the proposed threshold increase or decrease the 
number of issuers eligible to use Forms S-3 and F-3 under the current 
investment grade criteria? Is there a reason that this Form S-3 
eligibility requirement should not mirror the debt only well-known 
seasoned issuer definition?
     Should the measurement time period for $1 billion of 
issuance be longer than three years (e.g., four or five years)? If so, 
why? Would it be more appropriate for the threshold to include non-
convertible securities, other than common equity, outstanding rather 
than issued over the prior three years?
     Is there a better alternative by which Form S-3 
eligibility for non-convertible securities could be required? By what 
metrics could one measure the market following for debt issuers? Is 
there an alternative definition of ``investment grade debt securities'' 
that does not rely on NRSRO ratings and adequately meets the objective 
of relating short-form registration to the existence of widespread 
following in the marketplace?
     Should there be a different standard for foreign private 
issuers eligible to use Form F-3? If so, explain why and what would be 
a more appropriate criteria.
     Does the $1 billion threshold of offering in the prior 
three years present any issues that are unique to foreign private 
issuers, especially those that may undertake U.S. registered public 
offerings as only a portion of their overall plan of financing, and how 
might these problems be addressed? Would it be appropriate to provide a 
longer time period for measurement, or to include public offerings of 
securities for cash outside the United States?
2. U.S. GAAP Reconciliation Requirements
    The Commission's rules relating to U.S. GAAP reconciliation 
requirements for foreign filers also rely on ratings. Forms F-1, F-3, 
and F-4 under the Securities Act permit foreign private issuers 
registering offerings of investment grade securities to provide 
financial information in accordance with Item 17 of Exchange Act Form 
20-F. Item 17 requires foreign private issuers to reconcile their 
financial statements and schedules to U.S. GAAP if they are prepared in 
accordance with a basis of accounting other than U.S. GAAP or 
International Financial Reporting Standards as issued by the 
International Accounting Standards Board. This reconciliation need only 
include a narrative discussion of reconciling differences, a 
reconciliation of net income for each year and any interim periods 
presented, a reconciliation of major balance sheet captions for each 
year and any interim periods, and a reconciliation of cash flows for 
each year and any interim periods. Item 18 of Form 20-F, by contrast, 
requires that a foreign private issuer provide all of the information 
required by U.S. GAAP and Regulation S-X, in addition to the 
reconciling information for the line items specified in Item 17.\92\ 
Foreign private issuers of investment grade rated securities are 
permitted to provide the less-extensive U.S. GAAP reconciliation 
disclosure pursuant to Item 17 in registration statements and annual 
reports.
---------------------------------------------------------------------------

    \92\ See also Foreign Issuer Reporting Enhancements, Release No. 
33-8900 (Feb. 29, 2008) [73 FR 13404] at Section III.A.
---------------------------------------------------------------------------

    The definition of ``investment grade'' is the same as in the Form 
S-3 eligibility requirements. A security is ``investment grade'' if, at 
the time of sale, at least one NRSRO has rated it in one of its generic 
rating categories that signifies investment grade. Also, a foreign 
private issuer conducting a private placement of investment grade 
securities under Regulation D can provide Item 17 information to the 
extent the issuer is able to do so in a registration statement.\93\
---------------------------------------------------------------------------

    \93\ Rule 502 requires a foreign private issuer to provide the 
same kind of information the issuer would be required to include in 
a registration statement on a form the issuer would be eligible to 
use if any sales are made to investors who are not accredited 
investors. See 17 CFR 230.502(b)(2)(i)(C).
---------------------------------------------------------------------------

    The Commission recently proposed to require foreign private issuers 
offering investment grade securities, among others, to file financial 
statements that comply with the more complete Item 18 level of 
reconciliation, thus eliminating the option of providing Item 17 
financial disclosure.\94\ The Commission reasoned that ``a 
reconciliation that includes footnote disclosures required by U.S. GAAP 
and Regulation S-X \95\ can provide important additional information.'' 
\96\ The Commission specifically requested comment, however, on whether 
foreign private issuers should continue to be permitted to provide Item 
17 financial disclosure for offerings of, and periodic reporting 
relating to, investment grade securities.\97\ We now also propose to 
remove from these requirements the components relying on investment 
grade ratings and instead permit foreign private issuers to comply with 
the less extensive U.S. GAAP reconciliation requirements under Item 17 
in a registration statement or private offering document if the issuer 
would meet the proposed Form F-3 eligibility requirements (i.e., if the 
issuer has issued (as of a date within 60 days prior to the filing of 
the registration statement) for cash more than $1 billion in non-
convertible securities, other than common equity, through registered

[[Page 40113]]

primary offerings over the prior three years).
---------------------------------------------------------------------------

    \94\ See Release No. 33-8900.
    \95\ 17 CFR 210.1-01 et seq.
    \96\ Release No. 33-8900 at Section III.A.
    \97\ See Request for Comment No. 23 of Release No. 33-8900.
---------------------------------------------------------------------------

Request for Comment
     If the Commission does not adopt the proposal in Release 
No. 33-8900 that would eliminate the ability of a foreign private 
issuer to comply with the less extensive U.S. GAAP reconciliation 
requirements under Item 17 for filings with respect to investment grade 
securities, should the Commission revise the requirements as proposed 
to permit a foreign private issuer to comply with the less extensive 
U.S. GAAP reconciliation requirements under Item 17 if the issuer has 
met the proposed Form F-3 eligibility criteria for debt issuers? Are 
there different criteria that should be used?
3. Form F-9
    Form F-9 allows certain Canadian issuers to register investment 
grade debt or investment grade preferred securities that are offered 
for cash or in connection with an exchange offer, and which are either 
non-convertible or not convertible for a period of at least one year 
from the date of issuance.\98\ Under the Form's requirements, a 
security is rated ``investment grade'' if it has been rated investment 
grade by at least one NRSRO, or at least one Approved Rating 
Organization (as defined in National Policy Statement No. 45 of the 
Canadian Securities Administrator).\99\ This eligibility requirement 
was adopted as part of a 1993 revision to the multijurisdictional 
disclosure system originally adopted by the Commission in 1991 in 
coordination with the Canadian Securities Administrators.\100\ 
Consistent with the Commission's proposal to reduce reliance on 
security ratings in its rules and regulations the Commission is 
proposing to eliminate the eligibility requirement of Form F-9 that 
allows Canadian issuers to register certain debt and preferred 
securities if they are rated investment grade by at least one NRSRO. As 
with our proposals regarding Forms S-3 and F-3, this requirement would 
be replaced by a requirement that the issuer has issued in the three 
years immediately preceding the filing of the Form F-9 registration 
statement at least $1 billion of aggregate principal amount of debt or 
preferred securities for cash in primary offerings registered under the 
Securities Act.
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    \98\ Securities convertible after a period of at least one year 
may only be convertible into a security of another class of the 
issuer.
    \99\ See General Instruction I.A to Form F-9.
    \100\ See Amendments to the Multijurisdictional Disclosure 
System for Canadian Issuers, Release No. 33-7025 (Nov. 3, 1993) [58 
FR 62028]. See also Multijurisdictional Disclosure and Modifications 
to the Current Registration and Reporting System for Canadian 
Issuers, Securities Act Release No. 33-6902 (Jun. 21, 1991) [56 FR 
30036].
---------------------------------------------------------------------------

    The proposed revision would not change a Canadian issuer's ability 
to use Form F-9 to register debt or preferred securities meeting the 
requirements of current General Instruction I.A if the securities are 
rated ``investment grade'' by at least one Approved Rating Organization 
(as defined in National Policy Statement No. 45 of the Canadian 
Securities Administrators). While the proposal would still permit 
Canadian issuers to register certain securities rated investment grade 
by an Approved Rating Organization, the Commission believes this 
approach is appropriate and consistent with the Commission's intent in 
adopting the multijurisdictional disclosure system to look to form 
eligibility requirements under Canadian rules.\101\ To the extent that 
the Canadian securities regulators revise similar requirements to 
remove references to investment grade ratings, we may revise Form F-9 
to mirror those revisions.
---------------------------------------------------------------------------

    \101\ See Release No. 33-6902, section II.
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Request for Comment
     The Commission requests comment on whether the proposed 
threshold for issuances of debt or preferred securities in the three 
years immediately preceding the filing of the registration statement is 
appropriate. Should the Form F-9 eligibility requirements continue to 
permit the use of ratings by Approved Rating Organizations? Is a 
different threshold or measurement period more appropriate for Form F-
9?
4. NRSRO Ratings Reliance in Other Forms and Rules
a. Forms S-4 and F-4 and Schedule 14A
    Issuing investment grade securities confers benefits that extend to 
other forms and rules as well. Forms S-4 and F-4 allow registrants that 
meet the registrant eligibility requirements of Form S-3 or F-3 and are 
offering investment grade securities to incorporate by reference 
certain information.\102\ Similarly, Schedule 14A permits a registrant 
to incorporate by reference if the Form S-3 registrant requirements are 
met and the registrant is offering investment grade securities.\103\ 
Because the Commission proposes to change the eligibility requirements 
in Forms S-3 and F-3 to remove references to ratings by an NRSRO, the 
Commission believes the same standard should apply to the disclosure 
options in Forms S-4 and F-4 based on Form S-3 or F-3 eligibility. That 
is, a registrant will be eligible to use Forms S-4 and F-4 to register 
non-convertible debt or preferred securities if the issuer has issued 
(as of a date within 60 days prior to the filing of the registration 
statement) for cash more than $1 billion in non-convertible securities, 
other than common equity, through registered primary offerings over the 
prior three years. Similarly, we propose to amend Schedule 14A to refer 
simply to the requirements of General Instruction I.B.2. of Form S-3, 
rather than to ``investment grade securities.''
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    \102\ See General Instruction B.1 of Forms S-4 and Form F-4.
    \103\ See Note E and Item 13 of Schedule 14A.
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b. Securities Act Rules 138, 139 and 168
    The reliance on security ratings is also evident in other 
Securities Act rules. Rules 138, 139, and 168 under the Securities Act 
provide that certain communications are deemed not to be an offer for 
sale or offer to sell a security within the meaning of Sections 
2(a)(10) \104\ and 5(c) \105\ of the Securities Act when the 
communications relate to an offering of non-convertible investment 
grade securities. These communications include the following:
---------------------------------------------------------------------------

    \104\ 15 U.S.C. 77b(a)10.
    \105\ 15 U.S.C. 77e(c).
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     Under Securities Act Rule 138, a broker's or dealer's 
publication about securities of a foreign private issuer that meets F-3 
eligibility requirements (other than the reporting history 
requirements) and is issuing non-convertible investment grade 
securities;
     Under Securities Act Rule 139, a broker's or dealer's 
publication or distribution of a research report about an issuer or its 
securities where the issuer meets Form S-3 or F-3 registrant 
requirements and is or will be offering investment grade securities 
pursuant to General Instruction I.B.2 of Form S-3 or F-3, or where the 
issuer meets Form F-3 eligibility requirements (other than the 
reporting history requirements) and is issuing non-convertible 
investment grade securities; and
     Under Securities Act Rule 168, the regular release and 
dissemination by or on behalf of an issuer of communications containing 
factual business information or forward-looking information where the 
issuer meets Form F-3 eligibility requirements (other than the 
reporting history requirements) and is issuing non-convertible 
investment grade securities.
    The Commission proposes to revise Rules 138, 139, and 168 to be 
consistent with the proposed revisions to the eligibility requirements 
in Forms S-3 and F-3 since in order to rely on these rules the issuer 
must either satisfy the public float threshold of Form S-3 or F-

[[Page 40114]]

3, or issue non-convertible investment grade securities as defined in 
the instructions to Form S-3 or F-3 as proposed to be revised.
Request for Comment
     Should the Commission revise Rules 138, 139, and 168 as 
proposed?
c. Item 1100 of Regulation AB
    Under the existing Item 1100(c) of Regulation AB,\106\ if a 
significant obligor \107\ meets the registrant requirements for Form S-
3 or Form F-3 and the pool assets relating to the obligor are non-
convertible investment grade rated securities, then an ABS issuer's 
filings may include a reference to the financial information of the 
obligor rather than presenting the full financial information of the 
obligor. The Commission now proposes to amend this provision of Item 
1100(c) to remove the ratings reference and permit incorporation by 
reference of third party financial statements if the third party meets 
the registrant requirements of Form S-3 and the pool assets relating to 
such third party are non-convertible securities, other than common 
equity, that were issued in a primary offering for cash that was 
registered under the Securities Act. The Commission believes that, for 
the most part, non-convertible securities that were issued in a 
registered offering constitute higher quality securities than 
securities issued under an exemption under, for example, Securities Act 
Rule 144A, and then subsequently exchanged for registered securities 
because such securities are subject to the Securities Act.
---------------------------------------------------------------------------

    \106\ 17 CFR 229.1100(c).
    \107\ The term ``significant obligor'' is defined in Item 
1101(k) of Regulation AB [17 CFR 229.1101(k)].
---------------------------------------------------------------------------

Request for Comment
     Should the Commission revise Item 1100 of Regulation AB as 
proposed? If not, explain why?
d. Items 1112 and 1114 of Regulation AB
    Items 1112 and 1114 of Regulation AB require the disclosure of 
certain financial information regarding significant obligors of an 
asset pool and significant credit enhancement providers relating to a 
class of asset-backed securities. An instruction to Item 1112(b)\108\ 
provides that no financial information on a significant obligor, 
however, is required if the obligations of the significant obligor as 
they relate to the pool assets are backed by the full faith and credit 
of a foreign government and the pool assets are investment grade 
securities. Item 1114 of Regulation AB contains a similar instruction 
that relieves an issuer from providing financial information when the 
obligations of the credit enhancement provider are backed by a foreign 
government and the enhancement provider has an investment grade rating. 
Under both Items 1112 and 1114, to the extent that pool assets are not 
investment grade securities, information required by paragraph (5) of 
Schedule B of the Securities Act may be provided in lieu of the 
required financial information.\109\
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    \108\ Instruction 2 to 17 CFR 229.1112(b).
    \109\ Paragraph 5 of Schedule B requires disclosure of three 
years of the issuer's receipts and expenditures classified by 
purpose in such detail and form as the Commission prescribes.
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    We are now proposing to revise these instructions so that these 
exceptions based on investment grade ratings to the requirements of 
Items 1112 and 1114 of Regulation AB would no longer apply and 
information required by paragraph (5) of Schedule B would be required 
in all situations when the obligations of a significant obligor are 
backed by the full faith and credit of a foreign government. We are not 
aware of any benchmark comparable to an investment grade rating here 
and the requirement would not impose substantial costs or burdens to an 
ABS issuer, as such information should be readily available.
Request for Comment
     Should the Commission revise the instructions that rely on 
investment grade ratings in Items 1112 and 1114, as proposed? In the 
alternative, should the Commission instead permit issuers to omit all 
information relating to the obligors and credit enhancement providers 
when the obligations are backed by the full faith and credit of the 
foreign government? Are there any risks in doing so? Should the 
Commission allow incorporation by reference of the information required 
by paragraph (5) of Schedule B of the Securities Act in lieu of 
providing the information to the extent such information is contained 
in a filing with the Commission?
     Are there any other provisions in Regulation AB or other 
rules applicable to asset-backed securities that should be revised?

C. The Commission's Policy on Security Ratings

    As noted above, in 1981 the Commission issued its policy on 
disclosure of security ratings, articulated in Item 10(c) of Regulation 
S-K,\110\ that permits, but does not require, issuers to disclose in 
Commission filings security ratings assigned by credit rating agencies 
to classes of debt securities, convertible debt securities, and 
preferred stock.\111\ In 1994, the Commission proposed to change from 
permissible to mandated disclosure of security ratings.\112\ While the 
Commission did not adopt mandatory disclosure at that time, it signaled 
concerns relating to adequate disclosure to the markets regarding new 
financial products and security ratings. In the proposal we noted the 
dramatic proliferation in the types of securities offered in the 
marketplace with the development of the market for mortgage- and asset-
backed securities and other highly structured or derivative financial 
obligations. In response to the growth of this market, we adopted new 
and amended rules and forms to address comprehensively the 
registration, disclosure, and reporting requirements for asset-backed 
securities.\113\ The adoption of Regulation AB in 2004 codified 
disclosure requirements and assisted in providing more disclosure with 
greater comparability for investors in the asset-backed securities 
markets. While the adoption of Regulation AB has enhanced the 
disclosure about asset-backed securities, it did not significantly 
address securities ratings disclosure.
---------------------------------------------------------------------------

    \110\ 17 CFR 229.10(c).
    \111\ See the Integrated Disclosure Release. See also Release 
No. 33-6336. The release indicated that a debt rating was simply 
``an evaluation of the likelihood that an issuer will be able to 
make timely interest payments and will be able to repay principal.''
    \112\ See the 1994 Ratings Release.
    \113\ Release No. 33-8518.
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    Because mandating disclosure of, and about, securities ratings 
might unduly emphasize or over rely on ratings, the Commission is at 
this time retaining the current Item 10(c) policy on security ratings, 
with minor changes to accommodate our proposed changes to Rule 
436(g),\114\ which asks registrants to consider, but does not require, 
certain additional disclosure if a registration statement includes 
disclosure of a rating. While the Commission has not determined to 
propose mandatory disclosure, we are again requesting comment as to 
whether we should require disclosure by issuers regarding ratings in 
their Securities Act registration statements and their Exchange Act 
periodic reports. The goal of such disclosure requirements would be to 
enhance security rating disclosure so that investors are better able to 
understand the terms of a security rating and the limitations on the 
rating.
---------------------------------------------------------------------------

    \114\ 17 CFR 230.436(g).
---------------------------------------------------------------------------

    We are proposing to amend Rule 436(g) so that applicability would 
no longer be limited to just NRSROs.

[[Page 40115]]

Securities Act Rule 436(g)\115\ provides that a security rating 
assigned to a class of debt securities, a class of convertible debt 
securities, or a class of preferred stock is not a part of a 
registration statement prepared or certified by a person or a report or 
valuation prepared or certified by a person within the meaning of 
sections 7 and 11 of the Securities Act. We propose to amend the 
reference to ``nationally recognized statistical rating organization'' 
in Rule 436(g) to expand the relief to any ``credit rating agency'' as 
defined in 15 U.S.C. 78c(a)(61). By proposing to permit issuers to 
disclose security ratings provided by any credit rating agency without 
requiring consents, the Commission believes this relief may foster 
competition between credit rating agencies.\116\
---------------------------------------------------------------------------

    \115\ 17 CFR 230.436(g).
    \116\ See also Section II.B.1 of the 1994 Ratings Release where 
the Commission requested comment on eliminating the consent 
requirement for credit rating agencies that are not NRSROs.
---------------------------------------------------------------------------

Request for Comment
     Prior to 1981 the Commission precluded disclosure 
regarding security ratings in registration statements under the 
Securities Act. Should we revise our disclosure policy to prohibit 
disclosure of security ratings in an issuer's Securities Act 
registration statements or Exchange Act periodic reports? Should we 
simply delete Item 10(c) and provide no established disclosure policy 
regarding credit ratings?
     In 1994, the Commission noted ``the extensive use of, and 
reliance on, ratings, and the wide disparity in the meaning and 
significance of the rating'' as important factors in its decision to 
propose mandated disclosure.\117\ In light of the recent turmoil in the 
credit markets, some of the factors for the proposed disclosure may be 
no less of concern today than they were in 1994. Should the Commission 
require disclosure like the disclosure we currently recommend in Item 
10(c) of Regulation S-K in order to enhance issuers' security rating 
disclosure so that investors are better able to understand the terms of 
a security rating and the limitations on that rating? Would requiring 
disclosure of a security rating place the Commission's ``official seal 
of approval'' on security ratings such that it could adversely affect 
the quality of due diligence and investment analysis?
---------------------------------------------------------------------------

    \117\ See Section II.A of the 1994 Proposing Release.
---------------------------------------------------------------------------

     Item 10(c) of Regulation S-K currently refers to 
``security ratings'' while the 2006 Credit Rating Agency Reform Act 
added the definition of ``credit rating'' to the Exchange Act, which 
means an assessment of the creditworthiness of an obligor as an entity 
or with respect to specific securities or money market instruments. 
Should we revise the reference to ``security rating'' in Item 10(c) to 
refer to ``credit rating'' instead? Would such a revision increase or 
decrease the scope of ratings covered by 10(c)? Would such a change 
limit the types of ratings that could be disclosed in a registration 
statement? In particular, are there any types of ratings that are 
issued that would not be covered by the term ``credit rating,'' 
particularly for ABS or structured products that should be covered by 
Item 10(c)? Are there any other changes we should make to Item 10(c) to 
align it with the Credit Rating Agency Reform Act or otherwise 
modernize it? For instance, should we specifically delineate structured 
products and asset-backed securities in the list of securities covered 
by the item since it currently only lists debt securities, convertible 
debt securities and preferred stock?
     While Item 10(c) currently only recommends disclosure, 
commenters on the 1994 Ratings Release expressed that most issuers 
provide this disclosure in their Securities Act filings. Do issuers 
generally provide this disclosure today? Is disclosure about an 
issuer's securities rating appropriate disclosure for their Securities 
Act filings? Is it appropriate disclosure for their periodic Exchange 
Act filings? Is there any reason that this disclosure should only be 
recommended rather than required?
     In addition to the information Item 10(c) currently 
recommends disclosure regarding security ratings would it be valuable 
for investors to have additional disclosure of all material scope 
limitations of the rating and any related designation (or other 
published evaluation) of non-credit payment risks assigned by the 
rating agency with respect to the security assist investors in better 
understanding the credit rating and assessing the risks of an 
investment in the securities? What additional disclosure would be 
helpful to investors in making these assessments?
     If we were to mandate security rating disclosure, should 
disclosure be required for any published designation that reflects the 
results of any evaluation, other than a credit risk evaluation, done by 
a credit rating agency? Should disclosure be required for any 
evaluation by a credit rating agency that is communicated to the 
issuer, regardless of whether it is published?
     If the Commission were to require security rating 
disclosure, when should an issuer be required to provide that 
disclosure? In 1994, we proposed to require disclosure: if a registrant 
has obtained a security rating from an NRSRO with respect to a class of 
securities being registered under the Securities Act; if the rating is 
used in the offer or sale of the securities by any participant in an 
offering; or if the registrant voluntarily discloses a security rating. 
Should disclosure about the security rating be required under those 
circumstances? If not, under what circumstances, if any, should 
disclosure be required?
     Should we require disclosure of unsolicited ratings? It 
has been suggested that such ratings may not reflect the level of 
information on the security that is reflected in a solicited rating, at 
least in part because of a lack of access to the issuer by the 
unsolicited credit rating agency.\118\ Is there a difference between 
solicited and unsolicited ratings such that they should be treated 
disparately? Should it matter if the issuer uses the unsolicited rating 
in the offer and sale of the securities being rated? If we were to 
require disclosure of unsolicited ratings, should there be limitations 
on how many ratings or which credit rating agencies ratings should be 
required to be disclosed? At what point would this create too great a 
burden on the issuer?
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    \118\ However, in the corollary release amending rules for 
NRSROs, the Commission proposed various changes to Exchange Act Rule 
17g-5 [17 CFR 240.17g-5] that would provide the opportunity for 
other credit rating agencies to use the information to develop 
``unsolicited ratings'' for certain rated asset-backed securities. 
See proposed amendments to Rule 17g-5 in Release No. 34-57967 (Jun. 
16, 2008).
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     In Release 34-57967, we expressed our concerns about 
ratings shopping by issuers and the potential for credit rating 
agencies to use less conservative rating methodologies in order to gain 
business, presumably lessening the value of the ratings. If an issuer 
would be required to provide ratings disclosure where the issuer has 
obtained either a preliminary security rating or a final security 
rating from a rating agency, would such disclosure enhance investors' 
understanding of, and therefore the value of, the ratings? Would it 
help to address our concerns with ratings shopping? If you do not 
believe such disclosure would be helpful, how would you suggest that we 
address these concerns? Should we include a disclosure requirement for 
indications of a rating prior to a preliminary rating? Would disclosure 
of indication from a credit rating agency of a likely or possible 
rating be appropriate?

