Credit Rating Agency Proposals Will Affect Rating Agencies, Issuers
The credit rating agency (CRA) proposal approved for release on June 25 was the third in a series of proposals relating to CRAs considered by the SEC this month. (See our coverage of the first two proposals, voted on at the June 11 meeting.)
As described in SEC Chairman Christopher Cox’ opening remarks on June 25. the third CRA proposal (actually, a set of proposals) is “focused on the way the Commission's own rules refer to and rely upon credit ratings.”
Cox summarized the objectives of the third set of CRA proposals, based on the SEC staff’s review of existing rules, recent events in the subprime and credit markets, and related recommendations of the Financial Stability Forum:
- “[I]n some rules and forms, the reference [in SEC rules] to credit ratings isn't really necessary at all. In those cases, the proposed new rules would simply eliminate the reference.
- “In other cases, the staff has found that there is value in the use of a credit rating, but that the current way ratings are incorporated in the particular rule or form should be changed. In these cases the proposed rules would clearly state the regulatory purpose we are seeking to achieve, and then permit reliance on a credit rating as one way to achieve that purpose.
- “Finally, in just a few cases, the staff has concluded that the reference to a credit rating continues to be appropriate exactly as it is. In these cases, because there is no hazard of inducing undue reliance on the ratings by investors, the recommendation before us is to leave the rules as they are.”
As noted in our subsequent coverage of the SEC’s June 11 meeting, issuers may have direct disclosure obligations under the CRA proposals approved at the June 11 meeting, in addition to having to provide certain information to the CRA or arranger (underwriter) to disclose. Potential additional disclosure obligations for issuers in the proposals considered on June 25 were noted in Hearne’s remarks as follows:
“[T]he release does not propose to amend the Commission's policy on security ratings, as it is currently outlined in Item 10(c) of Regulation S-K. Information on ratings is permitted under Item 10(c) and in that item the Commission recommends issuers consider additional disclosure regarding the ratings. The release requests comment as to whether the Commission should instead mandate this disclosure and whether additional information regarding any material limitations or qualifications on the rating and any related designation or other published evaluation of non-credit payment risks assigned by the credit rating agency with respect to the security would be valuable to investors.”
Narrows Exemption of Certain Annuity Contracts from Federal Securities Laws
In other rulemaking action on June 25, the SEC voted to release a proposed rule relating to annuity contracts that would clarify the status under the federal securities laws of indexed annuities, under which payments to the purchaser are dependent on the performance of a securities index. A ‘more likely than not’-based determination of payments under the contract is proposed to determine if such contracts offered by insurance companies will remain exempt from the securities laws, or be subject to the securities laws.
The SEC’s proposal would exempt insurance companies from filing reports under the Securities Exchange Act of 1934 with respect to indexed annuities and certain other securities registered under the Securities Act and regulated as insurance under state law. The proposed exemption would be subject to the existence of state regulation of the insurer’s financial condition and the absence of trading interest in the securities; additionally, the insurer would have to takes steps to ensure a trading market in the exempted annuity does not develop. Prospective treatment is proposed (applying to indexed annuities issued on or after the effective date of a final rule, if adopted) and the proposed effective date is 12 months after the final rule (if adopted) is published in the Federal Register.
Foreign Broker Dealers Operations Can Expand
Also at the June 25 meeting, the SEC voted to release proposed rule amendments to expand the ability of foreign broker dealers to operate in the U.S. One such amendment would expand the category of U.S. investors to whom foreign broker dealers could provide research reports to and interact with, changing the current requirement from “institutional investors that own or control greater than $100 million in total assets,” to “all registered investment companies, corporations, companies, or partnerships that own or invest on a discretionary basis $25 million or more, and natural persons who own or invest on a discretionary basis at least $25 million.”
Additional proposals, including a proposal to remove a ‘chaperone’ requirement, whereby foreign broker dealers are currently required to be ‘chaperoned’ by U.S. broker-dealer personnel on certain interactions with U.S. investors, are aimed at expanding the ability of foreign broker dealers to operate in the U.S. without triggering registration, reporting or other requirements under the securities laws.
Commissioner Atkins said, “I commend Chairman Cox for your leadership on these long overdue amendments,” noting he was particularly pleased the proposed expansion of eligible investors included covered institutions as well as natural persons.
“I have to admit,” he added, “if we ultimately adopt these proposals, I will miss the opportunity for cheap jokes like the chaperone rule affords.”
SRO Proposals Respond to Inspector General Findings
Not only were NRSROs on the agenda at SEC’s June 25 meeting, so were SROs, as the SEC voted to release proposed rules to streamline the SRO rule filing process. These rule changes would streamline processes followed by SROs, and by the SEC with respect to its own Notice and filing requirements of SRO rulemaking.
Chairman Cox noted in his remarks on the SRO proposals, that the SEC’s Office of the Inspector General (IG) found that, although a requirement states that the SEC approve or institute proceedings to disapprove an SRO rule proposal within 35 days of its publication (which can be expanded to 90 days in certain cases), “The IG found that, on average, it took the Commission 57 days to issue a notice of a rule filing submitted pursuant to Section 19(b)(2) of the Exchange Act. The IG also identified two proposed rule changes where the Commission took more than five months and more than eight months to publish notices. The IG also analyzed an audit sample of rule filings that had been open for more than a year. The IG found that, on average, these rule filings had been open for well over two years, with the longest having been open for four years.” [See: report of the Inspector General, March 2008.]
The issue of timeliness of the SRO filing process has been around for a while. Commissioner Atkins observed that when he previously served on the staff of former Chairman Arthur Levitt, Jr., “One of the first assignments I had from Chairman Levitt, back [in] 1993, was to look at the SRO filings [backlog],” and he found at the time “some were decades old.”
The guidance proposed on June 25, said Cox, “should encourage SROs to file greater numbers of rule changes for immediate effectiveness where appropriate.”He added, “Importantly, however, SROs should understand that, as the volume of such rule changes increases, so may the possibility that certain rule changes could be abrogated. Undoubtedly, many market participants affected by such rule changes might try to persuade the Commission that a rule change filed for immediate effectiveness should be abrogated and re-filed for full Commission review. In my view, this would be a healthy outcome and one fully contemplated by the framework established under the Exchange Act.”
Thus, Cox explained, “In anticipation of this change in the Commission's processes, the staff also has recommended that the Commission now consider any such abrogations directly. Accordingly, the staff has recommended removing the provision delegating this authority to the Division of Trading and Markets. This change would enhance the Commission's involvement in this area, where industry and Commission practice likely will undergo a period of rapid transition over the coming months and years. Once the Commission and industry have had a chance to adjust to the new process and it has become more routinized, the Commission could once again call on the staff to administer abrogations by delegation.”
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