• SEC Proposes Rule Changes that Would Reduce Reliance on Credit Ratings
  • August 11, 2008
  • Law Firm: Wilmer Cutler Pickering Hale and Dorr LLP - Office
  • As expected, on July 1, 2008, the SEC issued simultaneously three releases that propose amendments to various rules and forms that rely on credit ratings issued by nationally recognized statistical rating organizations (“NRSROs”).  The proposed amendments are designed to address concerns that the references to NRSRO ratings in SEC rules and forms may have contributed to undue reliance on NRSRO ratings by market participants. 

    The SEC proposed to amend the following rules under the Investment Company Act of 1940 (“Investment Company Act”):

    (1) Rule 2a-7, which governs the operation of money market funds, would be amended to eliminate references to ratings, while offering protections similar to the current rule’s reliance on NRSRO ratings;

    (2) Rule 3a-7, which excludes from the Investment Company Act’s definition of “investment company” structured finance vehicles that carry an investment grade rating, subject to certain conditions, would be amended to limit the type of investors that may participate in offerings of these vehicles to accredited investors and qualified institutional buyers;

    (3) Rule 5b-3, which allows investment companies 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, if the obligation of the seller to repurchase the securities from the fund is “fully collateralized,” as defined in the Investment Company Act, would be amended to eliminate the requirement that collateral other than cash or government securities be rated by an NRSRO, and instead require the investment company’s board of directors (or its delegate) to determine that such collateral securities present minimum credit risk and are highly liquid; and

    (4) Rule 10f-3, which prohibits a registered investment company from purchasing any security for which an affiliated underwriter is acting as a principal underwriter during the existence of an underwriting or selling syndicate for that security, would be amended to eliminate references to ratings, while offering protections similar to the current rule’s reliance on NRSRO ratings.

    The SEC also proposed to amend Rule 206(3)-3T under the Investment Advisers Act of 1940 (“Advisers Act”), which provides a temporary alternative means for investment advisers who are registered with the SEC 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.  As proposed, Rule 206(3)-3T would be amended to eliminate the references to credit ratings and instead require an investment adviser to make a determination that a security presents minimal credit risk and is sufficiently liquid.  An adviser seeking to rely on Rule 206(3)-3T, would have to adopt and implement policies and procedures that address the adviser’s methodology for determining whether a security is investment grade quality.

    Finally, the SEC proposed to amend various rules and forms under the Securities Act of 1933 (“Securities Act”) and the Securities Exchange Act of 1934 (“Exchange Act”), including the shelf registration rule and the net capital rule.

    Comments on each release are due September 5, 2008.

    For more information, see the SEC Releases, which may be found at http://sec.gov/rules/proposed/2008/ic-28327.pdf; http://sec.gov/rules/proposed/2008/33-8940.pdf; and http://sec.gov/rules/proposed/2008/34-58070.pdf, and the WilmerHale Investment Management News Summary, dated June 2008, which may be found at http://www.wilmerhale.com/publications/whPubsDetail.aspx?publication=8359.