[[Page 40116]]

     If we were to interpret that a security rating is 
``obtained'' if: it is solicited by or on behalf of an issuer from a 
credit rating agency; or the issuer pays a credit rating agency for 
services related to a rating issued by that credit rating agency, would 
the standard capture sufficient disclosure about an issuer's security 
ratings and the credit rating agencies that have issued them? Could 
that lead to non-substantive or procedural modifications to the 
practice of assigning ratings so that issuers could avoid the 
disclosure requirement? Would that lead to disclosure of security 
ratings that would not be useful to investors? What standard would 
provide the most useful information for investors? Could this threshold 
lead to ratings being obtained in connection with an offering but not 
being disclosed?
     In the 1994 Ratings Release, we proposed to require 
issuers to disclose any material differences between the terms of the 
security as assumed in rating the security and (1) the terms of the 
security as specified in the governing instruments, and (2) the terms 
of the security as marketed to investors. The terms of the securities 
are required to be disclosed in the prospectus, a prospectus 
supplement, or a post-effective amendment, as applicable. Would this 
disclosure assist investors? Would requiring this disclosure in 
periodic filings assist investors in the secondary market in making 
their investment decisions?
     Having previously proposed requiring material changes in 
security ratings be reported on Form 8-K under the Exchange Act,\119\ 
we recognize that such security rating changes can be important 
information to an investor in making investment and voting decisions. 
We note, however, that issuer-paid rating agencies make their rating 
designations public. The current failures of security ratings, 
particularly in the asset-backed securities markets, have led us to re-
evaluate the required level of disclosure regarding security ratings. 
Would requiring detailed current and/or periodic reporting of an 
issuer's security ratings provide investors and the markets sufficient, 
timely information about an issuer's security ratings to assist them in 
making their investment decisions? Would a Form 8-K provide investors 
with material and timely information about an issuer's security ratings 
and changes in those ratings? Would periodic reports on Form 10-K, Form 
20-F, Form 10-Q and Form 10-D provide investors with material and 
timely information about an issuer's security ratings and changes in 
those ratings? Is the information that would be provided regarding a 
material change in a rating in a Form 8-K already provided by the 
credit rating agency? Would a Form 8-K be unduly burdensome? Should a 
Form 8-K requirement be limited to solicited ratings? If a credit 
rating agency does not publicly disclose the security rating of an 
issuer's securities, should we require disclosure of the rating in a 
Form 8-K or in the issuer's periodic reports? How would the existence 
of subscriber paid credit rating agencies affect your response?
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    \119\ See the 1994 Ratings Release and Release No. 33-8106.
---------------------------------------------------------------------------

     We are only proposing to amend Item 10(c) to remove 
references to consents in conjunction with our proposed amendments to 
Rule 436(g) to no longer requiring consents from any credit rating 
agencies for inclusion of their ratings in an issuer's registration 
statement. Should there be a written consent requirement? Would a 
written consent requirement create any issues if the Commission were to 
require disclosure regarding those ratings? Would issuers find it 
problematic or costly to obtain consents?
     Should we require the consent of a credit rating agency 
for the use of its security rating by an issuer? What would be the 
additional costs of such a requirement? Would a consent requirement 
result in fewer ratings being obtained?
     Should we continue to limit the consent requirement to 
non-NRSROs as our rules currently do? Does our proposed regulatory 
oversight and additional disclosure regarding the ratings process and 
results of ratings justify allowing the use of NRSROs ratings without 
requiring consents? Would such a provision provide a ``seal of 
approval'' for NRSROs? Would there be any competitive effect on non-
NRSRO credit rating agencies?
     Are there any issues with periodic disclosure regarding 
security ratings that are particular to ABS issuers? For instance, how 
would the responsibility to monitor changes or development in security 
ratings impact ABS offerings?

D. Other Rules Referencing Security Ratings

    Other rules under the Securities Act also reference security 
ratings assigned by NRSROs. Rule 134(a)(17)\120\ permits the disclosure 
of security ratings in certain communications deemed not to be a 
prospectus or free writing prospectus. We are not proposing to 
eliminate this reference to security ratings in our rules. However, we 
are proposing to revise the rule to allow for disclosure of ratings 
assigned by any credit rating agency, not just NRSROs. In addition, 
disclosure must also note that the credit rating agency is not an 
NRSRO, if that is the case.
---------------------------------------------------------------------------

    \120\ 17 CFR 230.134(a)(17).
---------------------------------------------------------------------------

    Under Rule 100(b)(2) of Regulation FD, disclosures to an entity 
whose primary business is the issuance of security ratings are excluded 
from coverage provided the information is disclosed solely for the 
purpose of developing a credit rating and the entity's ratings are 
publicly available. We believe this exception for disclosures to credit 
rating agencies is appropriate given the purpose of Regulation FD and 
are therefore not proposing to revise that provision.
Request for Comment
     Should we continue to allow disclosure of security ratings 
in ``tombstones'' to be deemed not to be a prospectus or free writing 
prospectus? Is it appropriate to allow such disclosure of a security 
rating by any credit rating agency and not limit the allowance to 
NRSROs? If the credit rating agency is not an NRSRO, is it appropriate 
to require additional disclosure to that effect?
     Should we revise Rule 100(b)(2) of Regulation FD to 
eliminate the requirement that the entity's ratings be publicly 
available or to require public disclosure of information submitted to 
credit rating agencies by issuers? If so, please explain the basis for 
recommending the change and discuss how to implement such changes.
     How would requiring disclosure under Regulation FD affect 
security ratings?

III. General Request for Comments

    We request and encourage any interested person to submit comments 
regarding:
     The proposed amendments that are the subject of this 
release;
     Additional or different changes; or
     Other matters that may have an effect on the proposals 
contained in this release.
    We request comment from the point of view of companies, investors, 
and other market participants. With regard to any comments, we note 
that such comments are of great assistance to our rulemaking initiative 
if accompanied by supporting data and analysis of the issues addressed 
in those comments.
    In addition, we request comment on the following:
     Should the Commission include a phase-in for issuers 
beyond the effective date to accommodate pending offerings?

[[Page 40117]]

If so, should a phase-in apply only to particular rules, such as Form 
S-3 eligibility? As proposed, compliance with the new standards would 
begin on the effective date of the new rules. Will a significant number 
of issuers have their offerings limited by the proposed rules? If a 
phase-in is appropriate, should it be for a certain period of time or 
only for the term of a pending registration statement?
     What impact on competition should the Commission expect 
were it to adopt the proposed non-convertible debt eligibility 
requirements? Would any issuers that currently take advantage, or are 
eligible to take advantage of the investment grade condition and are 
planning to do so, be adversely affected? Is the ability to offer debt 
off the shelf a significant competitive advantage that the Commission 
should be concerned about limiting to only large debt issuers?

IV. Paperwork Reduction Act

A. Background

    Certain provisions of the proposed rule amendments contain a 
``collection of information'' within the meaning of the Paperwork 
Reduction Act of 1995 (PRA).\121\ The Commission is submitting these 
proposed amendments and proposed rules 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 comply with, a 
collection of information unless it displays a currently valid control 
number. The titles for the collections of information are: \122\
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    \121\ 44 U.S.C. 3501 et seq. ; 5 CFR 1320.11.
    \122\ The paperwork burden from Regulation S-K and S-B is 
imposed through the forms that are subject to the requirements in 
those regulations and is reflected in the analysis of those forms. 
To avoid a Paperwork Reduction Act inventory reflecting duplicative 
burdens and for administrative convenience, we assign a one-hour 
burden to Regulation S-K.
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    ``Regulation S-K'' (OMB Control No. 3235-0071);
    ``Regulation C'' (OMB Control No. 3235-0074);
    ``Form S-1'' (OMB Control No. 3235-0065) ;
    ``Form S-3'' (OMB Control No. 3235-0073);
    ``Form S-4'' (OMB Control No. 3235-0324);
    ``Form F-1'' (OMB Control No. 3235-0258);
    ``Form F-3'' (OMB Control No. 3235-0256); and
    ``Form F-4'' (OMB Control No. 3235-0325).
    We adopted all of the existing regulations and forms pursuant to 
the Securities Act or the Exchange Act. These regulations and forms set 
forth the disclosure requirements for periodic reports and registration 
statements that are prepared by issuers to provide investors with 
information to make investment decisions in registered offerings and in 
secondary market transactions. Our proposed amendments to existing 
forms and regulations are intended to replace rule and form 
requirements of the Securities Act and the Exchange Act that rely on 
security ratings with alternative requirements.
    The hours and costs associated with preparing disclosure, filing 
forms, and retaining records constitute reporting and cost burdens 
imposed by the collection of information. There is no mandatory 
retention period for the information disclosed, and the information 
disclosed would be made publicly available on the EDGAR filing system.

B. Summary of Collection of Information Requirements

    The threshold we are proposing for issuers of non-convertible 
securities who are otherwise ineligible to use Form S-3 or Form F-3 to 
conduct primary offerings because they do not meet the aggregate market 
value requirement is designed to capture those issuers with an active 
market following. The Commission expects that under the proposed 
threshold, approximately the same number of issuers who are currently 
eligible will be eligible to register on Form S-3 or Form F-3 for 
primary offerings of non-convertible securities for cash. In addition, 
because these proposed amendments relate to those forms' eligibility 
requirements, rather than the disclosure requirements, the Commission 
does not expect that the proposed revisions will impose any new 
material recordkeeping or information collection requirements. Issuers 
may be required to ascertain the aggregate principal amount of non-
convertible securities issued in registered primary offerings for cash, 
but the Commission believes that this information should be readily 
available and easily calculable.
    Our proposed amendments to Form S-3 and Rule 415 for ABS offerings 
is intended to limit the investors purchasing asset-backed securities 
in a delayed offering and off a short-form registration statement to 
sophisticated and experienced investors without creating an undue 
detriment to the liquidity of the asset-backed securities market. The 
Commission expects preliminarily that the proposed amendments for ABS 
offerings would not substantially change the number of ABS issuers 
registering their offerings on Form S-3.\123\
---------------------------------------------------------------------------

    \123\ As noted above, we have identified two areas of exception: 
unit repackagings and securitizations of insurance funding 
agreements. We do not believe that changes in these areas would 
substantially change the number of issuers that would be eligible 
under the proposed Form S-3 eligibility requirement for ABS 
offerings.
---------------------------------------------------------------------------

C. Paperwork Reduction Act Burden Estimates

    For purposes of the Paperwork Reduction Act, we estimate that there 
will be no annual incremental increase in the paperwork burden for 
issuers to comply with our proposed collection of information 
requirements.

D. Solicitation of Comments

    We request comments in order to evaluate: (1) Whether the proposed 
collection of information is necessary for the proper performance of 
the functions of the agency, including whether the information would 
have practical utility; (2) the accuracy of our estimate of the burden 
of the proposed collection of information; (3) whether there are ways 
to enhance the quality, utility, and clarity of the information to be 
collected; and (4) whether there are ways to minimize the burden of the 
collection of information on those who are to respond, including 
through the use of automated collection techniques or other forms of 
information technology.\124\
---------------------------------------------------------------------------

    \124\ We request comment pursuant to 44 U.S.C. 3506(c)(2)(B).
---------------------------------------------------------------------------

    Any member of the public may direct to us any comments concerning 
the accuracy of these burden estimates and any suggestions for reducing 
these 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, 
Washington, DC 20503, and should send a copy to Secretary, Securities 
and Exchange Commission, 100 F Street, NE., Washington, DC 20549-1090, 
with reference to File No. S7-18-08. Requests for materials submitted 
to OMB by the Commission with regard to these collections of 
information should be in writing, refer to File No. S7-18-08, and be 
submitted to the Securities and Exchange Commission, Records 
Management, Office of Filings and Information Services, 100 F Street, 
NE., Washington, DC 20549. OMB is required to make a decision 
concerning the collection of information between 30 and 60 days after 
publication of this

[[Page 40118]]

release. Consequently, a comment to OMB is best assured of having its 
full effect if OMB receives it within 30 days of publication.

V. Cost-Benefit Analysis

A. Proposed Amendments

    The Commission is sensitive to the costs and benefits imposed by 
its rules. We have identified certain costs and benefits of the 
proposed amendments and request comment on all aspects of this cost-
benefit analysis, including identification and assessment of any costs 
and benefits not discussed in this analysis. We seek comment and data 
on the value of the benefits identified. We also welcome comments on 
the accuracy of the cost estimates in each section of this analysis, 
and request that commenters provide data that may be relevant to these 
cost estimates. In addition, we seek estimates and views regarding 
these costs and benefits for particular covered institutions, including 
small institutions, as well as any other costs or benefits that may 
result from the adoption of these proposed amendments.
    As discussed above, the proposed rule amendments are designed to 
address the risk that the reference to and use of NRSRO ratings in our 
rules is interpreted by investors as an endorsement of the quality of 
the credit ratings issued by NRSROs, and may encourage investors to 
place undue reliance on the NRSRO ratings. Today's proposals seek to 
replace rule and form requirements of the Securities Act and the 
Exchange Act that rely on security ratings by NRSROs with alternative 
requirements that do not rely on ratings.
    The Commission is proposing to revise the transaction eligibility 
requirements of Forms S-3, F-3, and F-9. Currently, these forms allow 
issuers who do not meet the forms' other transaction eligibility 
requirements to register primary offerings of non-convertible 
securities for cash if such securities are rated investment grade by an 
NRSRO.\125\ The proposed rules would replace the current eligibility 
requirement with a requirement that for primary offerings of non-
convertible securities for cash, an issuer must have issued in the 
three years (as of a date within 60 days prior to the filing of the 
registration statement) at least $1 billion aggregate principal amount 
of non-convertible securities, other than common equity, in registered 
primary offerings for cash. In addition, the Commission proposes to 
replace the Form S-3 eligibility requirement for ABS offerings to 
require that initial sales of eligible offerings be made only to 
qualified institutional buyers and that initial and subsequent resales 
of the securities in the eligible offerings be made only in 
denominations of at least $250,000. In conjunction with this proposal, 
the Commission proposes to amend Rule 415 to provide for delayed 
offerings of mortgage related securities, regardless of the security 
ratings, only if they meet the same criteria as proposed for ABS 
offerings on Form S-3.
---------------------------------------------------------------------------

    \125\ The proposed revisions to Form F-9 would eliminate a 
Canadian issuer's ability to rely on security ratings by NRSROs, but 
would continue to rely on ratings issued by Approved Rating 
Organizations, as defined in National Policy Statement No. 45 of the 
Canadian Securities Administrator.
---------------------------------------------------------------------------

    Currently, issuers are required to obtain consent from a rating 
agency that is not an NRSRO for disclosure of a security rating issued 
by that rating agency in a registration statement or report. The 
Commission is also proposing to amend Securities Act Rule 436(g) and 
related rules to expand the relief from the consent requirements for 
security ratings currently provided to NRSROs to other credit rating 
agencies that are not NRSROs. In addition, the proposed revision to 
Rule 134 of the Securities Act would permit an issuer to disclose the 
security rating of any credit rating agency, but would require an 
issuer to provide, if it elects to include a security rating in a 
communication under Rule 134, a statement as to whether the entity 
issuing the rating is an NRSRO.

B. Benefits

    The Commission anticipates that one of the primary benefits of the 
proposed amendments, if adopted, would be the benefit to investors of 
reducing their possible undue reliance on NRSRO ratings that could be 
caused by references to NRSROs in our rules. An over-reliance on 
ratings can inhibit independent analysis and could possibly lead to 
investment decisions that are based on incomplete information. The 
purpose of the proposed rule amendments is to encourage investors to 
examine more than a single source of information in making an 
investment decision. Eliminating reliance on ratings in the 
Commission's rules could also result in greater investor due diligence 
and investment analysis. In addition, the Commission believes that 
eliminating the reliance on ratings in its rules would remove any 
appearance that the Commission has placed its imprimatur on certain 
ratings.
    The Commission believes that the proposed amendments to the Form S-
3 eligibility requirements for ABS offerings and eligibility to rely on 
Rule 415(a)(vii) for mortgage-backed securities are designed to make 
shelf eligibility and short-form registration available to 
sophisticated and experienced investors. The proposed requirement to 
permit initial sales only to qualified institutional buyers is intended 
to limit the market to investors who understand the risks involved with 
an ABS offering. The proposed requirement that initial sales and 
subsequent resales of the securities are in minimum denominations of 
$250,000 is designed to limit offerings to investors with such capital, 
increasing the probability that these investors have the resources to 
analyze and comprehend the risks involved with an investment decision 
in the ABS offering. As with the other amendments to our rules and form 
requirements relying on investment grade ratings, the Commission 
believes that these proposals would reduce or eliminate undue reliance 
on ratings.
    The proposed revision to Rule 134 of the Securities Act would 
require an issuer to provide, if it elects to include a security rating 
in a communication under Rule 134, a statement as to whether the entity 
issuing the rating is an NRSRO. The Commission believes that disclosure 
of this information would be beneficial to investors in evaluating the 
value of the rating.
    Under our proposed amendment to Rule 436(g), an issuer would not be 
required to obtain consent from the rating agency even with respect to 
a rating disclosed in a registration statement or report that is issued 
by a credit rating agency that is not an NRSRO. We believe that our 
proposed change would foster competition between credit rating 
agencies.\126\
---------------------------------------------------------------------------

    \126\ This would be consistent with our proposed amendments to 
the rules governing NRSROs in Release No. 34-57967. As discussed in 
that release, such competition could promote ease of comparability 
between ratings.
---------------------------------------------------------------------------

C. Costs

    We are proposing to revise the transaction eligibility criteria for 
registering primary offerings of non-convertible securities on short-
form registration statements. Forms S-3 and F-3 would be available to 
register primary offerings of non-convertible securities if the issuer 
has issued (as of a date within 60 days prior to the filing of the 
registration statement) for cash more than $1 billion in non-
convertible securities, other than common equity, through registered 
primary offerings over the prior three years. The proposed eligibility 
thresholds may be more difficult to ascertain for some issuers than an 
NRSRO rating and impose some

[[Page 40119]]

burden on issuers to ascertain the information. In addition, while we 
do not anticipate that fewer issuers will be eligible, to the extent 
that the proposal results in fewer issuers eligible to use Forms S-3 
and F-3 to register primary offerings of non-convertible securities, 
this could result in increased costs of preparing and filing 
registration statements.\127\ Issuers who do not meet the proposed 
threshold and are not otherwise eligible to use Forms S-3 and F-3, 
would have to register offerings on Forms S-1 or F-1. This could result 
in additional time spent in the offering process, and issuers may incur 
costs associated with preparing and filing post-effective amendments to 
the registration statement.
---------------------------------------------------------------------------

    \127\ The ability to conduct primary offerings on short form 
registration statements confers significant advantages on eligible 
companies in terms of cost savings and capital formation. The time 
required to prepare Form S-3 or F-3 is significantly lower than that 
required for Forms S-1 and F-1 primarily because registration 
statements on Forms S-3 and F-3 can be automatically updated. Forms 
S-3 and F-3 permit registrants to forward incorporate required 
information by reference to disclosure in their Exchange Act 
filings.
---------------------------------------------------------------------------

    The Commission does not expect the proposed changes to Forms F-1, 
F-3 and F-4 to impact substantially the number of registrants able to 
provide information required by Item 17 of Form 20-F in lieu of Item 18 
information. However, because the Commission is proposing changes to 
the provisions of the forms that provide the eligibility requirements 
for registrants to provide Item 17 information instead of Item 18, 
registrants who do not meet the proposed criteria could incur more 
costs as a result of being required to provide Item 18 information 
instead.
    For the most part, the Commission believes that there would be 
minimal costs involved with the adoption of the proposed ABS offering 
Form S-3 eligibility requirements and eligibility to rely on Rule 
415(a)(vii) for mortgage-backed securities.\128\ Some costs may be 
incurred on the part of issuers to ensure that sales of the securities 
in an offering on Form S-3 are made only to qualified institutional 
buyers and in the prescribed denominations; however, the Commission 
believes these costs are not significant. To the extent that some 
issuers would no longer be able to use Form S-3 to register their 
offerings, those issuers may face some additional costs, such as those 
arising from no longer being able to utilize certain rules permitting 
the use of offering materials.
---------------------------------------------------------------------------

    \128\ ABS issuers generally provide the same disclosure in Form 
S-1 and Form S-3 registration statements. As such, there may not be 
the same cost concerns for ABS issuers that no longer qualify for 
registration on Form S-3 as for other issuers.
---------------------------------------------------------------------------

    The proposed revision to Rule 134 could impose a disclosure burden 
of ascertaining whether the entity is an NRSRO, but the Commission 
believes this burden is slight given the limited number of NRSROs, the 
availability of this information from public filings, and the issuer's 
relationship with the credit rating agency.

D. Request for Comments

    We seek comments and empirical data on all aspects of this Cost-
Benefit Analysis. Specifically, we ask the following:
     Are there any costs involved with tracking whether the 
initial purchaser is a qualified institutional buyer? Are most ABS 
offerings on Form S-3 sold to such purchasers? What kind of asset-
backed securities are sold to retail investors?
     Are there any costs entailed with tracking the 
denominations of the sale for the purposes of meeting the proposed ABS 
offering Form S-3 eligibility requirements?
     Would there be any significant transition costs imposed on 
issuers as a result of the proposals, if adopted? Please be detailed 
and provide quantitative data or support, as practicable.

VI. Consideration of Burden on Competition and Promotion of Efficiency, 
Competition, and Capital Formation

    Section 23(a) of the Exchange Act \129\ requires the Commission, 
when making rules and regulations under the Exchange Act, to consider 
the impact a new rule would have on competition. Section 23(a)(2) 
prohibits the Commission from adopting any rule which would impose a 
burden on competition not necessary or appropriate in furtherance of 
the purposes of the Exchange Act. Section 2(b) of the Securities Act 
\130\ and Section 3(f) of the Exchange Act \131\ require the 
Commission, when engaging in rulemaking, to consider whether an action 
is necessary or appropriate in the public interest, and in addition, to 
consider the protection of investors and whether the action would 
promote efficiency, competition, and capital formation.
---------------------------------------------------------------------------

    \129\ 15 U.S.C. 78w(a).
    \130\ 15 U.S.C. 77b(b).
    \131\ 15 U.S.C. 78c(f).
---------------------------------------------------------------------------

    The proposed amendments would eliminate reliance on ratings by an 
NRSRO in various rules and forms under the Securities Act and the 
Exchange Act. If adopted, the Commission believes that these amendments 
would reduce the potential for over-reliance on ratings, and thereby 
promote investor protection. The Commission anticipates that these 
proposed amendments would improve investors' ability to make informed 
investment decisions, which will therefore lead to increased efficiency 
and competitiveness of the U.S. capital markets. The Commission expects 
that this increased market efficiency and investor confidence also may 
encourage more efficient capital formation. Specifically, the proposed 
amendments would:
     Seek to limit the investors purchasing asset-backed 
securities off a short-form registration statement to sophisticated and 
experienced investors without creating an undue detriment to the 
liquidity of the asset-backed securities market; and
     Seek to limit the issuers eligible to register primary 
offerings of non-convertible securities on Forms S-3 and F-3 and 
incorporate by reference to issuers that are actively followed by the 
markets; and
     Enhance the ability of credit rating agencies to offer 
security ratings to issuers.
The Commission solicits comment on whether the proposed amendments 
would change the Forms S-3 and F-3 eligibility requirements for 
registering primary offerings of non-convertible securities, if 
adopted, would promote or burden efficiency, competition, and capital 
formation. The Commission also requests comment on whether the proposed 
amendments would have harmful effects on investors or on issuers who 
could use Form S-3 and Form F-3 for primary offerings of non-
convertible securities, and what options would best minimize those 
effects. The Commission requests comment on whether the proposed 
changes to the eligibility requirement on Form S-3 for offerings of 
asset-backed securities would promote or burden efficiency, 
competition, and capital formation. The Commission requests comment on 
whether the proposed eligibility criterion is less efficient than using 
the current NRSRO criterion? Additionally, the Commission solicits 
comment on whether the proposed expansion of the ability of credit 
rating agencies to proffer their security ratings without being 
required to provide a consent for an issuer to disclose those ratings 
would promote or burden efficiency, competition, and capital formation. 
Finally, the Commission requests comment on the anticipated effect of 
disclosure requirements on competition in the market for credit rating 
agencies.

[[Page 40120]]

The Commission requests commenters to provide empirical data and other 
factual support for their views, if possible.

VII. Regulatory Flexibility Act Certification

    The Commission hereby certifies, pursuant to 5 U.S.C. 605(b), that 
the amendments contained in this release, if adopted, would not have a 
significant economic impact on a substantial number of small entities. 
The proposed amendments would:
     Amend the Securities Act Form S-3 eligibility requirements 
for offerings of asset-backed securities by replacing the investment 
grade component with a minimum denomination requirement for initial and 
subsequent sales and require that initial sales of classes of 
securities only be made to qualified institutional buyers;
     Amend Rule 415 of the Securities Act that references 
mortgaged related securities by adding the requirement that an initial 
and subsequent sale of such a security must meet certain minimum 
denominations, and initial sales must be made to qualified 
institutional buyers;
     Amend the Securities Act Form S-3 and Form F-3 eligibility 
requirements for primary offerings of non-convertible securities if the 
issuer has issued (as of a date within 60 days prior to the filing of 
the registration statement) for cash more than $1 billion in non-
convertible securities, other than common stock, through registered 
primary offerings, within the prior three years;
     Amend Form F-9 which requires securities to be rated 
investment grade to instead require that the issuer have issued in the 
prior three years at least $1 billion of aggregate principle amount of 
debt or preferred securities for cash in registered primary offerings;
     Amend Forms S-4 and F-4 and Schedule 14A to conform with 
the proposed Form S-3/F-3 eligibility requirements;
     Amend Securities Act Rules 138, 139, and Rules 168 to be 
consistent with the proposed Form S-3/F-3 eligibility requirements;
     Amend Item 10(c) to conform to our proposed Rule 436(g) 
changes;
     Amend Rule 134(a)(17) to allow for disclosure of ratings 
assigned by any Credit Rating Agency--not just NRSROs; and
     Amend Rule 436(g) to replace the current reference to 
``nationally recognized statistical rating organization'' with a 
reference to ``credit rating agency.''

We are not aware of any issuers that currently rely on the rules that 
we propose to change or any issuers that would be eligible to register 
under the affected rules that is a small entity. In this regard, we 
note that credit rating agencies rarely, if ever, rate the securities 
of small entities. We further note most security ratings that will be 
disclosed are expected to be ratings obtained and used by the issuer. 
Issuers are required to pay for these security ratings and the cost of 
these ratings relative to the size of a debt or preferred securities 
offering by a small entity would generally be prohibitive. Finally, 
based on an analysis of the language and legislative history of the 
Regulatory Flexibility Act, we note that Congress did not intend that 
the Act apply to foreign issuers. Accordingly, some of the entities 
directly affected by the proposed rule and form amendments will fall 
outside the scope of the Act.
    For these reasons, the proposed amendments would not have a 
significant economic impact on a substantial number of small entities.

VIII. Small Business Regulatory Enforcement Fairness Act

    For purposes of the Small Business Regulatory Enforcement Fairness 
Act of 1996,\132\ a rule is ``major'' if it has resulted, or is likely 
to result in:
---------------------------------------------------------------------------

    \132\ Pub. L. No. 104-121, Title II, 110 Stat. 857 (1996).
---------------------------------------------------------------------------

     An annual effect on the U.S. economy of $100 million or 
more;
     A major increase in costs or prices for consumers or 
individual industries; or
     Significant adverse effects on competition, investment, or 
innovation. We request comment on whether our proposal would be a 
``major rule'' for purposes of the Small Business Regulatory 
Enforcement Fairness Act. We solicit comment and empirical data on:
     The potential effect on the U.S. economy on an annual 
basis;
     Any potential increase in costs or prices for consumers or 
individual industries; and
     Any potential effect on competition, investment, or 
innovation.

IX. Statutory Authority and Text of Proposed Rule and Form Amendments

    We are proposing the amendments contained in this document under 
the authority set forth in Sections 6, 7, 10, 19(a) of the Securities 
Act and Sections 12, 13, 14, 15(d) and 23(a) of the Exchange Act.

List of Subjects in 17 CFR Parts 229, 230, 239, and 240

    Reporting and recordkeeping requirements, Securities.

    For the reasons set out in the preamble, Title 17, Chapter II of 
the Code of Federal Regulations is proposed to be amended as follows:

PART 229--STANDARD INSTRUCTIONS FOR FILING FORMS UNDER SECURITIES 
ACT OF 1933, SECURITIES EXCHANGE ACT OF 1934 AND ENERGY POLICY AND 
CONSERVATION ACT OF 1975--REGULATION S-K

    1. The authority citation for part 229 continues to read in part as 
follows:

    Authority: 15 U.S.C. 77e, 77f, 77g, 77h, 77j, 77k, 77s, 77z-2, 
77z-3, 77aa(25), 77aa(26), 77ddd, 77eee, 77ggg, 77hhh, 77iii, 77jjj, 
77nnn, 77sss, 78c, 78i, 78j, 78l, 78m, 78n, 78o, 78u-5, 78w, 78ll, 
78mm, 80a-8, 80a-9, 80a-20, 80a-29, 80a-30, 80a-31(c), 80a-37, 80a-
38(a), 80a-39, 80b-11, and 7201 et seq.; 18 U.S.C. 1350, unless 
otherwise noted.
* * * * *
    2. Amend Sec.  229.10, paragraph (c)(1)(i) by:
    a. Removing the second sentence;
    b. Revising ``NRSRO'' in the third sentence to read, ``credit 
rating agency (as defined in 15 U.S.C. 78c(a)(61))''; and
    c. Revising the phrase ``Instruction to paragraph (a)(2)'' in the 
fourth sentence to read, ``paragraph A.2.(B)''.
    3. Amend Sec.  229.1100 by revising paragraph (c)(2)(ii)(B) to read 
as follows:


Sec.  229.1100 (Item 1100)  General.

* * * * *
    (c) * * *
    (2) * * *
    (ii) * * *
    (B) The third party meets the requirements of General Instruction 
I.A. of Form S-3 or General Instructions 1.A.1, 2, 3, 4, and 6 of Form 
F-3 and the pool assets relating to such third party are non-
convertible securities, other than common equity, that were issued in a 
primary offering for cash that was registered under the Securities Act.
* * * * *
    4. Amend Sec.  229.1112 by:
    a. In paragraph (b) remove Instruction 2 to Item 1112(b);
    b. Redesignating Instructions 3 and 4 to Items 1112(b) as 
Instructions 2 and 3 to Item 1112(b).
    5. Amend Sec.  229.1114 by:
    a. In paragraph (b) revise the heading for ``Instructions to Item 
1114:'' to read ``Instructions to Item 1114(b):''.
    b. Removing Instruction 3 to Item 1114.
    c. Redesignating Instructions 4 and 5 to Item 1114 as Instructions 
3 and 4 to Item 1114.

[[Page 40121]]

PART 230--GENERAL RULES AND REGULATIONS, SECURITIES ACT OF 1933

    6. The authority citation for part 230 continues to read in part as 
follows:

    Authority: 15 U.S.C. 77b, 77c, 77d, 77f, 77g, 77h, 77j, 77r, 
77s, 77z-3, 77sss, 78c, 78d, 78j, 78l, 78m, 78n, 78o, 78t, 78w, 
78ll(d), 78mm, 80a-8, 80a-24, 80a-28, 80a-29, 80a-30, and 80a-37, 
unless otherwise noted.
* * * * *
    7. Amend Sec.  230.134 by:
    a. Revising paragraph (a)(17)(i);
    b. Redesignating paragraph (a)(17)(ii) as paragraph (a)(17)(iii); 
and
    c. Adding new paragraph (a)(17)(ii).
    The revision and addition read as follows:


Sec.  230.134  Communications not deemed a prospectus.

* * * * *
    (a) * * *
    (17) * * *
    (i) Any security rating assigned, or reasonably expected to be 
assigned, by a credit rating agency, as that term is defined in 15 
U.S.C. 78c(a)(61), and the name or names of the credit rating agencies 
that assigned or is or are reasonably expected to assign the rating(s);
    (ii) If the credit rating agency or agencies that assigned or is or 
are reasonably expected to assign the rating(s) is not a nationally 
recognized security rating organization, as that term is defined in 15 
U.S.C. 78c(a)(62), include a statement to that effect; and
* * * * *
    8. Amend Sec.  230.138 by revising paragraph (a)(2)(ii)(B)(2) to 
read as follows:


Sec.  230.138  Publications or distributions of research reports by 
brokers or dealers about securities other than those they are 
distributing.

    (a) * * *
    (2) * * *
    (ii) * * *
    (B) * * *
    (2) Is issuing non-convertible securities and the registrant meets 
the provisions of General Instruction I.B.2 of Form F-3; and
* * * * *
    9. Amend Sec.  230.139 by revising paragraphs (a)(1)(i)(A)(1)(ii) 
and (a)(1)(i)(B)(2)(ii) to read as follows:


Sec.  230.139  Publications or distributions of research reports by 
brokers or dealers distributing securities.

    (a) * * *
    (1) * * *
    (i) * * *
    (A)(1) * * *
    (ii) At the date of reliance on this section, is, or if a 
registration statement has not been filed, will be, offering non-
convertible securities and meets the requirements for the General 
Instruction I.B.2 of Form S-3 or Form F-3; or
* * * * *
    (B) * * *
    (2) * * *
    (ii) Is issuing non-convertible securities and meets the provisions 
of General Instruction I.B.2. of Form F-3; and
* * * * *
    10. Amend Sec.  230.168 by revising paragraph (a)(2)(ii)(B) to read 
as follows:


Sec.  230.168  Exemption from sections 2(a)(10) and 5(c) of the Act for 
certain communications of regularly released factual business 
information and forward-looking information.

* * * * *
    (a) * * *
    (2) * * *
    (ii) * * *
    (B) Is issuing non-convertible securities and meets the provisions 
of General Instruction I.B.2 of Form F-3; and
* * * * *
    11. Amend Sec.  230.415 by revising paragraph (a)(1)(vii) to read 
as follows:


Sec.  230.415  Delayed or continuous offering and sale of securities.

    (a) * * *
    (1) * * *
    (vii) Mortgage backed securities, including such securities as 
mortgage backed debt and mortgage participation or pass through 
certificates, provided that:
    (A) Initial sale and any resales of the securities are made in 
minimum denominations of $250,000; and
    (B) Initial sales of the securities are made only to qualified 
institutional buyers (as defined in Sec.  230.144A(a)(1)); and
    (C) Either of the following is true:
    (1) Represents ownership of one or more promissory notes or 
certificates of interest or participation in such notes (including any 
rights designed to assure servicing of, or the receipt or timeliness of 
receipt by the holders of such notes, certificates, or participations 
of amounts payable under, such notes, certificates, or participations), 
which notes:
    (i) Are directly secured by a first lien on a single parcel of real 
estate, including stock allocated to a dwelling unit in a residential 
cooperative housing corporation, upon which is located a dwelling or 
mixed residential and commercial structure, on a residential 
manufactured home as defined in section 603(6) of the National 
Manufactured Housing Construction and Safety Standards Act of 1974, 
whether such manufactured home is considered real or personal property 
under the laws of the State in which it is to be located, or on one or 
more parcels of real estate upon which is located one or more 
commercial structures; and
    (ii) Were originated by a savings and loan association, savings 
bank, commercial bank, credit union, insurance company, or similar 
institution which is supervised and examined by a Federal or State 
authority, or by a mortgage approved by the Secretary of Housing and 
Urban Development pursuant to sections 203 and 211 of the National 
Housing Act, or, where such notes involve a lien on the manufactured 
home, by any such institution or by any financial institution approved 
for insurance by the Secretary of Housing and Urban Development 
pursuant to section 2 of the National Housing Act; or
    (2) Is secured by one or more promissory notes or certificates of 
interest or participations in such notes (with or without recourse to 
the issuer thereof) and, by its terms, provides for payments of 
principal in relation to payments, or reasonable projections of 
payments, on notes meeting the requirements of paragraphs 
(a)(1)(vii)(C)(1) (i) and (ii) of this section or certificates of 
interest or participations in promissory notes meeting such 
requirements.

    Note to paragraph (a)(1)(vii): For purposes of paragraph 
(a)(1)(vii) of the section, the term ``promissory note,'' when used 
in connection with a manufactured home, shall also include a loan, 
advance, or credit sale as evidence by a retail installment sales 
contract or other instrument.

* * * * *
    12. Amend Sec.  230.436 by revising paragraph (g) and removing the 
authority citations following the section to read as follows:


Sec.  230.436  Consents required in special cases.

* * * * *
    (g) Notwithstanding the provisions of paragraphs (a) and (b) of 
this section, the security rating assigned to a class of debt 
securities, a class of convertible debt securities, or a class of 
preferred stock by a credit rating agency as defined in 15 U.S.C. 
78c(a)(61), or with respect to registration statements on Form F-9 
(Sec.  239.39 of this chapter) by any other rating organization 
specified in the Instruction to paragraph A of General Instruction I of 
Form F-9, shall not be considered a part of the registration statement 
prepared or certified by a person within the meaning of sections 7 and 
11 of the Act.

[[Page 40122]]

PART 239--FORMS PRESCRIBED UNDER THE SECURITIES ACT OF 1933

    13. The authority citation for part 239 continues to read in part 
as follows:

    Authority: 15 U.S.C. 77f, 77g, 77h, 77j, 77s, 77z-2, 77z-3, 
77sss, 78c, 78l, 78m, 78n, 78o(d), 78u-5, 78w(a), 78ll, 78mm, 80a-
2(a), 80a-3, 80a-8, 80a-9, 80a-10, 80a-13, 80a-24, 80a-26, 80a-29, 
80a-30, and 80a-37, unless otherwise noted.
* * * * *
    14. Amend Form S-3 (referenced in Sec.  239.13) by:
    a. Revising General Instructions I.B.2 and I.B.5; and
    b. Removing Instruction 3 to the signature block.
    The revisions read as follows:

    Note: The text of Form S-3 does not, and this amendment will 
not, appear in the Code of Federal Regulations.

FORM S-3

REGISTRATION STATEMENT UNDER THE SECURITIES ACT OF 1933

* * * * *

GENERAL INSTRUCTIONS

I. Eligibility Requirements for Use of Form S-3

* * * * *

B. Transaction Requirements* * *

    2. Primary Offerings of Non-convertible Securities. Non-convertible 
securities to be offered for cash by or on behalf of a registrant, 
provided the registrant, as of a date within 60 days prior to the 
filing of the registration statement on this Form, has issued in the 
last three years at least $1 billion aggregate principal amount of non-
convertible securities, other than common equity, in primary offerings 
for cash, not exchange, registered under the Act.
* * * * *
    5. Offerings of Asset-backed Securities.
    (a) Asset-backed securities (as defined in 17 CFR 229.1101) to be 
offered for cash, provided:
    (i) Initial sales and any resales of the securities are made in 
minimum denominations of $250,000;
    (ii) Initial sales of the securities are made only to qualified 
institutional buyers (as defined in 17 CFR 230.144A(a)(1));
    (iii) Delinquent assets do not constitute 20% or more, as measured 
by dollar volume, of the asset pool as of the measurement date; and
    (iv) With respect to securities that are backed by leases other 
than motor vehicle leases, the portion of the securitized pool balance 
attributable to the residual value of the physical property underlying 
the leases, as determined in accordance with the transaction agreements 
for the securities, does not constitute 20% or more, as measured by 
dollar volume, of the securitized pool balance as of the measurement 
date.
    Instruction. For purposes of making the determinations required by 
paragraphs (a)(iii) and (a)(iv) of this General Instruction I.B.5, 
refer to the Instructions to Item 1101(c) of Regulation AB (17 CFR 
229.1101(c)).
* * * * *
    15. Amend Form S-4 (referenced in Sec.  239.25) by revising General 
Instruction B.1.a.(ii)(B) to read as follows:

    Note: The text of Form S-4 does not, and this amendment will 
not, appear in the Code of Federal Regulations.

FORM S-4

REGISTRATION STATEMENT UNDER THE SECURITIES ACT OF 1933

* * * * *

GENERAL INSTRUCTIONS

* * * * *

B. Information With Respect to the Registrant

    1. * * *
    a. * * *
    (ii) * * *
    (B) Non-convertible debt or preferred securities are to be offered 
pursuant to this registration statement and the requirements of General 
Instruction I.B.2. of Form S-3 have been met; or
* * * * *
    16. Amend Form F-1 (referenced in Sec.  239.31) by revising Item 
4.c, including the Instructions to read as follows:

    Note: The text of Form F-1 does not, and this amendment will 
not, appear in the Code of Federal Regulations.

FORM F-1

REGISTRATION STATEMENT UNDER THE SECURITIES ACT OF 1933

* * * * *
    Item 4. Information with Respect to the Registrant and the 
Offering.
* * * * *
    c. Information required by Item 17 of Form 20-F may be furnished in 
lieu of the information specified by Item 18 thereof if:
    1. The only securities being registered are non-convertible 
securities offered for cash and the registrant, as of a date within 60 
days prior to the filing of the registration statement on this Form, 
has issued in the last three years at least $1 billion aggregate 
principal amount of non-convertible securities, other than common 
equity, in primary offerings for cash registered under the Act; or
    2. The only securities to be registered are to be offered:
    i. Upon the exercise of outstanding rights granted by the issuer of 
the securities to be offered, if such rights are granted on a pro rata 
basis to all existing security holders of the class of securities to 
which the rights attach and there is no standby underwriting in the 
United States or similar arrangement; or
    ii. Pursuant to a dividend or interest reinvestment plan; or
    iii. Upon the conversion of outstanding convertible securities or 
upon the exercise of outstanding transferable warrants issued by the 
issuer of the securities to be offered, or by an affiliate of such 
issuer.
    Instruction: Attention is directed to section 10(a)(3) of the 
Securities Act.
* * * * *
    17. Amend Form F-3 (referenced in Sec.  239.33) by:
    a. Revising General Instruction I.B.2; and
    b. Deleting Instruction 3 to the signature block.
    The revision to General Instruction I.B.2 reads as follows:

    Note: The text of Form F-3 does not, and this amendment will 
not, appear in the Code of Federal Regulations.

FORM F-3

REGISTRATION STATEMENT UNDER THE SECURITIES ACT OF 1933

* * * * *

GENERAL INSTRUCTIONS

I. Eligibility Requirements for Use of Form F-3

* * * * *

B. Transaction Requirements * * *

    2. Primary Offerings of Non-convertible Securities. Non-convertible 
securities to be offered for cash provided the issuer, as of a date 
within 60 days prior to the filing of the registration statement on 
this Form, has issued in the last three years at least $1 billion 
aggregate principal amount of non-convertible securities, other than 
common equity, in primary offerings for cash, not exchange, registered 
under the Act. In the case of securities registered pursuant to this 
paragraph, the financial statements included in this registration 
statement may comply with Item 17 or 18 of Form 20-F.
* * * * *
    18. Amend Form F-4 (referenced in Sec.  239.34) by:
    a. revising General Instruction B.1(a)(ii)(B); and

[[Page 40123]]

    b. revising the following in Part I.B: Instruction 1 to Item 11 
following paragraph (a)(3); the first sentence in paragraph (b)(2) to 
Item 12; Instruction 1 to Item 13 following paragraph (b); and 
paragraph (h) to Item 14.
    The revisions read as follows:

    Note: The text of Form F-4 does not, and this amendment will 
not, appear in the Code of Federal Regulations.

FORM F-4

REGISTRATION STATEMENT UNDER THE SECURITIES ACT OF 1933

* * * * *

GENERAL INSTRUCTIONS

* * * * *

B. Information with Respect to the Registrant

    1. * * *
    a. * * *
    (ii) * * *
    (B) Non-convertible debt or preferred securities are to be offered 
pursuant to this registration statement and the requirements of General 
Instruction I.B.2. of Form F-3 have been met; or
* * * * *

PART I--INFORMATION REQUIRED IN THE PROSPECTUS

* * * * *

B. INFORMATION ABOUT THE REGISTRANT

* * * * *
    Item 11. Incorporation of Certain Information by Reference.
* * * * *
    (a) * * *
    (3) * * *
Instructions
    1. All annual reports or registration statements incorporated by 
reference pursuant to Item 11 of this Form shall contain financial 
statements that comply with Item 18 of Form 20-F except that financial 
statements of the registrants may comply with Item 17 of Form 20-F if 
the only securities being registered are non-convertible securities 
offered for cash and the requirements of General Instruction I.B.2 of 
Form F-3 have been satisfied.
* * * * *
    Item 12. Information With Respect to F-3 Registrants.
* * * * *
    (b) * * *
    (2) Include financial statements and information as required by 
Item 18 of Form 20-F, except that financial statements of the 
registrant may comply with Item 17 of Form 20-F if the requirements of 
General Instruction I.B.2 of Form F-3 have been satisfied. * * *
* * * * *
    Item 13. Incorporation of Certain Information by Reference.
* * * * *
    (b) * * *
    Instructions
    1. All annual reports incorporated by reference pursuant to Item 13 
of this Form shall contain financial statements that comply with Item 
18 of Form 20-F, except that financial statements of the registrants 
may comply with Item 17 of Form 20-F if the only securities being 
registered are non-convertible securities offered for cash and the 
requirements of General Instruction I.B.2 of Form F-3 have been 
satisfied.
* * * * *
    Item 14. Information With Respect to Foreign Registrants Other Than 
F-3 Registrants.
* * * * *
    (h) Financial statements required by Item 18 of Form 20-F, except 
that financial statements of the registrants may comply with Item 17 of 
Form 20-F if the only securities being registered are non-convertible 
securities offered for cash and the requirements of General Instruction 
I.B.2 of Form F-3 have been satisfied, as well as financial information 
required by Rule 3-05 and Article 11 of Regulation S-X with respect to 
transactions other than that pursuant to which the securities being 
registered are to be issued (Schedules required by Regulation S-X shall 
be filed as ``Financial Statement Schedules'' pursuant to Item 21 of 
this Form); and
* * * * *
    19. Amend Form F-9 (referenced in Sec.  239.39) by:
    a. Revising General Instruction I.A;
    b. Removing Instruction D to the signature block.
    The revision reads as follows:

    Note: The text of Form F-9 does not, and this amendment will 
not, appear in the Code of Federal Regulations.

FORM F-9

REGISTRATION STATEMENT UNDER THE SECURITIES ACT OF 1933

* * * * *

GENERAL INSTRUCTIONS

I. Eligibility Requirements for Use of Form F-9

    A. Form F-9 may be used for the registration under the Securities 
Act of 1933 (the ``Securities Act'') for an offering of debt or 
preferred securities if:
    (1) The debt or preferred securities to be offered are:
    (A) Offered for cash or in connection with an exchange offer; and
    (B) Either non-convertible or not convertible for a period of at 
least one year from the date of issuance and, except as noted in E. 
below, are thereafter only convertible into a security of another class 
of the issuer; and
    (2) Either of the following is true:
    (A) The registrant, as of a date within 60 days prior to the filing 
of the registration statement on this Form, has issued in the last 
three years at least $1 billion of aggregate principal amount of debt 
or preferred securities for cash in primary offerings registered under 
the Act; or
    (B) The securities are investment grade debt or investment grade 
preferred securities. Securities shall be ``investment grade'' for 
purposes of this requirement if, at the time of sale, at least one 
Approved Rating Organization (as defined in National Policy Statement 
No. 45 of the Canadian Securities Administrator, as the same may be 
amended from time to time) has rated the security in one of its generic 
rating categories that signifies investment grade; typically the four 
highest rating categories (within which there may be subcategories or 
gradations indicating relative standing) signify investment grade.

PART 240--GENERAL RULES AND REGULATIONS, SECURITIES EXCHANGE ACT OF 
1934

    20. The authority citation for part 240 continues to read in part 
as follows:

    Authority: 15 U.S.C. 77c, 77d, 77g, 77j, 77s, 77z-2, 77z-3, 
77eee, 77ggg, 77nnn, 77sss, 77ttt, 78c, 78d, 78e, 78f, 78g, 78i, 
78j, 78j-1, 78k, 78k-1, 78l, 78m, 78n, 78o, 78p, 78q, 78s, 78u-5, 
78w, 78x, 78ll, 78mm, 80a-20, 80a-23, 80a-29, 80a-37, 80b-3, 80b-4, 
80b-11, and 7201 et seq.; and 18 U.S.C. 1350, unless otherwise 
noted.
* * * * *
    21. Amend Sec.  240.14a-101 by revising Note E(2)(ii) to read as 
follows:


Sec.  240.14a-101  Schedule 14A. Information required in proxy 
statement.

* * * * *
Notes
* * * * *
    E. * * *
    (2) * * *
    (ii) Action is to be taken as described in Items 11, 12, and 14 of 
this schedule which concerns non-convertible debt or preferred 
securities issued by a registrant meeting the requirements of General 
Instruction I.B.2 of Form S-3; or
* * * * *

    By the Commission.


[[Page 40124]]


    Dated: July 1, 2008.
Florence E. Harmon,
Acting Secretary.
[FR Doc. E8-15281 Filed 7-10-08; 8:45 am]

BILLING CODE 8010-01-P


[Federal Register: July 11, 2008 (Volume 73, Number 134)]
[Proposed Rules]               
[Page 40124-40142]
From the Federal Register Online via GPO Access [wais.access.gpo.gov]
[DOCID:fr11jy08-18]                         

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SECURITIES AND EXCHANGE COMMISSION

17 CFR Parts 270 and 275

[Release Nos. IC-28327; IA-2751 File No. S7-19-08]
RIN 3235-AK19

 
References to Ratings of Nationally Recognized Statistical Rating 
Organizations

AGENCY: Securities and Exchange Commission.

ACTION: Proposed rule.

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SUMMARY: This is one of three releases that the Securities and Exchange 
Commission (``Commission'') is publishing simultaneously relating to 
the use in its rules and forms of credit ratings issued by nationally 
recognized statistical rating organizations (``NRSROs''). In this 
release, the Commission proposes to amend five rules under the 
Investment Company Act of 1940 and the Investment Advisers Act of 1940 
that rely on NRSRO ratings. The proposed amendments are designed to 
address concerns that the reference to NRSRO ratings in Commission 
rules may have contributed to an undue reliance on NRSRO ratings by 
market participants.

DATES: Comments should be received on or before September 5, 2008.

ADDRESSES: Comments may be submitted by any of the following methods:

Electronic Comments

     Use the Commission's Internet comment form (http://
www.sec.gov/rules/proposed.shtml); or
     Send an e-mail to rule-comments@sec.gov. Please include 
File Number S7-19-08 on the subject line; or
     Use the Federal eRulemaking Portal (http://
www.regulations.gov). Follow the instructions for submitting comments.

Paper Comments

     Send paper comments in triplicate to Secretary, Securities 
and Exchange Commission, 100 F Street, NE., Washington, DC 20549-1090.

All submissions should refer to File Number S7-19-08. This file number 
should be included on the subject line if e-mail is used. To help us 
process and review your comments more efficiently, please use only one 
method. The Commission will post all comments on the Commission's 
Internet Web site (http://www.sec.gov/rules/proposed.shtml). Comments 
are also available for public inspection and copying in the 
Commission's Public Reference Room, 100 F Street, NE., Washington, DC 
20549, on official business days between the hours of 10 a.m. and 3 
p.m. All comments received will be posted without change; we do not 
edit personal identifying information from submissions. You should 
submit only information that you wish to make publicly available.

FOR FURTHER INFORMATION CONTACT: Penelope Saltzman, Acting Assistant 
Director, or Vincent Meehan, Senior Counsel, (202) 551-6792, Office of 
Regulatory Policy, or Smeeta Ramarathnam, Senior Counsel, (202) 551-
6792, Office of Special Projects, Division of Investment Management, 
Securities and Exchange Commission, 100 F Street, NE., Washington, DC 
20549-5041.

SUPPLEMENTARY INFORMATION: The Commission is proposing for public 
comment amendments to rules 2a-7 [17 CFR 270.2a-7], 3a-7 [17 CFR 
270.3a-7], 5b-3 [17 CFR 270.5b-3], and 10f-3 [17 CFR 270.10f-3] under 
the Investment Company Act of 1940 (``Investment Company Act''),\1\ and 
amendments to rule 206(3)-3T [17 CFR 275.206(3)-3T] under the 
Investment Advisers Act of 1940 (``Investment Advisers Act'' or 
``Advisers Act'').\2\
---------------------------------------------------------------------------

    \1\ 15 U.S.C. 80a. Unless otherwise noted, all references to 
rules under the Investment Company Act will be to Title 17, Part 270 
of the Code of Federal Regulations [17 CFR 270], and all references 
to statutory sections are to the Investment Company Act.
    \2\ 15 U.S.C. 80b. Unless otherwise noted, all references to 
rules under the Investment Advisers Act will be to Title 17, Part 
275 of the Code of Federal Regulations [17 CFR 275], and all 
references to statutory sections are to the Investment Advisers Act.
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Table of Contents

I. Introduction
II. Background
III. Discussion
    A. Rule 2a-7
    1. Minimal Credit Risk Determination
    2. Portfolio Liquidity
    3. Monitoring Minimal Credit Risks
    4. Commission Notice of Rule 17a-9 Transactions
    B. Rule 3a-7
    C. Rule 5b-3
    D. Rule 10f-3
    E. Rule 206(3)-3T
IV. Request for Comment
V. Paperwork Reduction Act
VI. Cost-Benefit Analysis
VII. Consideration of Promotion of Efficiency, Competition and 
Capital Formation
VIII. Regulatory Flexibility Act Certification
IX. Initial Regulatory Flexibility Analysis
X. Statutory Authority
Text of Proposed Rule Amendments

I. Introduction

    On June 16, 2008, in furtherance of the Credit Rating Agency Reform 
Act of 2006,\3\ the Commission published for notice and comment two 
rulemaking initiatives.\4\ The first proposes additional requirements 
for NRSROs \5\ that were directed at reducing conflicts of interest in 
the credit rating process, fostering competition and comparability 
among credit rating agencies, and increasing transparency of the credit 
rating process.\6\ The second is designed to improve investor 
understanding of the risk characteristics of structured finance 
products. Those proposals address concerns about the integrity of the 
credit rating procedures and methodologies of NRSROs in light of the 
role they played in determining the credit ratings for securities that 
were the subject of the recent turmoil in the credit markets.
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    \3\ Public Law No. 109-291, 120 Stat. 1327 (2006).
    \4\ Proposed Rules for Nationally Recognized Statistical Rating 
Organizations, Securities Exchange Act Release No. 57967 (June 16, 
2008) [73 FR 36212 (June 25, 2008)] (``NRSRO June 16, 2008 Proposing 
Release'').
    \5\ As described in more detail below, an NRSRO is an 
organization that issues ratings that assess the creditworthiness of 
an obligor itself or with regard to specific securities or money 
market instruments, has been in existence as a credit rating agency 
for at least three years, and meets certain other criteria. The term 
is defined in section 3(a)(62) of the Securities Exchange Act of 
1934 (``Exchange Act''). A credit rating agency must apply with the 
Commission to register as an NRSRO, and currently there are ten 
registered NRSROs.
    \6\ See Press Release No. 2008-110 (June 11, 2008).
---------------------------------------------------------------------------

    Today's proposals comprise the third of these three rulemaking 
initiatives relating to credit ratings by an NRSRO that the Commission 
is proposing. This release, together with two companion releases, sets 
forth the results of the Commission's review of the requirements in its 
rules and forms that rely on credit ratings by an NRSRO. The proposals 
also address recent recommendations issued by the President's Working 
Group on Financial Markets (``PWG''), the Financial Stability Forum 
(``FSF'') and the Technical Committee of the International Organization 
of Securities Commissions (``IOSCO'').\7\ Consistent

[[Page 40125]]

with these recommendations, the Commission is considering whether the 
inclusion of requirements related to ratings in its rules and forms 
has, in effect, placed an ``official seal of approval'' on ratings that 
could adversely affect the quality of due diligence and investment 
analysis. The Commission believes that today's proposals could reduce 
undue reliance on credit ratings and result in improvements in the 
analysis that underlies investment decisions.
---------------------------------------------------------------------------

    \7\ See President's Working Group on Financial Markets, Policy 
Statement on Financial Market Developments (March 2008), available 
at www.ustreas.gov (``PWG Statement''); The Report of the Financial 
Stability Forum on Enhancing Market and Institutional Resilience 
(April 2008), available at www.fsforum.org (``FSF Report''); 
Technical Committee of the International Organization of Securities 
Commissions, Consultation Report: The Role of Credit Rating Agencies 
in Structured Finance Markets (March 2008), p. 9, available at 
www.iosco.org.
---------------------------------------------------------------------------

II. Background

    The Commission first used the term ``NRSRO'' in our rules in 1975 
in the net capital rule for broker-dealers, Rule 15c3-1 (``Net Capital 
Rule'') \8\ under the Securities Exchange Act of 1934 (the ``Exchange 
Act'') \9\ as an objective benchmark to prescribe capital charges for 
different types of debt securities. Since then, we have used the 
designation in a number of regulations under the federal securities 
laws. Although we originated the use of the term NRSRO for a narrow 
purpose in our own regulations, ratings by NRSROs today are used widely 
as benchmarks in federal and state legislation, rules issued by other 
financial regulators, in the United States and abroad, and private 
financial contracts.
---------------------------------------------------------------------------

    \8\ 17 CFR 240.15c3-1.
    \9\ 15 U.S.C. 78a.
---------------------------------------------------------------------------

    Referring to NRSRO ratings in regulations was intended to provide a 
clear reference point to both regulators and market participants. 
Increasingly, we have seen clear disadvantages of using the term in 
many of our regulations. Foremost, there is a risk that investors 
interpret the use of the term in laws and regulations as an endorsement 
of the quality of the credit ratings issued by NRSROs, which may have 
encouraged investors to place undue reliance on the credit ratings 
issued by these entities. In addition, as demonstrated by recent 
events,\10\ there has been increasing concern about ratings and the 
ratings process. Further, by referencing ratings in the Commission's 
rules, market participants operating pursuant to these rules may be 
vulnerable to failures in the ratings process. In light of this, the 
Commission proposes to amend regulations under the Investment Company 
Act and the Investment Advisers Act that use the term NRSRO or refer to 
NRSRO ratings.\11\
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    \10\ See NRSRO June 16, 2008 Proposing Release, supra note 4, at 
Section I.C.
    \11\ These regulations include rules 2a-7, 3a-7, 5b-3 and 10f-3 
under the Investment Company Act and rule 206(3)-3T under the 
Investment Advisers Act.
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III. Discussion

    The credit ratings issued by NRSROs are used in four of the 
Commission's rules under the Investment Company Act--rules 2a-7, 3a-7, 
5b-3, and 10f-3--and one rule under the Investment Advisers Act--rule 
206(3)-3T. These rules use the credit ratings issued by the NRSROs in 
different contexts, and for different purposes, to distinguish among 
various grades of debt and other rated securities. We propose to amend 
each rule to omit references to NRSRO ratings and, except with respect 
to one of the rules, substitute alternative provisions that are 
designed to appropriately achieve the same purpose as the ratings. 
Below we discuss these proposals in greater detail in the context of 
each rule we propose to amend.

A. Rule 2a-7

    Rule 2a-7 under the Investment Company Act governs the operation of 
money market funds. Unlike other investment companies (``funds''), 
money market funds seek to maintain a stable share price, typically at 
$1.00 per share. To do so, most money market funds use the amortized 
cost method of valuation (``amortized cost method'') or the penny-
rounding method of pricing (``penny-rounding method'') permitted by 
rule 2a-7.\12\ The Investment Company Act and applicable rules 
generally require funds to calculate current net asset value per share 
by valuing their portfolio instruments at market value or, if market 
quotations are not readily available, at fair value as determined in 
good faith by the board of directors.\13\ These valuation requirements 
are designed to prevent unfair share pricing from diluting or otherwise 
adversely affecting the interests of investors.\14\
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    \12\ Under the amortized cost method, portfolio instruments are 
valued by reference to their acquisition cost as adjusted for 
amortization of premium or accretion of discount. See rule 2a-
7(a)(2). Share price is determined under the penny-rounding method 
by valuing securities at market value, fair value or amortized cost 
and rounding the per share net asset value to the nearest cent on a 
share value of a dollar, as opposed to the nearest one tenth of one 
cent. See rule 2a-7 (a)(18).
    \13\ See section 2(a)(41) of the Investment Company Act 
(defining value) and rules 2a-4 (defining current net asset value) 
and 2a-7(c) thereunder (money market fund share price calculations).
    \14\ If shares are sold or redeemed based on a net asset value 
which turns out to have been either understated or overstated to the 
amount at which portfolio instruments could have been sold, then the 
interests of either existing shareholders or new investors will have 
been diluted. See Investment Trusts and Investment Companies: 
Hearings on S. 3580 Before a Subcomm. of the Sen. Comm. on Banking 
and Currency, 76th Cong., 3d Sess. 136-138, 288 (1940).
---------------------------------------------------------------------------

    Rule 2a-7 exempts money market funds from these provisions but 
contains maturity, quality, and diversification conditions designed to 
minimize the deviation between a money market fund's stabilized share 
price and the market value of its portfolio.\15\ Among these 
conditions, rule 2a-7 limits a money market fund's portfolio 
investments to securities that have received credit ratings from the 
``Requisite NRSROs'' in one of the two highest short-term rating 
categories or comparable unrated securities (i.e., ``Eligible 
Securities'').\16\ Rule 2a-7 further restricts money market funds to 
securities that the fund's board of directors (which typically rely on 
the fund's adviser \17\) determines present minimal credit risks, and 
specifically requires that determination ``be based on factors 
pertaining to credit quality in addition to any ratings assigned to 
such securities by an NRSRO.'' \18\
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    \15\ Rule 2a-7 contains conditions that apply to each investment 
a money market fund proposes to make, as well as conditions that 
apply to a money market fund's entire portfolio.
    \16\ The term ``Eligible Security'' is defined in rule 2a-
7(a)(10). ``Requisite NRSROs'' is defined in rule 2a-7(a)(21).
    \17\ See rule 2a-7(e).
    \18\ Rule 2a-7(c)(3)(i). Thus, under the current rule, where the 
security is rated, having the requisite NRSRO rating is a necessary 
but not sufficient condition for investing in the security and 
cannot be the sole factor considered in determining whether a 
security presents minimal credit risks. See Revisions to Rules 
Regulating Money Market Funds, Investment Company Act Release No. 
18005 (Feb. 20, 1991) [56 FR 8113 (Feb. 27, 1991)], at text 
preceding n.18.
---------------------------------------------------------------------------

    We propose to eliminate references to ratings by amending rule 2a-7 
in four principal ways.\19\ In combination, these proposed amendments 
are designed to offer similar protections to the current rule's 
reliance on NRSRO ratings.\20\
---------------------------------------------------------------------------

    \19\ The proposed amendments would also make conforming 
amendments to rule 2a-7's record keeping and reporting requirements. 
See proposed rule 2a-7(c)(11).
    \20\ In 2003, the Commission published a concept release in 
which we sought comment on the use of NRSRO ratings in our rules. 
See Rating Agencies and the Use of Credit Ratings Under the Federal 
Securities Laws, Investment Company Act Release No. 26066 (June 4, 
2003) [68 FR 35258 (June 12, 2003)]. Comments on the concept release 
are available at: http://www.sec.gov/rules/concept/s71203.shtml. As 
discussed above, recent events have highlighted the need to revisit 
our reliance on NRSRO ratings in the context of these developments. 
See also the extensive discussion of market developments in the 
NRSRO June 16, 2008 Proposing Release, supra note 4.
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1. Minimal Credit Risk Determination
    Under the proposed amendments, we would rely on money market fund 
boards of directors to determine that each portfolio instrument 
presents minimal credit risks,\21\ and whether the

[[Page 40126]]

security is a ``First Tier Security'' or a ``Second Tier Security'' for 
purposes of the rule.\22\ We believe that money market fund boards of 
directors would still be able to use quality determinations prepared by 
outside sources, including NRSRO ratings that they conclude are 
credible, in making credit risk determinations. We expect that the 
boards of directors (or their delegates) would understand the basis for 
the rating and make an independent judgment of credit risks.
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    \21\ See proposed rule 2a-7(a)(10).
    \22\ Rule 2a-7(c)(4) addresses portfolio diversification 
requirements for money market funds, including diversification 
requirements relating to First and Second Tier Securities.
---------------------------------------------------------------------------

    Under the proposed amendments, a security would be an Eligible 
Security if the board of directors determines that it presents minimal 
credit risks, which determination must be based on factors pertaining 
to credit quality and the issuer's ability to meet its short-term 
financial obligations.\23\ A security would be a First Tier Security if 
the fund's board had determined that the issuer has the ``highest 
capacity to meet its short-term financial obligations.'' \24\ A 
security would be a Second Tier Security if it is an Eligible Security 
but is not a First Tier Security.\25\ We have designed these proposed 
definitions to retain a degree of risk limitations similar to what is 
in the current rule.
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    \23\ Proposed rule 2a-7(a)(10).
    \24\ Proposed rule 2a-7(a)(12).
    \25\ See rule 2a-7(a)(22). The specific language of this 
provision would not change, but the definitions of ``Eligible 
Security'' and ``First Tier Security'' would change under the 
proposal. Consistent with the current rule, under proposed rule 2a-
7, a money market fund that is not a tax exempt fund generally must 
limit its investments in Second Tier Securities to no more than five 
percent of fund assets, with investment in the Second Tier 
Securities of any one issuer being limited to the greater of one 
percent of fund assets or one million dollars. Proposed rule 2a-
7(c)(3)(ii)(A) and (c)(4)(i)(C)(1). Tax exempt money market funds 
are subject to different limitations on investments in Second Tier 
Conduit Securities. Rule 2a-7(c)(3)(ii)(B) and (c)(4)(i)(C)(2).
---------------------------------------------------------------------------

    We request comment on the proposed amendments. What are the 
advantages and disadvantages of eliminating the requirement to use 
NRSRO ratings from rule 2a-7? Would eliminating the rating requirements 
from rule 2a-7 affect the amount or nature of risks money market funds 
would be willing or able to take? What are the advantages and 
disadvantages of relying on minimum credit risk determinations? What 
are the advantages and disadvantages of having fund directors and 
investment advisers exclusively make credit quality determinations? Are 
we correct that the current rule's reliance on credit ratings 
discourages fund directors and investment advisers from performing 
independent credit risk assessments? What other alternatives could we 
adopt to encourage more independent credit risk analysis and meet the 
regulatory objectives of rule 2a-7's requirement of NRSRO ratings? Are 
the distinctions our proposed amendments would draw between First Tier 
and Second Tier Securities workable? Is there a better way to describe 
the characteristics of a First Tier Security without reference to 
ratings? Are we correct in our expectation that the proposed standards 
would not impose additional burdens on boards or investment advisers, 
or require new recordkeeping requirements?
2. Portfolio Liquidity
    Under the proposed amendments, a money market fund must hold 
securities that are sufficiently liquid to meet reasonably foreseeable 
redemptions in light of the fund's obligations under section 22(e) of 
the Investment Company Act and any commitments the fund has made to its 
shareholders.\26\ In addition, the proposed amendments would expressly 
limit a money market fund's investment in illiquid securities to not 
more than 10 percent of its total assets.\27\ The proposed amendments 
would define a Liquid Security as a security that can be sold or 
disposed of in the ordinary course of business within seven days at 
approximately the value ascribed to it by the money market fund.\28\ 
These proposed provisions should be familiar to managers of money 
market funds. Past releases proposing, adopting and amending rule 2a-7 
repeatedly emphasized the special duty of the board of directors of a 
money market fund to monitor purchases of illiquid instruments.\29\ 
Money market funds often have a greater and perhaps less predictable 
volume of redemptions than other open-end investment companies. 
Further, the portfolio management of a money market fund may be 
impaired if a fund were forced to meet redemption requests by selling 
marketable securities that it would otherwise wish to retain in order 
to avoid attempting to dispose of illiquid portfolio instruments.\30\ 
In light of these potential problems, the proposal would prohibit money 
market funds from acquiring illiquid securities representing more than 
10 percent of their total assets.\31\ In the event that changes in the 
money market fund's portfolio or other external events cause the fund's 
investments in illiquid instruments to exceed 10 percent of the fund's 
assets, the money market fund would have to take steps to bring the 
aggregate amount of illiquid securities back within the proposed 
limitations as soon as reasonably practicable. However, consistent with 
the current rule, this requirement generally would not force the money 
market fund to liquidate any portfolio security where the fund would 
suffer a loss on the sale of that instrument.\32\
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    \26\ See proposed rule 2a-7(c)(5). Section 22(e) of the 
Investment Company Act prohibits registered investment companies 
from suspending the right of redemption or postponing the date of 
payment upon redemption of any redeemable security for more than 
seven days except for certain periods specified in the provision. 
While the Investment Company Act requires only that an investment 
company make payment of the proceeds of redemption within seven 
days, most money market funds promise investors that they will 
receive proceeds much sooner, often on the same day that the request 
for redemption is received by the fund.
    \27\ The proposed standard codifies the current standard 
regarding portfolio liquidity. See Revisions to Rules Regulating 
Money Market Funds, Investment Company Act Release No. 21837 (Mar. 
21, 1996) [61 FR 13956 (Mar. 28, 1996)] (``Rule 2a-7 1996 Amending 
Release''), at text accompanying n.108 (``The limit on money fund 
holdings of illiquid securities is ten percent of fund assets.''); 
Acquisition and Valuation of Certain Portfolio Instruments by 
Registered Investment Companies, Investment Company Act Release No. 
14983 (Mar. 12, 1986) [51 FR 9773 (Mar. 21, 1986)] (``1986 Valuation 
Release''). Although credit ratings do not directly incorporate 
liquidity risks, they have been used as a proxy for liquidity 
because a security may lose liquidity if its credit rating falls.
    \28\ See proposed rule 2a-7(a)(17). See also 1986 Valuation 
Release, supra note 27 at text following n.21.
    \29\ See, e.g., Valuation of Debt Instruments and Computation of 
Current Price per Share by Certain Open-End Investment Companies 
(Money Market Funds), Investment Company Act Release No. 12206 (Feb. 
1, 1982) [47 FR 5428 (Feb. 5, 1982)] (proposing rule 2a-7); 
Valuation of Debt Instruments and Computation of Current Price Per 
Share by Certain Open-End Investment Companies (Money Market Funds), 
Investment Company Act Release No. 13380 (July 11, 1983) [48 FR 
32555 (July 18, 1983)] (``Rule 2a-7 Adopting Release''); 1986 
Valuation Release, supra note 27.
    \30\ Rule 2a-7 Adopting Release, supra note 29, at text 
preceding, accompanying and following nn.37-39.
    \31\ Proposed rule 2a-7(c)(5). Money market funds must limit 
their investments in illiquid assets to not more than 10 percent of 
their net assets. See rule 2a-7 1996 Amending Release, supra note 
27, at n.108 and accompanying text. An investment company's 
portfolio security is illiquid if it cannot be disposed of in the 
ordinary course of business within seven days at approximately the 
value ascribed to it by the investment company. See id. at n.107 and 
accompanying text.
    \32\ See Rule 2a-7 Adopting Release, supra note 29, at n.38.
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    We request comment on the proposed amendments. Should we include in 
rule 2a-7 an express requirement that money market funds limit their 
exposure to illiquid securities? Do the proposed requirements provide 
money market funds sufficient flexibility to retain securities that may 
be illiquid if the disposal of those securities would not be in the 
best interests of the fund? Are there alternative or additional 
provisions that we should consider to address the way in which money 
market

[[Page 40127]]

funds should evaluate liquidity risk and determine whether to dispose 
of securities that present an increasing liquidity risk?
3. Monitoring Minimal Credit Risks
    The proposed amendments would also amend rule 2a-7's downgrade and 
default provisions. We propose that in the event the money market 
fund's investment adviser becomes aware of any information about a 
portfolio security or an issuer of a portfolio security that suggests 
that the security may not continue to present minimal credit risks, the 
money market fund's board of directors would have to reassess promptly 
whether the portfolio security continues to present minimal credit 
risks.\33\ This proposed requirement would replace the provisions in 
the current rule that generally require a money market fund board to 
promptly reassess whether a security that has been downgraded by an 
NRSRO continues to present minimal credit risks, and take such action 
as the board determines is in the best interests of the fund and its 
shareholders.\34\ We do not believe that the proposed amendments would 
require investment advisers to subscribe to every rating service 
publication in order to comply with this proposal. However, we would 
expect an investment adviser to exercise reasonable diligence in 
keeping abreast of new information about a portfolio security that is 
reported in the national financial press or in publications to which 
the investment adviser subscribes.
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    \33\ Proposed rule 2a-7(c)(7) (``In the event the money market 
fund's investment adviser (or any person to whom the fund's board of 
directors has delegated portfolio management responsibilities) 
becomes aware of any information about a portfolio security or an 
issuer of a portfolio security that may suggest that the security 
may not continue to present minimal credit risks, the board of 
directors shall reassess promptly whether such security continues to 
present minimal credit risks and shall cause the fund to take such 
action as the board of directors determines is in the best interests 
of the money market fund and its shareholders.'').
    \34\ Rule 2a-7(c)(6)(i)(A). This current assessment is not 
required, however, if the downgraded security is disposed of or 
matures within five business days of the specified event and in the 
case of events specified in rule 2a-7(c)(6)(i)(A)(2), the board is 
subsequently notified of the adviser's actions. Rule 2a-
7(c)(6)(i)(B).
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    We request comment on the proposed amendments. Would the 
requirement that the board of directors reassess the credit risk of a 
security when investment advisers become aware of information that may 
suggest the security no longer presents minimal credit risks provide 
adequate investor protections? Would investment advisers be able to 
stay abreast of new information about their portfolio securities?
4. Commission Notice of Rule 17a-9 Transactions
    Finally, the proposed amendments would require that money market 
funds provide the Commission with prompt notice when an affiliate of 
the money market fund (or its promoter or principal underwriter) 
purchases from the fund a security that is no longer an Eligible 
Security, pursuant to rule 17a-9 under the Investment Company Act.\35\ 
We believe that the current notice provisions, which are triggered when 
a security held by a fund defaults, provide us with incomplete 
information about money market funds holding distressed securities, 
particularly those that have engaged in an affiliated transaction with 
an affiliated person. The additional notice, which we believe would 
impose little burden on money market funds or their managers, would 
enhance our oversight of money market funds especially during times of 
economic stress.
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    \35\ Proposed rule 2a-7(c)(7)(iii)(B) (requiring notice to the 
Commission of any ``purchase of a security from the fund by an 
affiliated person or promoter of or principal underwriter for the 
fund or an affiliated person of such a person in reliance on rule 
17a-9''). See rule 17a-9 (exempting from section 17(a) of the Act 
the purchase of a security ``that is no longer an Eligible Security 
(as defined in [rule 2a-7(a)(10)]) under certain conditions).'' 
Notification under this proposed provision would also be amended to 
require electronic mail, instead of the other means currently listed 
in rule 2a-7(c)(6)(iii). We believe this change is appropriate in 
light of recent changes in telecommunications technology, and 
because most of the notices of default that we have received in the 
past year have been transmitted electronically.
---------------------------------------------------------------------------

    We request comment on the proposed amendments.

B. Rule 3a-7

    Rule 3a-7 under the Investment Company Act excludes structured 
finance vehicles from the Act's definition of ``investment company'' 
subject to certain conditions.\36\ In a typical financing, a sponsor 
transfers a pool of assets (such as residential mortgages) to a limited 
purpose entity, which in turn issues fixed income securities that are 
rated investment grade or higher by at least one NRSRO. Payment on the 
securities depends primarily on the cash flows generated by the pooled 
assets. As a result, these are often referred to as ``asset-backed'' 
securities.
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    \36\ Structured financings meet the definition of investment 
company under section 3(a) of the Act because they issue securities 
and invest in, own, hold, or trade securities. Almost none of the 
structured financings, however, are able to operate under the Act's 
requirements. See Exclusion from the Definition of Investment 
Company for Structured Financings, Investment Company Act Release 
No. 19105 (Nov. 19, 1992) [57 FR 56248 (Nov. 27, 1992)] (``Rule 3a-7 
Adopting Release'').
---------------------------------------------------------------------------

    Rule 3a-7 contains a number of conditions that differentiate 
investment companies from structured financings. The conditions include 
the requirement that structured financings offered to the general 
public are rated by at least one NRSRO in one of the four highest 
ratings categories.\37\ The rule contains an exception under which 
asset-backed securities sold to accredited investors \38\ and qualified 
institutional buyers \39\ may be unrated, or may be rated less than 
investment grade, if the issuer and its underwriters use reasonable 
care to ensure that all excepted sales are to such persons.\40\ We 
concluded that these persons are in a position to evaluate the 
structured financing vehicle and to take steps to protect themselves 
from the types of abusive practices against which the Investment 
Company Act was designed to protect.\41\
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    \37\ Rule 3a-7(a)(2).
    \38\ The exception permits the sale of asset backed fixed-income 
securities to ``accredited investors'' as defined in paragraphs (1), 
(2), (3) and (7) of rule 501(a) under the Securities Act [17 CFR 
230.501(a)], and includes any entity in which all of the equity 
owners come within such paragraphs. Rule 3a-7(a)(2)(i).
    \39\ The exception permits the sale of any asset backed 
securities to ``qualified institutional buyers'' as defined in rule 
144A under the Securities Act [17 CFR 230.144A] and certain other 
persons involved in the organization or operation of the issuer or 
an affiliate, as defined in rule 405 under the Securities Act [17 
CFR 230.405]. Rule 3a-7(a)(2)(ii).
    \40\ Rule 3a-7(a)(2).
    \41\ See Exclusion from the Definition of Investment Company for 
Certain Structured Financings, Investment Company Act Release No. 
18736 (May 29, 1992) [57 FR 23980 (June 5, 1992)] (proposing rule 
3a-7).
---------------------------------------------------------------------------

    We understand that today most asset-backed securities are issued by 
special purpose vehicles that do not rely on rule 3a-7 to exclude them 
from the application of the Investment Company Act. Instead, they rely 
on section 3(c)(7), which was added to the Act in 1996, after the 
Commission adopted rule 3a-7, and provides an exception from the Act 
for companies whose securities are limited to any issuer, the 
outstanding securities of which are owned exclusively by persons who 
are qualified purchasers, and that is not making and does not at that 
time propose to make a public offering of such securities. Moreover, 
asset-backed securities issued by financing vehicles that rely on rule 
3a-7, even when highly rated, generally are not marketed to retail 
investors.\42\ Accordingly, we propose to eliminate the rule's reliance 
on ratings by amending the rule to

[[Page 40128]]

eliminate the exclusion for structured financings offered to the 
general public.
---------------------------------------------------------------------------

    \42\ See Credit & Finance Risk Analysis Asset Backed Securities 
and Structural Finance, at http://www.credfinrisk.com/
assetsecure.html.
---------------------------------------------------------------------------

    In addition, we are proposing to amend the part of the rule that 
addresses substitution of eligible assets to remove the reference to 
ratings downgrades. The rule permits the issuer to acquire additional 
eligible assets or dispose of assets only if, among other conditions, 
the acquisition or disposition of the assets does not result in a 
downgrading in the rating of the issuer's outstanding fixed-income 
securities.\43\ We propose to require instead that the issuer have 
procedures to ensure that the acquisition or disposition does not 
adversely affect the full and timely payment of the outstanding fixed 
income securities.\44\
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    \43\ Rule 3a-7(a)(3)(ii).
    \44\ Proposed rule 3a-7(a)(3)(ii).
---------------------------------------------------------------------------

    Finally, we propose to amend the portion of the rule that deals 
with the safekeeping of assets.\45\ Among other requirements, the rule 
provides that cash flows from the asset pool periodically be deposited 
in a segregated account, consistent with the rating of the outstanding 
fixed income securities.\46\ This provision was intended to ensure that 
the segregated account in which the cash flows are deposited and the 
length of time that the servicer holds the cash flows before depositing 
them in the segregated account would pose a minimal risk of loss to the 
fixed income security holders. We propose to change this provision to 
require that the cash flows be deposited in a segregated account 
consistent with the full and timely payment of the outstanding fixed 
income securities.\47\ The proposed amendment is designed to minimize 
the risk of loss of cash flows pending payment to the fixed income 
securities holders.
---------------------------------------------------------------------------

    \45\ Rule 3a-7(a)(4).
    \46\ Rule 3a-7(a)(4)(iii).
    \47\ Proposed rule 3a-7(a)(4)(iii). The proposed amendment would 
require the issuer to take ``actions necessary for the cash flows 
derived from eligible assets for the benefit of the holders of 
fixed-income securities to be deposited periodically in a segregated 
account that is maintained or controlled by the trustee consistent 
with the full and timely payment of the outstanding fixed income 
securities.''
---------------------------------------------------------------------------

    We request comment on our proposed amendments to rule 3a-7. What 
are the advantages and disadvantages of eliminating the NRSRO rating 
requirement from the rule? Is our understanding that structured 
financings are generally not marketed to retail investors correct? If 
not, should we retain an exclusion for structured finance offerings to 
the general public? If so, what standards should we impose that could 
distinguish structured finance vehicles from investment companies for 
those investors? For example, should we permit offerings to the general 
public if a sponsor or trustee conducts an independent statistical 
analysis of the anticipated cash flows? Are we correct in our 
assumption that dropping the rating requirement from the rule will not 
blur the current distinction between structured finance vehicles and 
investment companies? If not, should the rule incorporate alternatives 
to the rule's rating requirement that would clarify the distinction? 
For example, should the rule contain specific requirements regarding 
abuses that the Act is designed to address, such as self-dealing and 
overreaching by the issuer? Does our proposal regarding the deposit of 
cash flows into a segregated account provide sufficient protection 
against the possibility of loss while the servicer is handling cash 
flows pending payment to the fixed income security holders? Would an 
alternative standard provide better protection?

C. Rule 5b-3

    Rule 5b-3 under the Investment Company Act permits a fund, subject 
to certain conditions, to treat a repurchase agreement as an 
acquisition of the securities collateralizing the repurchase agreement 
in determining whether the fund is in compliance with two provisions of 
the Act that may affect a fund's ability to invest in repurchase 
agreements.\48\ Section 12(d)(3) of the Investment Company Act 
generally prohibits a fund from acquiring an interest in a broker, 
dealer, or underwriter. Because a repurchase agreement may be 
considered to be the acquisition of an interest in the counterparty, 
section 12(d)(3) may limit a fund's ability to enter into repurchase 
agreements with many of the firms that act as repurchase agreement 
counterparties. Section 5(b)(1) of the Act limits the amount that a 
fund that holds itself out as being a diversified investment company 
may invest in the securities of any one issuer (other than the U.S. 
Government). This provision may limit the number and principal amounts 
of repurchase agreements a diversified fund may enter into with any one 
counterparty.
---------------------------------------------------------------------------

    \48\ In a typical investment company repurchase agreement, a 
fund enters into a contract with a broker, dealer, or bank (the 
``counterparty'' to the transaction) for the purchase of securities. 
The counterparty agrees to repurchase the securities at a specified 
future date, or on demand, for a price that is sufficient to return 
to the fund its original purchase price, plus an additional amount 
representing the return on the fund's investment. Repurchase 
agreements provide funds with a convenient means to invest excess 
cash on a secured basis, generally for short periods of time. 
Economically, a repurchase agreement functions as a loan from the 
fund to the counterparty, in which the securities purchased by the 
fund serve as collateral for the loan and are placed in the 
possession or under the control of the fund's custodian during the 
term of the agreement. See Treatment of Repurchase Agreements and 
Refunded Securities as an Acquisition of the Underlying Securities, 
Investment Company Act Release No. 25058 (July 5, 2001) [66 FR 36156 
(July 11, 2001)] (``Rule 5b-3 Adopting Release'').
---------------------------------------------------------------------------

    Rule 5b-3 allows funds to treat the acquisition of a repurchase 
agreement as an acquisition of securities collateralizing the 
repurchase agreement for purposes of sections 5(b)(1) and 12(d)(3) of 
the Act if the obligation of the seller to repurchase the securities 
from the fund is ``collateralized fully.'' \49\ A repurchase agreement 
is collateralized fully if, among other things, the collateral for the 
repurchase agreement consists entirely of (i) cash items, (ii) 
government securities, (iii) securities that at the time the repurchase 
agreement is entered into are rated in the highest rating category by 
the ``Requisite NRSROs'' or (iv) unrated securities that are of a 
comparable quality to securities that are rated in the highest rating 
category by the Requisite NRSROs, as determined by the fund's board of 
directors or its delegate.\50\
---------------------------------------------------------------------------

    \49\ Rule 5b-3(a). The term ``Collateralized Fully'' is defined 
in rule 5b-3(c)(1). An investment company investing in a repurchase 
agreement primarily looks to the value and liquidity of the 
securities collateralizing the repurchase agreement rather than the 
credit quality of the counterparty for satisfaction of the 
repurchase agreement.
    \50\ Rule 5b-3(c)(1)(iv). The term ``Requisite NRSROs'' means 
any two NRSROs that have issued a rating with respect to a security 
or class of debt obligations of an issuer or, if only one NRSRO has 
issued a rating with respect to such security or class of debt 
obligations of an issuer at the time the investment company acquires 
the security, that NRSRO. Rule 5b-3(c)(6). The term ``unrated 
securities'' means securities that have not received a rating from 
the Requisite NRSROs. Rule 5b-3(c)(8).
---------------------------------------------------------------------------

    In proposing rule 5b-3, the Commission explained that the highest 
rating category requirement in the definition of collateralized fully 
was designed to ensure that the market value of the collateral would 
remain fairly stable and that the fund could more readily liquidate the 
collateral quickly in the event of a default.\51\
---------------------------------------------------------------------------

    \51\ See Treatment of Repurchase Agreements and Refunded 
Securities as an Acquisition of the Underlying Securities, 
Investment Company Act Release No. 24050 (Sept. 23, 1999) [64 FR 
52476 (Sept. 29, 1999)] (``Rule 5b-3 Proposing Release''), at n.43 
and accompanying text.
---------------------------------------------------------------------------

    We propose to eliminate the requirement that collateral other than 
cash or government securities be rated by an NRSRO. As an alternative, 
we propose to require that if the collateral is not cash or government 
securities, the fund's board of directors (or its delegate)

[[Page 40129]]

determines that the collateral securities present minimum credit risks 
and are highly liquid. Specifically, the proposal would require 
collateral other than cash or government securities to consist of 
securities that the fund's board of directors (or its delegate) 
determines at the time the repurchase agreement is entered into (i) are 
sufficiently liquid that they can be sold at or near their carrying 
value within a reasonably short period of time, (ii) are subject to no 
greater than minimal credit risk, and (iii) are issued by a person that 
has the highest capacity to meet its financial obligations.\52\ 
Although the rule would no longer require the collateral to be rated by 
an NRSRO, we anticipate that evaluating credit risk and liquidity of 
the collateral could incorporate ratings, reports, analyses, and other 
assessments issued by NRSROs and other persons.\53\
---------------------------------------------------------------------------

    \52\ Proposed rule 5b-3(c)(1)(iv)(C). Under the proposal, the 
board would make credit quality determinations for all non-
government collateral securities, rather than just unrated 
securities. As in the current rule, the proposed rule would permit 
the board to delegate this credit quality and liquidity 
determination.
    \53\ A fund that acquires repurchase agreements would have to 
adopt and implement a written policy reasonably designed to comply 
with this requirement under rule 38a-1 under the Investment Company 
Act. See rule 38a-1(a) (requiring registered funds to adopt and 
implement written policies and procedures reasonably designed to 
prevent the fund's violation of federal securities laws).
---------------------------------------------------------------------------

    NRSRO ratings are also used in a provision of rule 5b-3 that 
permits a fund to deem the acquisition of a ``refunded security'' as 
the acquisition of the escrowed government securities for purposes of 
section 5(b)(1)'s diversification requirements.\54\ Under this 
provision, a debt security must satisfy certain conditions to be 
considered a refunded security under the rule. One of these conditions 
is that an independent certified public accountant must have certified 
to the escrow agent that the escrowed securities will satisfy all 
scheduled payments of principal, interest, and applicable premiums on 
the refunded securities.\55\ This condition is not required, however, 
if the refunded security has received a debt rating in the highest 
rating category from an NRSRO.\56\
---------------------------------------------------------------------------

    \54\ Rule 5b-3(b). Under the rule, a refunded security means a 
debt security the principal and interest payments of which are to be 
paid by U.S. government securities that have been irrevocably placed 
in an escrow account and are pledged only to the payment of the debt 
security. Rule 5b-3(c)(4).
    \55\ Rule 5b-3(c)(4)(iii).
    \56\ Id.
---------------------------------------------------------------------------

    We are proposing to eliminate the exception to the certification 
requirement for securities that have received the highest rating from 
an NRSRO. Rule 5b-3 requires the certification by an independent 
certified public accountant (together with the other conditions) to 
ensure that the bankruptcy of the issuer of the pre-refunded securities 
would not affect payments on the securities from the escrow 
account.\57\ The Commission included this exception because in rating 
refunded securities, NRSROs typically require that an independent third 
party make the same determination.\58\
---------------------------------------------------------------------------

    \57\ See Rule 5b-3 Adopting Release, supra note 48, at text 
accompanying n.25 (explaining that the conditions required in the 
definition of refunded security correspond to those in the 
definition of the term in rule 2a-7); Rule 2a-7 1986 Amending 
Release, supra note 31, at section II.D.2.
    \58\ See Technical Revisions to the Rules and Forms Regulating 
Money Market Funds, Investment Company Act Release No. 22921 (Dec. 
2, 1997) [62 FR 64968 (Dec. 9, 1997)], at section I.B.2.c.
---------------------------------------------------------------------------

    We request comment on the proposed amendments. How would the 
proposed elimination of the rating requirement from the definition of 
``collateralized fully'' affect funds? Would the proposed board 
determinations sufficiently address our concerns that collateral 
securities be of high quality in order to limit a fund's exposure to 
counterparties' credit risks? If not, are there additional or 
alternative standards that would better address our concerns? How would 
the proposal to eliminate the exception for rated securities from the 
condition that refunded securities obtain a certification from an 
independent auditor affect funds? We expect that with respect to rated 
refunded securities, funds may be able to satisfy the certification 
requirement by determining that an NRSRO required an independent 
certified public accountant to make the same determination.\59\ Would 
funds incur any costs in determining that a refunded security has 
received an accountant certification rather than relying on an NRSRO 
rating? Is there an alternative standard that would provide an 
equivalent evaluation? For example, should we permit the board to rely 
on another independent third party to provide the certification?
---------------------------------------------------------------------------

    \59\ See, e.g., Standard & Poor's, Public Finance Criteria: 
Defeasance: Legal Defeasance Criteria, Cash Flow Verification (Sept. 
8, 2006).
---------------------------------------------------------------------------

D. Rule 10f-3

    Section 10(f) of the Investment Company Act prohibits a registered 
investment company from purchasing any security for which an affiliated 
underwriter is acting as a principal underwriter \60\ during the 
existence of an underwriting or selling syndicate for that 
security.\61\ The prohibition was intended to address Congress's 
concern that underwriters were ``dumping'' otherwise unmarketable 
securities on affiliated funds, either by forcing the fund to purchase 
unmarketable securities from the underwriting affiliate itself, or by 
forcing or encouraging the fund to purchase the securities from another 
member of the syndicate.\62\ Congress also expressed concern regarding 
the amount of underwriting fees earned by the sponsors and affiliated 
persons who placed the securities with the fund.\63\
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    \60\ The term ``principal underwriter'' means (in relevant part) 
an underwriter who, in connection with a primary distribution for 
securities: (i) Is in privity of contract with the issuer or an 
affiliated person of the issuer; (ii) acting alone or in concert 
with one or more other persons, initiates or directs the formation 
of an underwriting syndicate; or (iii) is allowed a rate of gross 
commission, spread, or other profit greater than the rate allowed 
another underwriter participating in the distribution. 15 U.S.C. 
80a-2a(a)(29).
    \61\ Section 10(f) prohibits a fund from purchasing a security 
during the existence of an underwriting or selling syndicate if a 
principal underwriter of the security is an officer, director, 
member of an advisory board, investment adviser, or employee of the 
fund or is a person of which any such officer, director, member of 
an advisory board, investment adviser, or employee is an affiliated 
person. An affiliated person of a fund includes, among others: (i) 
Any person directly or indirectly owning, controlling, or holding 
with power to vote, five percent or more of the outstanding voting 
securities of the fund; (ii) any person five percent or more of 
whose outstanding voting securities are directly or indirectly 
owned, controlled, or held with power to vote by the fund; and (iii) 
any person directly or indirectly controlling, controlled by, or 
under common control with such other person. 15 U.S.C. 80a-
2(a)(3)(A), (B) and (C).
    \62\ See Report of the SEC, Investment Trusts and Investment 
Companies, H.R. Doc. No. 279, 76th Cong., 2d Sess., pt. 3, at 2581, 
2589 (1939). The sales were also used to alleviate certain of an 
affiliated underwriter's financial difficulties. For example, an 
underwriter could benefit by rapidly turning over its securities 
inventory to produce working capital and to reduce the related 
expenses of carrying the inventory.
    \63\ See Hearings on S.3580 Before a Subcommittee of the 
Commission on Banking and Currency, 76th Cong., 3d Sess. 209, 212-23 
(1940).
---------------------------------------------------------------------------

    The Commission adopted rule 10f-3 in 1958 to permit a fund that is 
affiliated with members of an underwriting syndicate to purchase 
securities from the syndicate if certain conditions are met.\64 \We 
amended rule 10f-3 in 1979 to add municipal securities to the class of 
securities that funds could purchase under the rule.\65\ The rule 
defines

[[Page 40130]]

municipal securities that may be purchased during an underwriting in 
reliance on the rule (``eligible municipal securities'') to include 
securities that have an investment grade rating from at least one NRSRO 
or, if the issuer or the entity supplying the revenues or other 
payments from which the issue is to be paid has been in continuous 
operation for less than three years (i.e., a less seasoned security), 
one of the three highest ratings from an NRSRO.\66\ The Commission 
explained that the rationale behind the rating requirement was to 
prevent the purchase of less seasoned securities and reduce the risk of 
unloading unmarketable securities on the fund.\67\
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    \64\ Adoption of Rule N-10-F-3 Permitting Acquisition of 
Securities of Underwriting Syndicate Pursuant to Section 10(f) of 
the Investment Company Act of 1940, Release No. 2797 (Dec. 2, 1958) 
[23 FR 9548 (Dec. 10, 1958)]. The rule codified the conditions of 
orders that the Commission had granted prior to 1958 exempting 
certain funds from section 10(f) to permit them to purchase specific 
securities.
    \65\ Exemption of Acquisition of Securities During the Existence 
of Underwriting Syndicate, Investment Company Act Release No. 10736 
(June 14, 1979) [44 FR 36152 (June 20, 1979)] (``Rule 10f-3 1979 
Adopting Release''). Rule 10f-3(c)(1)(iii).
    \66\ Rule 10f-3(a)(3).
    \67\ Exemption of Acquisition of Securities During the Existence 
of Underwriting Syndicate, Investment Company Act Release No. 10592 
(Feb. 13, 1979) [44 FR 10580 (Feb. 21, 1979)] (``1979 10f-3 
Amendments Proposing Release'').
---------------------------------------------------------------------------

    We propose to eliminate the references to ratings in rule 10f-3, 
and amend the rule's definition of ``eligible municipal security'' to 
mean securities that are sufficiently liquid that they can be sold at 
or near their carrying value within a reasonably short period of time. 
In addition, the securities would have to be either: (i) Subject to no 
greater than moderate credit risk; or (ii) if they are less seasoned 
securities, subject to a minimal or low amount of credit risk.\68\
---------------------------------------------------------------------------

    \68\ Proposed rule 10f-3(a)(3). The proposed rule would define 
``eligible municipal securities'' to mean ``'municipal securities'' 
as defined in section 3(a)(29) of the Securities Exchange Act of 
1934, that have sufficient liquidity such that they can be sold at 
or near their carrying value within a reasonably short period of 
time and either (i) are subject to no greater than moderate credit 
risk or (ii) if the issuer of the municipal securities, or the 
entity supplying the revenues or other payments from which the issue 
is to be paid, has been in continuous operation for less than three 
years, including the operation of any predecessors, the securities 
are subject to a minimal or low amount of credit risk.''
---------------------------------------------------------------------------

    Unlike our proposals to amend other rules, we are not proposing to 
add a requirement that the board of directors make the determination 
regarding credit risk and liquidity. Rule 10f-3 already requires a 
fund's directors, including a majority of disinterested directors, to 
approve procedures regarding purchases made in reliance on the rule and 
to determine each quarter that all purchases were made in compliance 
with the procedures.\69\ Accordingly, the board, including a majority 
of disinterested directors, already is required to review purchases of 
municipal securities made in reliance on the rule, and would continue 
to do so under our proposal. In addition, pursuant to its oversight 
role, the board would be required to approve procedures for ensuring 
that municipal securities meet the proposed conditions for credit 
quality and liquidity. Although the rule would no longer require 
municipal securities to be rated by an NRSRO, fund boards of directors 
would still be able to incorporate quality determinations prepared by 
outside sources, including ratings, reports, analyses, and other 
assessments issued by NRSROs and other persons, in their approval of 
procedures and in their review of transactions under the rule.
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    \69\ Rule 10f-3(c)(10). The Commission added the requirement 
that disinterested directors adopt procedures made in reliance on 
the rule and periodically review the fund's compliance with these 
procedures in 1979. See Rule 10f-3 1979 Adopting Release, supra note 
65. At the time, we stressed that in determining specific procedures 
to be included in the guidelines for transactions in reliance on the 
rule, the board should be aware generally of the nature of any 
affiliation that the investment company (or any of its officers, 
directors, employees or adviser) may have with underwriters and any 
role the affiliate person would play in mounting the underwriting of 
a particular issue. See 1979 10f-3 Amendments Proposing Release, 
supra note 67, at text preceding n.23. Our proposal would not affect 
this existing requirement with respect to the purchase of municipal 
securities.
---------------------------------------------------------------------------

    We request comment on the proposed amendment to rule 10f-3. What 
would be the effect of eliminating the rating requirement in the 
definition of ``eligible municipal securities''? Is the proposed 
standard that municipal securities purchased in reliance on rule 10f-3 
present no more than moderate credit risks and are highly liquid 
sufficient to limit the possibility underwriters may sell unmarketable 
securities to the fund? Is there an alternative that would better 
address our regulatory concerns?

E. Rule 206(3)-3T

    Rule 206(3)-3T under the Investment Advisers Act of 1940 
establishes a temporary alternative means for investment advisers who 
are registered with the Commission as broker-dealers to meet the 
requirements of section 206(3) of the Advisers Act when they act in a 
principal capacity in transactions with certain of their advisory 
clients.\70\ That section makes it unlawful for any investment adviser, 
directly or indirectly ``acting as principal for his own account, 
knowingly to sell any security to or purchase any security from a 
client * * *, without disclosing to such client in writing before the 
completion of such transaction the capacity in which he is acting and 
obtaining the consent of the client to such transaction.'' \71\ Rule 
206(3)-3T contains several conditions that are designed to prevent 
overreaching by advisers by requiring an adviser to disclose to its 
client the conflicts of interest involved in principal transactions, 
inform the client of the circumstances in which the adviser may effect 
a trade on a principal basis, and provide the client with meaningful 
opportunities to refuse to consent to a particular transaction or 
revoke the prospective general consent to these transactions.\72\
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    \70\ Rule 206(3)-3T [17 CFR 275.206(3)-3T]. See also Temporary 
Rule Regarding Principal Trades with Certain Advisory Clients, 
Investment Advisers Act Release No. 2653 (Sept. 24, 2007) [72 FR 
55022 (Sept. 28, 2007)] (``Principal Trade Rule Release'').
    \71\ 15 U.S.C. 80b-6(3).
    \72\ See Principal Trade Rule Release, supra note 70, at text 
accompanying n.28.
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    An adviser generally may not rely on the rule for principal trades 
of securities if the investment adviser or a person who controls, is 
controlled by, or is under common control with the adviser (``control 
person'') is the issuer or is an underwriter of the security.\73\ As we 
stated when we adopted the rule, the incentives associated with 
underwriting securities may bias the advice being provided or lead the 
adviser to exert undue influence on its client's decision to invest in 
the offering or the terms of that investment.\74\ The rule contains an 
exception to this ``underwritten securities'' exclusion for trades in 
which the adviser or a control person is an underwriter of non-
convertible investment-grade debt securities.\75\ We provided this 
exception because non-convertible investment grade debt securities may 
be less risky and therefore less likely to be ``dumped'' on 
clients.\76\ The rule defines an ``investment grade debt security'' as 
a non-convertible debt security that, at the time of sale, is rated in 
one of the four highest rating categories of at least two NRSROs.\77\
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    \73\ Rule 206(3)-3T(a)(2).
    \74\ Principal Trade Rule Release, supra note 70, at n.35 and 
accompanying and following text.
    \75\ Id. at text accompanying n.36. There is no exception if the 
adviser or a control person is the issuer of the securities.
    \76\ Id. at text following n.36. We also noted in the Principal 
Trade Rule Release that it may be easier for clients to identify 
whether the price they are being quoted for a non-convertible 
investment grade debt security is fair given the relative 
comparability, and the significant size, of the non-convertible 
investment grade debt markets. Id.
    \77\ Rule 206(3)-3T(c).
---------------------------------------------------------------------------

    We propose to amend rule 206(3)-3(T), to eliminate an adviser's 
ability to rely exclusively on NRSRO ratings to determine whether a 
security is investment grade for purposes of the rule. Instead, the 
adviser would have to make its own assessment taking into account 
specified criteria, including that the security: (i) Has no greater 
than

[[Page 40131]]

moderate credit risk; and (ii) is sufficiently liquid that it can be 
sold at or near its carrying value within a reasonably short period of 
time.\78\
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    \78\ Proposed rule 206(3)-3T(c). Although the proposed amendment 
would no longer require a security underwritten by an adviser or its 
control person to be rated by NRSROs to be eligible under the rule, 
investment advisers could refer to ratings, reports, analyses, and 
other assessments issued by NRSROs and other persons, for the 
purpose of evaluating credit risk and liquidity.
---------------------------------------------------------------------------

    Finally, as we stated when we adopted rule 206(3)-3T, an adviser 
subject to rule 206(4)-7 of the Advisers Act must adopt and implement 
written policies and procedures reasonably designed to prevent 
violations of the Advisers Act (and the rules thereunder) by the 
adviser or any of its supervised persons.\79\ An adviser seeking to 
rely on rule 206(3)-3T, therefore, would have to adopt and implement 
policies and procedures that address the adviser's methodology for 
determining whether a security is investment grade quality.
---------------------------------------------------------------------------

    \79\ Principal Trade Rule Release, supra note 70, at nn.56-58 
and accompanying text. In that connection, an adviser seeking to 
rely on rule 206(3)-3T, as proposed to be amended, would need to 
adopt and implement policies and procedures reasonably designed to 
ensure that the adviser's methodology for determining investment 
grade quality is consistent with the adviser's legal obligations.
---------------------------------------------------------------------------

    We request comment on our proposed revised definition of 
``investment grade debt security.'' Is it appropriate for us to allow 
advisers seeking to rely upon the rule to determine whether a security 
is investment grade based on the criteria in the rule? Is there another 
definition of ``investment grade'' elsewhere in the federal securities 
laws that we should incorporate by reference into the rule? Are there 
alternative methods to ensure that advisers seeking to rely on the 
exception to the underwriting exclusion do so only with respect to 
investment grade debt? Are there alternative or additional factors we 
should require an adviser to consider in making its determination? In 
addition, we expect that advisers, in order to establish their 
eligibility to rely on the rule, would document their determination 
that a security is investment grade quality, as well as the process for 
making such a determination. Are we correct? Should we make such 
documentation an explicit requirement of the rule, or amend rule 204-2 
under the Advisers Act \80\ (the books and records rule) to require 
such documentation?
---------------------------------------------------------------------------

    \80\ 17 CFR 275.204-2.
---------------------------------------------------------------------------

IV. Request for Comment

    We request comment on the rule amendments proposed in this release. 
We also request suggestions for additional changes to existing rules, 
and comments on other matters that might have an effect on the 
proposals contained in this release. Commenters are requested to 
provide empirical data to support their views.

V. Paperwork Reduction Act

    Certain provisions of the proposed amendments to rules 2a-7, 3a-7, 
5b-3, and 10f-3 under the Investment Company Act, and rule 206(3)-(3)T 
under the Investment Advisers Act, contain ``collection of 
information'' requirements within the meaning of the Paperwork 
Reduction Act of 1995 (``PRA'').\81\ The Commission is submitting this 
proposal to the Office of Management and Budget (``OMB'') for review in 
accordance with 44 U.S.C. 3507(d) and 5 CFR 1320.11. The titles for the 
collections of information are: ``Rule 2a-7 under the Investment 
Company Act of 1940, Money market funds'' (OMB Control No. 3235-0268); 
``Rule 10f-3 under the Investment Company Act of 1940, Exemption for 
the Acquisition of Securities During the Existence of an Underwriting 
and Selling Syndicate'' (OMB Control No. 3235-0226); and ``Temporary 
rule for principal trades with certain advisory clients, rule 206(3)-
3T'' (OMB Control No. 3235-0630). There are currently no approved 
collections for rules 3a-7 and 5b-3, and the proposed amendments would 
not create any new collections. We adopted the rules pursuant to the 
Investment Company Act and the Investment Advisers Act.
---------------------------------------------------------------------------

    \81\ 44 U.S.C. 3501-3520.
---------------------------------------------------------------------------

    Our proposed amendments are designed to address the risk that the 
reference to and required use of NRSRO ratings in our rules:
     Is interpreted by investors as an endorsement of the 
quality of the credit ratings issued by NRSROs; and
     Encourages investors to place undue reliance on NRSRO 
ratings.
    An agency may not conduct or sponsor, and a person is not required 
to respond to, a collection of information unless it displays a 
currently valid control number.

A. Rule 2a-7

    Rule 2a-7 under the Investment Company Act exempts money market 
funds from the Act's valuation requirements, permitting money market 
funds to maintain stable share pricing, subject to certain risk-
limiting conditions. We propose to amend rule 2a-7 in four principal 
ways to: (i) Rely on money market fund boards of directors (who usually 
rely on the funds' advisers) to determine that each portfolio 
instrument presents minimal credit risks, and whether the security is a 
``First Tier Security'' or a ``Second Tier Security;'' (ii) add a 
portfolio liquidity requirement to the rule that would require that 
money market funds hold securities that are sufficiently liquid to meet 
reasonably foreseeable shareholder redemptions, and expressly limit 
their investment in illiquid securities to not more than 10% of their 
total assets; (iii) in the event the money market fund's investment 
adviser becomes aware of any new information about a portfolio security 
(or an issuer of a portfolio security) that may suggest that the 
security may not continue to present minimal credit risks, the proposal 
would amend rule 2a-7's downgrade and default provisions to require a 
money market fund's board of directors to reassess promptly whether the 
portfolio security continues to present minimal credit risks; and (iv) 
require a money market fund to notify the Commission of the purchase of 
a money market fund's portfolio security by an affiliated person in 
reliance on rule 17a-9 under the Investment Company Act.\82\ The 
proposed amendments also would make conforming amendments to rule 2a-
7's record keeping and reporting requirements.\83\
---------------------------------------------------------------------------

    \82\ See rule 17a-9.
    \83\ See proposed rule 2a-7(c)(11).
---------------------------------------------------------------------------

    The proposed amendments to rule 2a-7 would impose a new reporting 
obligation on money market funds. The proposed reporting requirement to 
notify the Commission of the purchase of a money market fund's 
portfolio securities by an affiliated person in reliance on rule 17a-9 
under the Investment Company Act is designed to assist Commission staff 
in overseeing money market funds' affiliated transactions that are 
otherwise prohibited. If adopted, the new collection of information 
would be mandatory for money market funds. Information submitted to the 
Commission related to a rule 17a-9 transaction would be accorded 
confidential treatment to the extent permitted by law.\84\
---------------------------------------------------------------------------

    \84\ See, e.g., 17 CFR 200.83.
---------------------------------------------------------------------------

    Commission staff estimates that there are 808 money market funds, 
all of whom are subject to rule 2a-7.\85\ Of these money market funds, 
Commission staff estimates that an average of 10 funds per year would 
be required to provide notice to the Commission of a rule 17a-9 
transaction, with the total

[[Page 40132]]

annual responses per fund, on average, requiring .5 hours of an 
attorney's time at a cost of $147.50.\86\ Given these estimates, we 
estimate that the total annual burden of the proposed amendments to 
rule 2a-7 for all money market funds would be approximately 5 hours and 
$1,475.\87\
---------------------------------------------------------------------------

    \85\ These include registered money market funds and series of 
registered money market funds. See Investment Company Institute, 
Trends in Mutual Fund Investing April 2008, May 29, 2008. Available 
at http://www.ici.org/stats/latest/trends_04_08.html.
    \86\ Based on information provided by money market fund 
representatives, Commission staff estimates the cost would equal 0.5 
hours of an attorney's time at $295 per hour (0.5 hours x $295 per 
hour = $147.50). The estimated hourly wages used in this PRA 
analysis were derived from reports prepared by the Securities 
Industry and Financial Markets Association. See Securities Industry 
and Financial Markets Association, Report on Management and 
Professional Earnings in the Securities Industry--2007 (2007), 
modified to account for an 1800-hour work year and multiplied by 
5.35 to account for bonuses, firm size, employee benefits and 
overhead; and Securities Industry and Financial Markets Association, 
Office Salaries in the Securities Industry--2007 (2007), modified to 
account for an 1800-hour work year and multiplied by 2.93 to account 
for bonuses, firm size, employee benefits and overhead.
    \87\ These estimates are based on the following calculations: 
(10 money market funds x .5 hours) = 5 hours; (10 money market funds 
x 147.50) = $1,475.
---------------------------------------------------------------------------

    We seek comment on these estimates. If commenters believe these 
estimates are not reasonable, we request they provide data that would 
allow us to make more accurate estimates.

B. Rule 3a-7

    Rule 3a-7 under the Investment Company Act excludes structured 
finance vehicles from the Act's definition of ``investment company'' 
subject to certain conditions. The conditions include the requirement 
that structured financings offered to the general public are rated by 
at least one NRSRO in one of the four highest rating categories. The 
proposed amendments would: (i) Eliminate rule 3a-7's reliance on 
ratings by eliminating the exclusion for structured financings offered 
to the general public; (ii) remove the reference to ratings downgrades 
in the section of the rule that addresses substitution of eligible 
assets; and (iii) amend the portion of the rule that deals with 
safekeeping of assets. Commission staff estimates that the proposal may 
result in a new collection of information but any collection of 
information would not have an associated burden. Although in the 
condition in rule 3a-7 dealing with the substitution of assets, the 
proposed amendments would require the issuer to have procedures to 
ensure that the acquisition or disposition of assets does not adversely 
affect the full and timely payment of the outstanding fixed income 
securities, Commission staff believes that almost all issuers currently 
have these procedures in place.
    We request comment on whether issuers currently have these 
procedures in place.

C. Rule 5b-3

    Rule 5b-3 under the Investment Company Act allows funds to treat 
the acquisition of a repurchase agreement as an acquisition of 
securities collateralizing the repurchase agreement for purposes of 
sections 5(b)(1) and 12(d)(3) of the Investment Company Act under 
certain conditions. We propose to amend rule 5b-3 by requiring a fund's 
board of directors, or its delegate, to determine that the securities 
collateralizing a repurchase agreement present minimum credit risks and 
are highly liquid.\88\ To that end, the fund's board of directors, 
pursuant to rule 38a-1 under the Investment Company Act, would have to 
develop procedures to ensure that at the time the repurchase agreement 
is entered into the securities meet the requirements for collateral 
outlined in the amendments to the proposed rule. These procedures are 
necessary to make sure that the market value of the collateral remains 
fairly stable and that the fund would be able to liquidate the 
collateral quickly in the event of a default.\89\ This collection of 
information would be mandatory for funds that rely on rule 5b-3. 
Records of information made in connection with this requirement would 
be required to be maintained for inspection by Commission staff, but 
the collection would not otherwise be submitted to the Commission.
---------------------------------------------------------------------------

    \88\ Proposed rule 5b-3(c)(1)(iv)(C).
    \89\ See Rule 5b-3 Proposing Release, supra note 51, at text 
accompanying n.43.
---------------------------------------------------------------------------

    The existing rule provides that unrated securities are collateral 
if the fund's board, or its delegate, makes the determination that the 
unrated securities are comparable to securities that are rated in the 
highest rating category by the Requisite NRSROs.\90\ Thus, fund boards 
may have existing procedures regarding credit quality determinations 
for unrated securities. In addition, as a matter of good business 
practice, we believe that some funds currently evaluate the credit risk 
and liquidity of rated securities. Thus, we believe that most funds 
already have procedures to evaluate collateral securities. As of March 
31, 2008, 4,714 investment companies were registered with the 
Commission. Commission staff estimates that 90% of all registered 
investment companies, or 4,243 funds, currently have procedures for 
evaluating collateral securities. Commission staff therefore estimates 
that 471 funds would need to develop procedures and evaluate collateral 
securities, and the staff estimates this would involve a one-time 
burden of 942 hours and an ongoing burden of 5,652 hours, at a cost of 
approximately $1,294,308.\91\
---------------------------------------------------------------------------

    \90\ Rule 5b-3(c)(1)(iv)(D).
    \91\ Commission staff estimates that each fund board would incur 
a one-time burden of 2 hours to develop procedures for evaluating 
credit and liquidity risks (471 boards x 2 hours = 942 hours). 
Commission staff believes that any incidental costs incurred by 
boards of directors would be incorporated into funds' overall board 
costs and would not add any particular costs. In addition, staff 
estimates that a board delegate would spend an average of 1 hour to 
evaluate the credit risks for the collateral for each of an average 
of 12 repurchase agreements each year (471 funds x 12 hours = 5,652 
hours). Assuming the evaluation would be performed by a senior 
business analyst (at $229 per hour), the total cost estimate would 
be $1,294,308.
---------------------------------------------------------------------------

    We seek comment on these estimates. If commenters believe these 
estimates are not reasonable, we request they provide data that would 
allow us to make more accurate estimates.

D. Rule 10f-3

    Rule 10f-3, permits funds that are affiliated with members of an 
underwriting syndicate to purchase securities from the syndicate if 
certain conditions are met. We are proposing to amend the rule's 
definition of ``eligible municipal securities'' to include credit 
quality and liquidity requirements.
    Under the current rule, fund boards are required to approve 
procedures regarding purchases made in reliance on the rule and to 
determine each quarter that all purchases were made in compliance with 
the procedures.\92\ Accordingly, the board currently reviews purchases 
of municipal securities made in reliance on the rule, and would 
continue to do so under our proposal. Pursuant to the amendments to the 
proposed rule, fund boards would need to approve additional procedures 
for ensuring that municipal securities meet the standards for credit 
quality and liquidity. These procedures are necessary to eliminate any 
possibility that an affiliated underwriter may ``unload'' otherwise 
unmarketable securities on a fund. This collection of information would 
be mandatory for funds that rely on rule 10f-3. Records of information 
made in connection with this requirement would be required to be 
maintained for inspection by Commission staff, but the collection would 
not otherwise be submitted to the Commission.
---------------------------------------------------------------------------

    \92\ Rule 10f-3(c)(10).
---------------------------------------------------------------------------

    In our most recent PRA submission, we estimated that approximately 
350 funds engage in rule 10f-3 transactions each year. We further 
estimated that each fund would, on average, take two

[[Page 40133]]

hours to review and revise, as needed, written procedures for rule 10f-
3 transactions. We believe that any revisions funds would have to make 
to comply with the proposed amendments would be incorporated in the two 
hours of review. Accordingly, we do not believe that the proposed 
amendments to rule 10f-3 would change the burdens currently approved 
for rule 10f-3.
    We seek comment on these estimates. If commenters believe these 
estimates are not reasonable, we request they provide data that would 
allow us to make more accurate estimates.

E. Rule 206(3)-3T

    Rule 206(3)-3T under the Advisers Act establishes a temporary 
alternative means for investment advisers who are registered with the 
Commission as broker-dealers to meet the requirements of section 206(3) 
of the Advisers Act when they act in a principal capacity in 
transactions with certain of their advisory clients. So long as each 
condition of the rule is met, an eligible adviser may provide the 
transaction-by-transaction disclosure required under section 206(3) of 
the Advisers Act either orally or in writing. One condition of the rule 
is that an adviser generally may not rely on rule 206(3)-3T for 
principal trades of securities if the investment adviser or a person 
who controls, is controlled by, or is under common control with the 
adviser (``control person'') is the issuer or is an underwriter of the 
security. The rule contains an exception to this ``underwritten 
securities'' exclusion for trades in which the adviser or a control 
person is an underwriter of non-convertible investment-grade debt 
securities. The proposed amendment to rule 206(3)-3T would modify the 
definition of ``investment grade debt security'' to mean a non-
convertible debt security that, at the time of sale, the investment 
adviser has determined to be subject to no greater than moderate credit 
risk and sufficiently liquid that it can be sold at or near its 
carrying value within a reasonably short period of time.
    Under the proposed amendment to rule 206(3)-3T, there is a single 
new collection burden. Pursuant to its obligations under rule 206(4)-7 
under the Advisers Act, an adviser seeking to rely on rule 206(3)-3T 
must adopt and implement written policies and procedures reasonably 
designed to prevent violations of the Advisers Act that address the 
adviser's methodology for determining whether a security is investment 
grade quality pursuant to the definition. This collection of 
information is designed to minimize the incentives associated with 
underwriting securities that may bias the advice being provided or may 
lead the adviser to exert undue influence on its client's decision to 
invest in the offering or the terms of that investment. Although the 
rule does not call for any of the information collected to be provided 
to us, to the extent advisers include any of the information in a 
filing, such as Form ADV, the information would not be kept 
confidential.
    We anticipate that the burden associated with this collection would 
mostly be borne upfront as advisers develop their policies and 
procedures for how to identify non-convertible investment grade debt 
securities in connection with the credit risk and liquidity elements 
specified under the rule. This would require drafting the policies and 
procedures, potentially subjecting them to review of outside counsel, 
implementing them, and explaining their contours in the adviser's Form 
ADV.
    We estimate that the average burden for drafting the required 
policies and procedures for each eligible adviser that chooses to rely 
on the rule in connection with underwritten securities in particular, 
would be approximately 10 hours on average. Further, we expect the 
drafting burden would be uniform with respect to each eligible adviser 
regardless of how many individual non-discretionary advisory accounts 
that adviser administers or seeks to engage with in principal trading. 
As of June 1, 2008, there were 639 advisers that were eligible to rely 
on the temporary rule (i.e., also registered as broker-dealers), 409 of 
which indicate that they have non-discretionary advisory accounts.\93\ 
We estimate that 90% of those 409 advisers, or a total of 368 of those 
advisers, rely on the rule.\94\ Of those, we estimate that only 50% 
would seek to engage in principal trades with clients of securities 
they or a control person underwrote. Thus, we estimate that the total 
number of advisers who would rely on the non-convertible investment 
grade debt exception to the ``underwritten securities'' exclusion under 
the rule would be approximately 185.
---------------------------------------------------------------------------

    \93\ IARD data as of June 1, 2008, for Items 6.A(1) and 
5.F(2)(e) of Part 1A of Form ADV.
    \94\ We anticipate that most investment advisers that are dually 
registered as broker-dealers will make use of the rule to engage in, 
at a minimum, riskless principal transactions to limit the need for 
these advisers to process trades for their advisory clients with 
other broker-dealers. We estimate that 10% of these advisers will 
determine that the costs involved to comply with the rule are too 
significant in relation to the benefits that the adviser, and their 
clients, will enjoy.
---------------------------------------------------------------------------

    Accordingly, we estimate that the total burden for creating initial 
policies and procedures under the proposal for the estimated 185 
advisers that would rely on the rule would be 1,850 hours.\95\ We also 
estimate an average one-time cost for the preparation of the policies 
and procedures for approximately three hours of outside legal counsel 
time of $1,200 per eligible adviser on average,\96\ for a total of 
$222,000.\97\
---------------------------------------------------------------------------

    \95\ This estimate is based on the following calculation: 10 
hours per adviser x 185 eligible advisers that will rely on the rule 
= 1,850 total hours.
    \96\ Outside legal fees are in addition to the projected 10 
hours per adviser burden discussed in note 95 and accompanying text.
    \97\ This estimate is based on the following calculation: ($400 
per hour x 3 hours x 185 advisers = $222,000).
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F. Request for Comments

    We request comment on whether these estimates are reasonable. 
Pursuant to 44 U.S.C. 3506(c)(2)(B), the Commission solicits comments 
in order to: (i) 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; (ii) evaluate the accuracy of the Commission's 
estimate of the burden of the proposed collections of information; 
(iii) determine whether there are ways to enhance the quality, utility, 
and clarity of the information to be collected; and (iv) 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.
    Persons wishing to submit comments on the collection of information 
requirements of the proposed amendments should direct them to the 
Office of Management and Budget, Attention Desk Officer for the 
Securities and Exchange Commission, Office of Information and 
Regulatory Affairs, Room 10102, New Executive Office Building, 
Washington, DC 20503, and should send a copy to Florence E. Harmon, 
Acting Secretary, Securities and Exchange Commission, 100 F Street, 
NE., Washington, DC 20549-1090, with reference to File No. S7-19-08. 
OMB is required to make a decision concerning the collections of 
information between 30 and 60 days after publication of this Release; 
therefore a comment to OMB is best assured of having its full effect if 
OMB receives it within 30 days after publication of this Release. 
Requests for materials submitted to OMB by the Commission with regard 
to these collections of information should be in

[[Page 40134]]

writing, refer to File No. S7-19-08, and be submitted to the Securities 
and Exchange Commission, Public Records Management Office Room, 100 F 
Street, NE., Washington, DC 20549-1110.

VI. Cost-Benefit Analysis

    The Commission is sensitive to the costs and benefits imposed by 
its rules. We have identified certain costs and benefits of the 
proposed amendments and request comment on all aspects of this cost-
benefit analysis, including identification and assessment of any costs 
and benefits not discussed in this analysis. We seek comment and data 
on the value of the benefits identified. We also welcome comments on 
the accuracy of the cost estimates in each section of this analysis, 
and request that commenters provide data that may be relevant to these 
cost estimates. In addition, we seek estimates and views regarding 
these costs and benefits for particular covered institutions, including 
small institutions, as well as any other costs or benefits that may 
result from the adoption of these proposed amendments.
    As discussed above, the proposed rule amendments are designed to 
address the risk that the reference to and use of NRSRO ratings in our 
rules is interpreted by investors as an endorsement of the quality of 
the credit ratings issued by NRSROs, and may encourage investors to 
place undue reliance on the NRSRO ratings. The proposed amendments to 
rules 2a-7, 3a-7, 5b-3, and 10f-3 under the Investment Company Act and 
rule 206(3)-(3)T under the Investment Advisers Act would eliminate the 
reference to and requirement for the use of NRSRO ratings in these 
rules.

A. Benefits

    The Commission anticipates that one of the primary benefits of the 
proposed amendments, if adopted, would be the benefit to investors of 
reducing their possible undue reliance on NRSRO ratings that could be 
caused by references to NRSROs in our rules. An over-reliance on 
ratings can inhibit independent analysis and could possibly lead to 
investment decisions that are based on incomplete information. The 
purpose of the proposed rule amendments is to encourage investors to 
examine more than a single source of information in making an 
investment decision. Eliminating reliance on ratings in the 
Commission's rules could also result in greater investor due diligence 
and investment analysis. In addition, the Commission believes that 
eliminating the reliance on ratings in its rules would remove any 
appearance that the Commission has placed its imprimatur on certain 
ratings.
    More specifically, the principal benefit of the proposed amendments 
to rule 2a-7 would be to emphasize the importance of money market funds 
making independent assessments of credit risks. The benefit of the 
proposed amendments to rule 3a-7 would be to emphasize that ratings are 
not necessary for accredited investors and qualified institutional 
buyers to protect themselves in evaluating structured finance vehicles 
issued under the rule. Similarly, the benefit of the proposed 
amendments to rules 5b-3 and 10f-3 would be to emphasize the importance 
to funds that acquire repurchase agreements or securities in an 
affiliated underwriting of making an independent evaluation of the 
credit risks associated with the collateral or the underwritten 
security, respectively. In addition, by moving away from a required 
reliance on credit ratings in our rules, funds may benefit by acquiring 
a wider range of securities that present attractive investment 
opportunities and the requisite level of credit risks, although they do 
not meet the current rules' ratings requirements. The principal benefit 
of the proposed amendment to rule 206(3)-3T would be to allow advisers 
to consider factors other than only a rating by NRSROs of the credit 
quality of a debt security for purposes of eligibility of the rule. 
Advisers would determine, based upon established criteria of whether 
the security presents no more than moderate credit risk and has 
sufficient liquidity, whether a security is investment grade for 
purposes of the rule. Investment advisers could, in addition to 
considering NRSRO ratings, weigh various factors and consider a 
security's credit quality based on those qualitative and quantitative 
elements it deems most relevant. An additional benefit of the proposed 
amendment would be that non-discretionary advisory clients of advisers 
also registered with us as broker-dealers may have easier access to a 
wider range of securities. This, in turn, would increase liquidity in 
the markets for these securities and promote capital formation in these 
areas. These benefits are difficult to measure quantitatively, but 
qualitatively we believe the potential benefits are significant.
    We request comment on available metrics to quantify these benefits 
and any other benefits the commenter may identify. Commenters are also 
requested to identify sources of empirical data that could be used for 
the metrics they propose.

B. Costs

    We anticipate that funds and investment advisers could incur 
certain costs if the proposed amendments are adopted. Funds and 
investment advisers may incur additional costs if they perform a more 
detailed and comprehensive analysis before making an investment 
decision. Such costs are difficult to measure, but we believe that they 
would be justified by the benefits related to a more informed 
investment decision as discussed in the previous section. In addition, 
the purpose of the proposal is to emphasize that it is not the 
Commission's intent to encourage investors to place undue reliance on 
NRSRO ratings in making investment decisions. In many cases, investors 
may still choose to rely solely on NRSRO ratings without incurring 
additional costs.
    Additionally, in proposing to remove the ratings requirements from 
our rules, we would broaden the set of potential investments available 
to funds and investment advisers. For example, under the proposed 
amendments to rule 2a-7, money market funds would be able to invest in 
securities that have received credit ratings outside of the two highest 
short-term rating categories. It is possible that some investors, 
funds, or investment advisers may incur additional costs if funds and 
investment advisers use this expanded discretion to purchase (or sell 
in the case of principal transactions under rule 206(3)-3T) risky or 
illiquid securities. We believe that these potential costs would be 
mitigated, however, by market forces, including, in the case of money 
market funds, investors' desire to maintain the principal value of 
their investments.
    We request comment on these costs. Would eliminating the rating 
requirements from our rules affect the amount or nature of risks that 
investment companies and investment advisers would be willing or able 
to take? We request comment on available metrics to quantify these 
costs and any other costs the commenter may identify. Commenters are 
also requested to identify sources of empirical data that could be used 
for the metrics they propose.
    Rule 2a-7. We anticipate that the proposed amendments to rule 2a-7 
would impose minimal new costs on a portion of money market funds. In 
general, we expect that money market fund boards of directors (or their 
delegates) would incur no additional costs in making credit and 
liquidity risk determinations regarding portfolio securities because 
the proposed rules would codify the determinations

[[Page 40135]]

regarding credit risk and liquidity that we believe boards (or their 
delegates) make under the current rule. Some money market funds, 
however, would incur costs to notify the Commission regarding rule 17a-
9 transactions. For purposes of the PRA analysis, Commission staff 
estimates that on average 10 money market funds each year are likely to 
provide notices regarding rule 17a-9 transactions, at a cost of 
approximately $1,475.\98\ We request comment on these cost estimates. 
Do commenters foresee additional or alternative costs if the proposed 
amendments to rule 2a-7 are adopted? Have we accurately estimated the 
number of money market funds that would have to report rule 17a-9 
transactions annually? Have we accurately estimated money market funds' 
potential costs in reporting rule 17a-9 transactions?
---------------------------------------------------------------------------

    \98\ See supra note 87 and accompanying text.
---------------------------------------------------------------------------

    Rule 3a-7. Our proposed amendments to rule 3a-7 under the 
Investment Company Act may impose minor costs. Specifically, retail 
investors who are able, because of the rule, to buy structured finance 
products would no longer be able to participate in the market. We 
understand that these products generally are not marketed to retail 
investors, however, and the number of retail investors affected, if 
there are any, may be quite low. The proposed amendments also may 
result in more limited access to capital for issuers of structured 
financings to the extent there is a retail market that is eliminated 
under the proposed amendments. All investors who hold structured 
finance products bought under the existing rule may bear some costs of 
reduced liquidity to the extent a retail market no longer exists 
because the pool of potential buyers in the secondary market may be 
reduced. These costs are difficult to assess given that any existing 
market may be very small.
    Commission staff estimates the following potential costs associated 
with the proposed amendments to rule 3a-7:
     Costs to retail investors--Retail investors may incur 
certain opportunity costs under the proposal because they would not be 
able to purchase the securities of structured finance vehicles that 
rely on rule 3a-7. These potential costs may be mitigated, however, 
because we understand, based on staff experience that this market, if 
it exists, represents a very small amount of all structured finance 
products (perhaps less than 1% of the $306.7 billion in asset-backed 
securities issued in 2007).\99\
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    \99\ See Worldwide ABS Issuance, Asset-Backed Alert: The Weekly 
Update on Worldwide Securitization (June 13, 2008), p. 11.
---------------------------------------------------------------------------

     Procedures for the acquisition or disposition of assets--
Although we are proposing to remove rule 3a-7's rating requirement, we 
anticipate that structured financing vehicles would be rated by the 
NRSROs. We expect that market participants generally will continue to 
require that issuers obtain ratings. Accordingly, as a matter of good 
business practice, Commission staff estimates that almost all issuers 
will continue to have procedures in place to ensure that the 
acquisition or disposition of assets does not adversely affect the full 
and timely payments to outstanding security holders. Thus, Commission 
staff believes that the proposed amendments would not impose any new 
cost burdens on issuers.
     Deposits in segregated accounts--We believe that almost 
all issuers have already taken the actions necessary for cash flows to 
be deposited in segregated accounts consistent with the full and timely 
payment of outstanding fixed income securities in meeting the current 
rule's ratings requirement. Commission staff does not anticipate any 
new costs associated with this provision of the proposal.
We request comment on these cost estimates. Are structured financings 
offered to the retail market under rule 3a-7? If so, how large is the 
retail market for these products? What costs would retail investors 
incur if the proposed amendments are adopted? How would retail 
investors sell or dispose of their current structured finance vehicle 
holdings if the proposed amendments were adopted? How should any 
opportunity costs investors may face if the proposed amendments are 
adopted be quantified? Would there be any new costs associated with 
developing procedures for the acquisition or disposition of assets and 
deposits in segregated accounts?
    Rule 5b-3. Our proposed amendments to rule 5b-3 under the 
Investment Company Act may impose costs on funds that rely on the rule. 
Specifically, a fund's board of directors, or its delegate, pursuant to 
rule 38a-1 under the Investment Company Act, would be required to 
develop written policies and procedures to ensure that at the time the 
repurchase agreement is entered into the collateral meets the 
requirements outlined in the amendments to the proposed rule.\100\ The 
proposal would require collateral other than cash or government 
securities to consist of securities that the fund's board of directors 
(or its delegate) determines at the time the repurchase agreement is 
entered into: (i) Are sufficiently liquid that they can be sold at or 
near their carrying value within a reasonably short period of time; 
(ii) are subject to no greater than minimal credit risk; and (iii) the 
issuer of which has the highest capacity to meet its financial 
obligations. The existing rule provides that collateral may consist of 
unrated securities if the fund's board, or its delegate, makes the 
determination that the unrated securities are comparable to securities 
that are rated in the highest rating category by the Requisite NRSROs. 
Consistent with the requirements of rule 38a-1 under the Investment 
Company Act, we expect that fund boards would have existing procedures 
regarding credit quality determinations for unrated securities. In 
addition, as a matter of good business practice, we believe that most 
funds currently evaluate the credit risk and liquidity of rated 
securities. Thus, we believe that most funds already have procedures to 
evaluate collateral securities. For purposes of the PRA analysis, 
Commission staff estimates that 90% of all investment companies, or 
4,243 funds, currently have procedures for evaluating collateral 
securities.\101\ Commission staff therefore estimates that 471 funds 
would need to develop procedures and evaluate collateral securities, at 
an annual cost of approximately $1,294,308.\102\
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    \100\ Rule 38a-1(a).
    \101\ See supra text preceding note 90.
    \102\ See supra note 91.
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    Our proposed amendments to rule 5b-3 may result in another cost to 
affected funds. Currently, NRSRO ratings are used in a provision of 
rule 5b-3 that permits a fund to deem the acquisition of a ``refunded 
security'' as the acquisition of the escrowed government securities for 
purposes of section 5(b)(1)'s diversification requirements.\103\ Under 
this provision, a debt security must satisfy certain conditions to be 
considered a refunded security under the rule. One of these conditions 
is that an independent certified public accountant must have certified 
to the escrow agent that the escrowed securities would satisfy all 
scheduled payments of principal, interest, and applicable premiums on

[[Page 40136]]

the refunded securities.\104\ This condition is not required, however, 
if the refunded security has received a debt rating in the highest 
rating from an NRSRO.\105\
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    \103\ Under the rule, a refunded security is defined as a debt 
security the principal and interest payments of which are to be paid 
by U.S. government securities that have been irrevocably placed in 
an escrow account and are pledged only to the payment of the debt 
security. Rule 5b-3(c)(4).
    \104\ Rule 5b-3(c)(4)(iii).
    \105\ Id.
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    We propose to eliminate the exception to the certification 
requirement for securities that have received the highest rating from 
an NRSRO. As previously discussed, the Commission included this 
exception because in rating refunded securities, NRSROs typically 
require that an independent third party make the same 
determination.\106\ As previously noted, Commission staff believes that 
market pressures currently require almost all issuers to have refunded 
securities certified by an independent accountant. To the extent that 
refunded securities are rated, and the rating agency requires 
certification by an independent certified public accountant, funds 
would not incur additional costs in determining whether a security had 
been certified in accordance with the rule. Accordingly, we do not 
expect there would be a change in current costs to issuers as a result 
of this proposal.
---------------------------------------------------------------------------

    \106\ See rule 5b-3 Proposing Release, supra note 51.
---------------------------------------------------------------------------

    We request comment on these cost estimates. Do commenters foresee 
additional or alternative costs if the proposed amendments to rule 5b-3 
are adopted? Have we accurately estimated current and future costs for 
collateral procedures? Are we correct in estimating that funds are 
unlikely to incur any additional costs in determining that a refunded 
security has received an accountant certification?
    Rule 10f-3. We do not believe that our proposed amendments to rule 
10f-3 would impose costs on funds that rely on rule 10f-3 to purchase 
municipal securities. Under the current rule, fund boards are required 
to adopt procedures regarding purchases made in reliance on the rule 
and to determine each quarter that all purchases were made in 
compliance with the procedures.\107\ Commission staff estimates that 
these costs would not change. As noted above in our analysis of the 
PRA, we currently estimate that boards spend, on average, two hours 
each year to review and revise their procedures for acquiring 
securities in compliance with the conditions in rule 10f-3. We believe 
that any changes funds would make to their procedures in order to 
comply with the proposed amendments to the rule would be included in 
this annual review and revision.
---------------------------------------------------------------------------

    \107\ Rule 10f-3(c)(10).
---------------------------------------------------------------------------

    We request comment on these cost estimates. Have we accurately 
estimated the costs associated with the proposal's required additional 
procedures for purchases of municipal securities? Do commenters foresee 
additional or alternative costs if the proposed amendments to rule 10f-
3 are adopted?
    Rule 206(3)-3T. In lieu of relying exclusively on credit ratings to 
determine eligibility for principal trading of underwritten securities 
under the rule, advisers would need to make a determination of a 
security's credit risk and liquidity. This determination would impose 
some costs on advisers. Advisers seeking to rely on the exception would 
need to develop and implement procedures regarding their eligibility 
determinations in accordance with their responsibilities under Advisers 
Act rule 206(4)-7. And, in making their determinations, many advisers 
would expend resources beyond merely obtaining credit ratings from 
NRSROs, as is required under the current rule.
    Commission staff estimates that the costs of preparing the 
procedures for making the determinations of credit quality and 
liquidity under the rule would be borne upfront. Once generated, 
reviewed, and implemented by eligible advisers, advisers would be able 
to follow them for purposes of making further determinations of 
eligibility for underwritten securities under the requirements of the 
rule. For purposes of the PRA analysis, our staff has estimated the 
number of hours and costs the average adviser would spend in the 
initial preparation of its policies and procedures.\108\ Based on those 
estimates, our staff estimates that advisers would incur costs of 
approximately $1,820 on average per adviser, including legal 
consultation.\109\ Assuming there are 185 eligible advisers (i.e., 
advisers that also are registered broker-dealers) that would prepare 
relevant policies and procedures, our staff estimates that the total 
costs would be $336,700.\110\
---------------------------------------------------------------------------

    \108\ See supra note 97 and accompanying text. We estimate the 
following burdens and/or costs: (i) for drafting the policies and 
procedures, approximately 10 hours on average per eligible adviser, 
of which we estimate there are 185, for a total of 1,850 hours; and 
(ii) for utilizing outside legal professionals in the preparation of 
the policies and procedures, approximately $1,200 on average per 
eligible adviser, for a total of $222,000.
    \109\ We estimate that the internal preparation function will 
most likely be performed by a compliance clerk at $62 per hour. $62 
per hour x 10 hours = $620 on average per adviser of internal costs 
for preparation of the policies and procedures. $620 on average per 
adviser of internal costs + $1,200 on average per adviser of costs 
for outside legal counsel = $1,820 on average per adviser.
    \110\ This estimate is based on the following calculation: 
$1,820 on average per adviser x 185 advisers = $336,700 in total 
costs for preparation of the policies and procedures.
---------------------------------------------------------------------------

    We request comment on these cost estimates. Are the cost estimates 
accurate regarding the proposed procedures for making credit quality 
determinations? Do commenters foresee additional or alternative costs 
if the proposed amendments to rule 206(3)-3T are adopted?

C. Request for Comment

    We request comment on all aspects of this cost-benefit analysis, 
including comment as to whether the estimates we have used in our 
analysis are reasonable. We welcome comment on any aspect of our 
analysis, including the estimates and the assumptions we have 
described. In particular, we request comment as to any costs or 
benefits we may not have considered here that could result from the 
adoption of the proposed amendments. We also request comment on the 
numerical estimates discussed above, and request comment on specific 
costs and benefits from covered institutions that have experienced any 
of the situations analyzed above.

VII. Consideration of Promotion of Efficiency, Competition and Capital 
Formation

    Investment Company Act section 2(c) and Investment Advisers Act 
section 202(c) require us, when engaging in rulemaking where we are 
required to consider or determine whether an action is necessary or 
appropriate in the public interest, to consider, in addition to the 
protection of investors, whether the action will promote efficiency, 
competition, and capital formation.\111\ If adopted, the Commission 
believes that these amendments would reduce the potential for over-
reliance on ratings, and thereby promote investor protection. The 
Commission anticipates that these proposed amendments would improve 
investors' ability to make informed investment decisions, which would 
therefore lead to increased efficiency and competitiveness of the U.S. 
capital markets. The Commission expects that this increased market 
efficiency and investor confidence also may encourage more efficient 
capital formation.
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    \111\ 15 U.S.C. 80a-2(c) and 15 U.S.C. 80b-2(c).
---------------------------------------------------------------------------

    Efficiency. As discussed above, the proposed amendments could 
result in additional costs for investment companies and registered 
investment advisers, which could affect the

[[Page 40137]]

efficiency of these institutions. The proposed amendments to rule 2a-7 
may slightly decrease the efficiency of certain money market funds, to 
the extent that any funds may be relying exclusively on credit ratings 
to make current minimal credit risk determinations. We believe that 
independently generated assessments of credit risks are important, 
however, and a slight decrease in efficiency may be warranted. Our 
proposed amendments to rule 3a-7 may reduce market efficiency by 
limiting the ability of retail investors who invest in structured 
financing vehicles. However, the proposal to eliminate sales of 
structured finance vehicles to the retail market would clearly 
delineate investors who are eligible to buy these products, which may 
increase market efficiency.
    Ratings provide a standard for retail investors, funds, and 
advisers alike. By eliminating reliance on ratings, the proposed 
amendments may have a negative impact on efficiency by eliminating an 
objective standard in credit quality determinations. The proposed 
amendments also could decrease efficiency to the extent that funds 
acquired securities that do not meet the particular ratings requirement 
and that result in the concerns that the rating requirements were 
designed to address. On the other hand, the proposed amendments may 
result in some increased market efficiency by affording funds access to 
securities that do not meet the rating requirements in the current 
rules, but that would satisfy the credit risk and liquidity standards 
in the proposed amendments. We do not anticipate that the proposed 
amendments to rules 2a-7, 5b-3, and 10f-3 would have other impacts on 
the efficiency of funds that rely on those rules. The proposed 
amendments to rule 206(3)-3T may increase efficiency by affording 
clients access to certain investment grade debt securities underwritten 
by the adviser or its affiliate that they might not have had access to 
under the standard requiring NRSRO ratings.
    Competition. If investors believe the proposed amendments to rule 
2a-7 would make the rule less rigorous in part because of the loss of 
an independent third party check on money market fund investments, they 
may turn to other cash investment vehicles they perceive as offering 
greater protections. In addition, investors in money market funds may 
unduly rely on ratings of the money market funds themselves as a proxy 
for the quality and safety of these funds' portfolio securities. This 
may potentially increase costs to money market funds that would not 
otherwise seek ratings. The proposed amendments to rule 3a-7, may 
impact certain issuers of structured finance vehicles that, for 
example, may specialize in the retail market if they had some 
competitive advantage, such as a distribution channel. Eliminating the 
exclusion for structured finance vehicles offered to retail investors 
may make these issuers less competitive in this market. The proposed 
amendments to rule 206(3)-3T may promote competition because, by 
providing a more subjective standard for the underwritten securities 
exception, they may increase the alternative sources of the security 
for the client without diminishing the adviser's best execution 
obligations, thereby potentially improving price. We do not believe the 
proposed amendments to rules 5b-3 or 10f-3 would significantly affect 
competition because these amendments would apply to all money market 
funds and other funds.
    Capital formation. We do not believe the proposed amendments to the 
rules would have a significant effect on capital formation. To the 
extent potential money market fund investors may react positively to 
money market funds' independent credit risk assessments and management 
of risks, we believe any effect the proposed amendments to rule 2a-7 
may have on capital formation would be positive. Our proposed 
amendments to rule 3a-7 would limit capital formation for issuers that 
offer structured finance products to retail investors in reliance on 
rule 3a-7. The proposed amendments would have no effect on the ability 
of issuers who rely on rule 3a-7 to offer structured financings to 
accredited investors and qualified institutional buyers to raise 
capital. We do not expect that the proposed amendments to rules 5b-3 or 
10f-3 would have an adverse effect on capital formation. If the 
proposed amendments to rule 206(3)-3T have any effect on capital 
formation, it is likely to be positive, although indirect. Providing a 
means for advisers, consistent with their fiduciary obligations, to 
offer their clients underwritten investment grade securities sold as 
principal, might serve to broaden the potential universe of purchasers 
of securities, opening the door to greater investor participation in 
the securities markets with a potential positive effect on capital 
formation.
    We request comment on all aspects of this analysis, and 
specifically request comment on any effect the proposed amendments 
might have on the promotion of efficiency, competition, and capital 
formation that we have not considered. Commenters are requested to 
provide empirical data and other factual support for their views to the 
extent possible.

VIII. Regulatory Flexibility Act Certification

    Section 3(a) of the Regulatory Flexibility Act of 1980 \112\ 
(``RFA'') requires the Commission to undertake an initial regulatory 
flexibility analysis (``IRFA'') of the proposed rule amendments on 
small entities unless the Commission certifies that the rule, if 
adopted, would not have a significant economic impact on a substantial 
number of small entities.\113\ Pursuant to Section 605(b) of the RFA, 
the Commission hereby certifies that the proposed amendments to rules 
2a-7 and 3a-7 under the Investment Company Act, would not, if adopted, 
have a significant economic impact on a substantial number of small 
entities. The proposal would:
---------------------------------------------------------------------------

    \112\ 5 U.S.C. 603(a).
    \113\ 5 U.S.C. 605(b).
---------------------------------------------------------------------------

    (a) Amend rule 2a-7 under the Investment Company Act to: (i) Rely 
on money market fund boards of directors (who usually rely on the 
funds' advisers) to determine that each portfolio instrument presents 
minimal credit risks, and whether the security is a ``First Tier 
Security'' or a ``Second Tier Security''; (ii) add a portfolio 
liquidity requirement to the rule that would require that money market 
funds hold securities that are sufficiently liquid to meet reasonably 
foreseeable shareholder redemptions, and expressly limit their 
investment in illiquid securities to not more than 10% of the their 
total assets; (iii) in the event the money market fund's portfolio 
manager becomes aware of any new information about a portfolio security 
(or an issuer of a portfolio security) that may suggest that the 
security may not continue to present minimal credit risks, the proposal 
would amend rule 2a-7's downgrade and default provisions to require a 
money market fund's board of directors to reassess promptly whether the 
portfolio security continues to present minimal credit risks; and (iv) 
require a money market fund to notify the Commission of the purchase of 
a money market fund's portfolio securities by an affiliated person in 
reliance on rule 17a-9 under the Investment Company Act. The proposed 
amendments also would make conforming amendments to rule 2a-7's record 
keeping and reporting requirements; and
    (b) Amend rule 3a-7 under the Investment Company Act to: (i) 
Eliminate the rule's reliance on ratings by eliminating the exclusion 
for

[[Page 40138]]

structured financings offered to the general public; (ii) remove the 
reference to ratings downgrades in the section of the rule that 
addresses substitution of eligible assets; and (iii) amend the portion 
of the rule that deals with safekeeping of assets.
    Based on information in filings submitted to the Commission, we 
believe that there are no money market funds that are small 
entities.\114\ In addition, we are not aware of any issuers that 
currently rely on rule 3a-7 that are small entities. For these reasons, 
the Commission believes the proposed amendments to rules 2a-7 and 3a-7 
under the Investment Company Act would not, if adopted, have a 
significant economic impact on a substantial number of small entities.
---------------------------------------------------------------------------

    \114\ Under the Investment Company Act, an investment company is 
considered a small entity if it, together with other investment 
companies in the same group of related investment companies, have 
net assets of $50 million or less as of the end of its most recent 
fiscal year. See 17 CFR 270.0-10.
---------------------------------------------------------------------------

    We encourage written comments regarding this certification. The 
Commission solicits comment as to whether the proposed amendments to 
rules 2a-7 and 3a-7 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.

IX. Initial Regulatory Flexibility Analysis

    This IRFA has been prepared in accordance with 5 U.S.C. 603. It 
relates to proposed amendments to rules 5b-3 and 10f-3 under the 
Investment Company Act and rule 206(3)-(3)T under the Investment 
Advisers Act. The proposed amendments would remove references to and 
the required use of NRSRO ratings from these rules.

A. Reasons for the Proposed Action

    As discussed above, the proposed rule amendments are designed to 
address the risk that the reference to and use of NRSRO ratings in our 
rules is interpreted by investors as an endorsement of the quality of 
the credit ratings issued by NRSROs, and may encourage investors to 
place undue reliance on the NRSRO ratings.

B. Objectives of the Proposed Action

    Our proposed amendments are designed to address the risk that 
reference to and use of NRSRO ratings in our rules:
     Is interpreted by investors as an endorsement of the 
quality of the credit ratings issued by NRSROs; and
     encourages investors to place undue reliance on the NRSRO 
ratings.

C. Legal Basis

    The Commission is proposing amendments to rule 5b-3 under the 
authority set forth in sections 6(c) and 38(a) of the Investment 
Company Act [15 U.S.C. 80a-6(c) and 80a-37(a)]. The Commission is 
proposing amendments to rule 10f-3 under the authority set forth in 
sections 10(f), 31(a) and 38(a) of the Investment Company Act [15 
U.S.C. 80a-10(f), 80a-30(a) and 80a-37(a)]. The Commission is proposing 
amendments to rule 206(3)-(3)T under the authority set forth in 
sections 206A and 211(a) of the Investment Advisers Act [15 U.S.C. 80b-
6A, 80b-11(a)].

D. Small Entities Subject to the Proposed Rule Amendments

    The proposed amendments to rules 5b-3 and 10f-3 under the 
Investment Company Act and rule 206(3)-(3)T under the Investment 
Advisers Act would affect funds and registered investment advisers, 
including entities that are considered to be a small business or small 
organization (collectively, ``small entity'') for purposes of the RFA. 
Under the Investment Company Act, a fund is considered a small entity 
if it, together with other funds in the same group of related funds, 
has net assets of $50 million or less as of the end of its most recent 
fiscal year.\115\ Under the Investment Advisers Act, a small entity is 
an investment adviser that: (i) Manages less than $25 million in 
assets; (ii) has total assets of less than $5 million on the last day 
of its most recent fiscal year; and (iii) does not control, is not 
controlled by, and is not under common control with another investment 
adviser that manages $25 million or more in assets, or any person 
(other than a natural person) that has had total assets of $5 million 
or more on the last day of the most recent fiscal year.\116\ Based on 
Commission filings, we estimate that 122 investment companies may be 
considered small entities. We also estimate that as of June 1, 2008, 
572 investment advisers were small entities.\117\ The Commission 
assumes for purposes of this IRFA that 19 of these small entities 
(those that are both investment advisers and broker-dealers) could rely 
on rule 206(3)-3T,\118\ and that 50% of these, or 10 advisers, will 
seek to engage in principal trades with clients of securities they or a 
control person underwrote.
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    \115\ 17 CFR 270.0-10.
    \116\ 17 CFR 275.0-7.
    \117\ IARD data as of June 1, 2008, for Item 12 of Part 1A of 
Form ADV.
    \118\ IARD data as of June 1, 2008, for Items 6.A(1) and 12 of 
Part 1A of Form ADV.
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E. Reporting, Recordkeeping, and Other Compliance Requirements

    The proposed amendments to rule 5b-3 would require collateral for 
repurchase agreements other than cash or government securities to have 
minimal credit risk and be highly liquid. Specifically, the proposal 
would require collateral other than cash or government securities to 
consist of securities that the fund's board of directors (or its 
delegate) determines at the time the repurchase agreement is entered 
into: (i) Are sufficiently liquid that they can be sold at or near 
their carrying value within a reasonably short period of time; (ii) are 
subject to no greater than minimal credit risk, and (iii) the issuer of 
which has the highest capacity to meet its financial obligations.\119\ 
The proposed amendments to rule 10f-3 would amend the rule's definition 
of ``eligible municipal security'' to mean securities that are 
sufficiently liquid that they can be sold at or near their carrying 
value within a reasonably short period of time. In addition, the 
securities would have to be either: (i) subject to no greater than 
moderate credit risk; or (ii) if they are less seasoned securities, 
subject to a minimal or low amount of credit risk.\120\ The proposed 
amendments to rule 206(3)-3T would impose a new compliance requirement 
in connection with advisers' obligations relating to written policies 
and procedures under rule 206(4)-7 under the Advisers Act.
---------------------------------------------------------------------------

    \119\ Proposed rule 5b-3(c)(1)(iv)(C).
    \120\ Proposed rule 10f-3(a)(3).
---------------------------------------------------------------------------

    Small entities registered with the Commission as investment 
companies or investment advisers seeking to rely on each of the rules 
as it is proposed to be amended would be subject to the same 
requirements as larger entities. With respect to rule 206(3)-3T, in 
each case, however, an investment adviser, whether large or small, 
would only be able to rely on the rule as it is proposed to be amended 
if it also is registered with us as a broker-dealer. As noted above, we 
estimate that 19 small entities are advisers that are also registered 
as broker-dealers and therefore only those small entities are eligible 
to rely on the rule. In developing the requirements of the proposed 
amendments to each of rules 5b-3 and 10f-3 under the Investment Company 
Act, and rule 206(3)-3T under the Investment Advisers Act, we 
considered the extent to which the proposed amendments would have a 
significant impact on a substantial number of small entities.

[[Page 40139]]

    We encourage written comments regarding this analysis. We solicit 
comments as to whether the proposed amendments could have any effect 
that we have not considered. We also request that commenters describe 
the nature of any impact on small entities and provide empirical data 
to support the extent of the impact.

F. Duplicative, Overlapping, or Conflicting Federal Rules

    Rule 31a-1 under the Act requires the retention of ledger accounts 
for each portfolio security and each person through which a portfolio 
transaction is effected. Although some of the procedures under the 
proposed amendments to rules 5b-3 and 10f-3 may overlap with 
information in the ledgers, the rule 5b-3 and 10f-3 procedures would 
contain additional information specifically related to the concerns 
underlying these rules.
    The Commission believes that there are no rules that duplicate or 
conflict with the proposed amendments to rule 206(3)-3T.

G. Significant Alternatives

    The RFA directs us to consider significant alternatives that would 
accomplish our stated objective, while minimizing any significant 
adverse impact on small entities. Alternatives in this category would 
include: (i) Establishing different compliance or reporting standards 
or timetables that take into account the resources available to small 
entities; (ii) clarifying, consolidating, or simplifying compliance 
requirements under the rule for small entities; (iii) using performance 
rather than design standards; and (iv) exempting small entities from 
coverage of the rule, or any part of the rule.
    With respect to rules 5b-3 and 10f-3, the Commission preliminarily 
believes that special compliance requirements or timetables for small 
entities, or an exemption from coverage for small entities, may create 
a risk that those entities could acquire repurchase agreements with 
collateral that may not retain its market value or liquidity in the 
event of a counterparty default. We do not expect that the requirement 
that refunded securities be certified by a certified public accountant 
would result in any costs or burdens for either small or large 
entities. With respect to rule 10f-3, we preliminarily believe that 
special compliance requirements or timetables for small entities, or an 
exemption from coverage for small entities, may put those entities at 
greater risk for purchasing unmarketable municipal securities in an 
affiliated underwriting. We preliminarily believe, therefore, that it 
is important for the credit quality and liquidity considerations 
required by the proposed amendments to rules 5b-3 and 10f-3 to apply to 
all funds relying on the rules, not just those that are not considered 
small entities. Further consolidation or simplification of the 
proposals for funds that are small entities would be inconsistent with 
the Commission's goals of fostering investor protection.
    With respect to rule 206(3)-3T, the Commission preliminarily 
believes that special compliance or reporting requirements or 
timetables for small entities, or an exemption from coverage for small 
entities may create the risk that the investors who are advised by and 
effect securities transactions in underwritten securities through such 
small entities may not receive adequate protection combined with access 
to securities. We believe, therefore, that it is important for the 
investment quality consideration required by the proposed amendments to 
apply to all advisers, not just those that are not considered small 
entities. Further consolidation or simplification of the proposals for 
investment advisers that are small entities would be inconsistent with 
the Commission's goals of fostering investor protection.
    We have endeavored through the proposed amendments to rules 5b-3, 
10f-3 and 206(3)-3T to minimize the regulatory burden on all entities 
eligible to rely on the respective rules, including small entities, 
while meeting our regulatory objectives. It was our goal to ensure that 
eligible small entities may benefit from the Commission's approach to 
the proposed amendments to the same degree as other funds or eligible 
advisers, as appropriate.
    We request comment on whether it is feasible or necessary for small 
entities to have special requirements or timetables for, or exemptions 
from, compliance with the proposed amendments to each of the rules. In 
particular, could any of the proposed amendments be altered in order to 
ease the regulatory burden on small entities, without sacrificing the 
effectiveness of the proposed amendments?

H. Request for Comments

    We encourage the submission of comments with respect to any aspect 
of this IRFA. In particular, we request comments regarding: (i) The 
number of small entities that may be affected by the proposed 
amendments; (ii) the existence or nature of the potential impact of the 
proposed amendments on small entities discussed in the analysis; and 
(iii) how to quantify the impact of the proposed amendments. Commenters 
are asked to describe the nature of any impact and provide empirical 
data supporting the extent of the impact. Such comments will be 
considered in the preparation of the Final Regulatory Flexibility 
Analysis, if the proposed amendments are adopted, and will be placed in 
the same public file as comments on the proposed amendments. Comments 
should be submitted to the Commission at the addresses previously 
indicated.

X. Statutory Authority

    The Commission is proposing amendments to rules 2a-7, 3a-7, and 5b-
3 under the authority set forth in sections 6(c) and 38(a) of the 
Investment Company Act [15 U.S.C. 80a-6(c), 80a-37(a)]. The Commission 
is proposing amendments to rule 10f-3 under the authority set forth in 
sections 10(f), 31(a) and 38(a) of the Investment Company Act [15 
U.S.C. 80a-10(f), 80a-30(a), 80a-37(a)]. The Commission is proposing 
amendments to rule 206(3)-(3)T under the authority set forth in 
sections 206A and 211(a) of the Investment Advisers Act [15 U.S.C. 80b-
6A, 80b-11(a)].

List of Subjects

17 CFR Part 270

    Investment companies, Reporting and recordkeeping requirements, 
Securities.

17 CFR Part 275

    Reporting and recordkeeping requirements, Securities.

Text of Proposed Rule Amendments

    For reasons set out in the preamble, Title 17, Chapter II of the 
Code of Federal Regulations is proposed to be amended as follows:

PART 270--RULES AND REGULATIONS, INVESTMENT COMPANY ACT OF 1940

    1. The authority citation for part 270 continues to read in part as 
follows:

    Authority: 15 U.S.C. 80a-1 et seq., 80a-34(d), 80a-37, and 80a-
39, unless otherwise noted.
* * * * *
    2. Section 270.2a-7 is amended by:
    a. Revising paragraphs (a)(10), (a)(12), and (a)(17);
    b. Removing paragraph (a)(19);
    c. Redesignating paragraph (a)(20) as paragraph (a)(19);
    d. Removing paragraph (a)(21);
    e. Redesignating paragraphs (a)(22) through (a)(27) as paragraphs 
(a)(20) through (a)(25);
    f. Removing paragraph (a)(28);
    g. Redesignating paragraph (a)(29) as paragraph (a)(26);

[[Page 40140]]

    h. In paragraphs (b)(1) and (b)(2), revising the phrase ``(c)(2), 
(c)(3), and (c)(4)'' to read ``(c)(2), (c)(3), (c)(4), and (c)(5)'';
    i. Revising paragraphs (c)(3)(i), (c)(3)(iii), and (c)(3)(iv)(C);
    j. Adding paragraph (c)(3)(iv)(D);
     k. In paragraph (c)(4)(v), revising the phrase ``requirements of 
paragraphs (c)(4) and (c)(5)'' to read ``requirements of paragraphs 
(c)(4) and (c)(6)'';
    l. Redesignating paragraphs (c)(5) through (c)(10) as paragraphs 
(c)(6) through (c)(11);
    m. Adding new paragraph (c)(5);
    n. In newly redesignated paragraph (c)(6), revising the phrase 
``(pursuant to paragraphs (c)(9)(ii) and (c)(10)(vi) of this section)'' 
to read ``(pursuant to paragraphs (c)(10)(ii) and (c)(11)(vi) of this 
section)'';
    o. In newly redesignated paragraph (c)(7):
    i. revising the paragraph heading;
    ii. revising paragraph (i);
    iii. in the introductory text of paragraph (ii), revising the 
phrase ``paragraphs (c)(6)(ii)(A) through (D)'' to read ``paragraphs 
(c)(7)(ii)(A) through (C)'';
    iv. adding ``or'' at the end of paragraph (ii)(B);
    v. removing paragraph (ii)(C) and redesignating paragraph (ii)(D) 
as paragraph (ii)(C);
    vi. revising paragraph (iii);
    vii. revising the heading to paragraph (iv); and
    viii. in paragraph (iv), revising the phrase ``For purposes of 
paragraphs (c)(6)(ii) and (iii)'' to read ``For purposes of paragraphs 
(c)(7)(ii) and (iii)'';
    p. Revising newly designated paragraph (c)(10)(ii);
    q. In newly redesignated paragraph (c)(11):
    i. in paragraph (i), revising the phrase ``paragraphs (c)(6) 
through (c)(9)'' to read ``paragraphs (c)(7) through (c)(10)'';
    ii. revising paragraph (iii);
    iii. in paragraph (iv), revising the phrase ``paragraph (c)(9)(iii) 
of this section'' to read ``paragraph (c)(10)(iii) of this section'';
    iv. in the introductory text of paragraph (v), in the first 
sentence, revising ``paragraph (c)(9)(iv) of this section'' to read 
``paragraph (c)(10)(iv) of this section'';
    v. in paragraph (vi), revising the phrase ``paragraph (c)(9)(ii)'' 
to read ``paragraph (c)(10)(ii)'';
    vi. in paragraph (vii), in the first sentence, revising the phrase 
``this paragraph (c)(10)'' to read ``this paragraph (c)(11)''; and
    vii. in paragraph (vii), in the second sentence, revising the 
phrase ``paragraphs (c)(6)(ii) (with respect to defaulted securities 
and events of insolvency) or (c)(7)(ii)'' to read ``paragraphs 
(c)(7)(ii) (with respect to defaulted securities and events of 
insolvency) or (c)(8)(ii)''; and
    r. Revising the introductory text of paragraph (e) and in paragraph 
(e)(2) revising the phrase ``paragraph (c)(6)(iii) of this section'' to 
read ``paragraph (c)(7)(iii) of this section''.
    These additions and revisions read as follows:


Sec.  270.2a-7  Money market funds.

    (a) * * *
    (10) Eligible Security means a security with a remaining maturity 
of 397 calendar days or less that the fund's board of directors 
determines presents minimal credit risks (which determination must be 
based on factors pertaining to credit quality and the issuer's ability 
to meet its short-term financial obligations).
* * * * *
    (12) First Tier Security means a security the issuer of which the 
fund's board of directors has determined has the highest capacity to 
meet its short-term financial obligations.
* * * * *
    (17) Liquid Security means a security that can be sold or disposed 
of in the ordinary course of business within seven days at 
approximately the value ascribed to it by the money market fund.
* * * * *
    (c) * * *
    (3) * * *
    (i) General. The money market fund shall limit its portfolio 
investments to those United States Dollar-Denominated securities that 
are at the time of Acquisition Eligible Securities.
* * * * *
    (iii) Securities Subject to Guarantees. A security that is subject 
to a Guarantee may be determined to be an Eligible Security or a First 
Tier Security based solely on whether the Guarantee is an Eligible 
Security or First Tier Security, as the case may be; Provided, however, 
that the issuer of the Guarantee, or another institution, has 
undertaken to promptly notify the holder of the security in the event 
the Guarantee is substituted with another Guarantee (if such 
substitution is permissible under the terms of the Guarantee).
    (iv) * * *
    (C) The issuer of the Demand Feature, or another institution, has 
undertaken to promptly notify the holder of the security in the event 
the Demand Feature is substituted with another Demand Feature (if such 
substitution is permissible under the terms of the Demand Feature); and
    (D) The fund's board of directors determines that the Underlying 
Security or any Guarantee of such security presents minimal credit 
risks (which determination must be based on factors pertaining to 
credit quality).
* * * * *
    (5) Portfolio Liquidity. The money market fund shall hold 
securities that are sufficiently liquid to meet reasonably foreseeable 
shareholder redemptions in light of the fund's obligations under 
section 22(e) of the Act (15 U.S.C. 80a-22(e)) and any commitments it 
has made to shareholders; Provided, however, immediately after the 
Acquisition of any security, a money market fund shall not have 
invested more than ten percent of its Total Assets in securities that 
are not Liquid Securities.
* * * * *
    (7) Monitoring, Defaults and Other Events. 
    (i) Monitoring. In the event the money market fund's investment 
adviser (or any person to whom the fund's board of directors has 
delegated portfolio management responsibilities) becomes aware of any 
information about a portfolio security or an issuer of a portfolio 
security that may suggest that the security may not continue to present 
minimal credit risks, the board of directors shall reassess promptly 
whether such security continues to present minimal credit risks and 
shall cause the fund to take such action as the board of directors 
determines is in the best interests of the money market fund and its 
shareholders.
* * * * *
    (iii) Notice to the Commission. The money market fund shall 
promptly notify the Commission by electronic mail directed to the 
Director of the Division of Investment Management of any:
    (A) Default with respect to one or more portfolio securities (other 
than an immaterial default unrelated to the financial condition of the 
issuer) or an Event of Insolvency with respect to the issuer of the 
security or any Demand Feature or Guarantee to which it is subject, 
where immediately before default the securities (or the securities 
subject to the Demand Feature or Guarantee) accounted for \1/2\ of 1 
percent or more of a money market fund's Total Assets, of such fact and 
the actions the money market fund intends to take in response to such 
situation; or
    (B) Purchase of a security from the fund by an affiliated person or 
promoter of or principal underwriter for the fund

[[Page 40141]]

or an affiliated person of such a person in reliance on Sec.  270.17a-
9.
* * * * *
    (iv) Defaults for Purposes of Paragraphs (c)(7) (ii) and (iii).* * 
*
* * * * *
    (10) * * *
    (ii) Securities Subject to Demand Features or Guarantees. In the 
case of a security subject to one or more Demand Features or Guarantees 
that the fund's board of directors has determined that the fund is not 
relying on to determine the quality (pursuant to paragraph (c)(3) of 
this section), maturity (pursuant to paragraph (d) of this section) or 
liquidity (pursuant to paragraph (c)(5) of this section) of the 
security subject to the Demand Feature or Guarantee, written procedures 
shall require periodic evaluation of such determination.
* * * * *
    (11) * * *
    (iii) Credit Risk Analysis. For a period of not less than three 
years from the date that the credit risks of a portfolio security were 
most recently reviewed, a written record of the determination that a 
portfolio security presents minimal credit risks used to determine the 
status of the security as an Eligible Security shall be maintained and 
preserved in an easily accessible place.
* * * * *
    (e) Delegation. The money market fund's board of directors may 
delegate to the fund's investment adviser or officers the 
responsibility to make any determination required to be made by the 
board of directors under this section (other than the determinations 
required by paragraphs (c)(1) (board findings); (c)(7)(ii) (defaults 
and other events); (c)(8)(i) (general required procedures: Amortized 
Cost Method); (c)(8)(ii)(A) (shadow pricing), (B) (prompt consideration 
of deviation), and (C) (material dilution or unfair results); and 
(c)(9) (required procedures: Penny Rounding Method) of this section) 
provided:
* * * * *
    3. Section 270.3a-7 is amended by:
    a. Revising paragraph (a)(2) introductory text;
    b. In paragraph (a)(2)(i) revising the phrase ``Any fixed-income 
securities may be sold'' to read ``Any fixed-income securities sold'';
    c. In paragraph (a)(2)(ii), revising the phrase ``Any securities 
may be sold'' to read ``Any securities sold'';
    d. In the undesignated paragraph after paragraph (a)(2)(ii), revise 
the phrase ``persons specified in paragraphs (a)(2) (i) and (ii) of 
this section'' to read ``persons specified in this section'';
     e. Revising paragraph (a)(3)(ii); and
    f. Revising paragraph (a)(4)(iii).
    The revisions read as follows:


Sec.  270.3a-7  Issuers of asset-backed securities.

    (a) * * *
    (2) Securities sold by the issuer or any underwriter thereof are:
* * * * *
    (3) * * *
    (ii) The issuer has procedures to ensure that the acquisition or 
disposition does not adversely affect the full and timely payment of 
the outstanding fixed-income securities; and
* * * * *
    (4) * * *
    (iii) Takes actions necessary for the cash flows derived from 
eligible assets for the benefit of the holders of fixed-income 
securities to be deposited periodically in a segregated account 
consistent with the full and timely payment of the outstanding fixed-
income securities.
* * * * *
    4. Section 270.5b-3 is amended by:
    a. Adding ``or'' at the end of paragraph (c)(1)(iv)(B);
    b. Revising paragraph (c)(1)(iv)(C);
    c. Removing paragraph (c)(1)(iv)(D);
    d. Revising paragraph (c)(4)(iii);
    e. Removing paragraphs (c)(5), (c)(6), and (c)(8); and
    f. Redesignating paragraph (c)(7) as paragraph (c)(5).
    The revisions read as follows:


Sec.  270.5b-3  Acquisition of repurchase agreement or refunded 
security treated as acquisition of underlying securities.

* * * * *
    (c) * * *
    (1) * * *
    (iv) * * *
    (C) Securities that the investment company's board of directors, or 
its delegate, determines at the time the repurchase agreement is 
entered into:
    (1 ) Are sufficiently liquid that they can be sold at or near their 
carrying value within a reasonably short period of time;
    (2) Are subject to no greater than minimal credit risk; and
    (3) The issuer of which has the highest capacity to meet its 
financial obligations; and
* * * * *
    (4) * * *
    (iii) At the time the deposited securities are placed in the escrow 
account, or at the time a substitution of the deposited securities is 
made, an independent certified public accountant has certified to the 
escrow agent that the deposited securities will satisfy all scheduled 
payments of principal, interest and applicable premiums on the Refunded 
Securities.
* * * * *
    5. Section 270.10f-3 is amended by:
    a. Revising paragraph (a)(3);
    b. Removing paragraph (a)(5); and
    c. Redesignating paragraphs (a)(6), (a)(7), and (a)(8) as 
paragraphs (a)(5), (a)(6), and (a)(7).
    The revision reads as follows:


Sec.  270.10f-3  Exemption for the acquisition of securities during the 
existence of an underwriting or selling syndicate.

    (a) * * *
    (3) Eligible Municipal Securities means ``municipal securities,'' 
as defined in section 3(a)(29) of the Securities Exchange Act of 1934 
(15 U.S.C. 78c(a)(29)), that are sufficiently liquid that they can be 
sold at or near their carrying value within a reasonably short period 
of time and either:
    (i) Are subject to no greater than moderate credit risk; or
    (ii) If the issuer of the municipal securities, or the entity 
supplying the revenues or other payments from which the issue is to be 
paid, has been in continuous operation for less than three years, 
including the operation of any predecessors, the securities are subject 
to a minimal or low amount of credit risk.
* * * * *

PART 275--RULES AND REGULATIONS, INVESTMENT ADVISERS ACT OF 1940

    6. The authority citation for part 275 continues to read in part as 
follows:

    Authority: 15 U.S.C. 80b-2(a)(11)(G), 80b-2(a)(17), 80b-3, 80b-
4, 80b-4a, 80b-6(4), 80b-6a, and 80b-11, unless otherwise noted.

* * * * *
    7. Section 275.206(3)-3T is amended by revising paragraph (c) to 
read as follows:


Sec.  275.206(3)-3T  Temporary rule for principal trades with certain 
advisory clients.

* * * * *
    (c) For purposes of paragraph (a)(2) of this section, an investment 
grade debt security means a non-convertible debt security that, at the 
time of sale, the investment adviser has determined to be subject to no 
greater than moderate credit risk and sufficiently liquid that it can 
be sold at or near its carrying value within a reasonably short period 
of time.
* * * * *

[[Page 40142]]


    By the Commission.
    Dated: July 1, 2008.
Florence E. Harmon,
Acting Secretary.
[FR Doc. E8-15282 Filed 7-10-08; 8:45 am]

BILLING CODE 8010-01-P