On March 23, 2022, the U.S. Securities and Exchange Commission (SEC) issued its most recent proposal to remove credit rating references from Regulation M (Proposal),1 as mandated by Section 939A of the Dodd-Frank Wall Street Reform and Consumer Protection Act (DFA).2
Presently, Rules 101 and 102 of Regulation M contain identical exceptions from the rules’ prohibitions for nonconvertible debt securities, nonconvertible preferred securities, and asset-backed securities that are in each case rated investment grade by at least one nationally recognized statistical rating organization (commonly referred to as the “investment grade exceptions”).3
In an effort to comply with Section 939A of the DFA, the SEC is proposing to:
- replace the investment grade exception in Rule 101 with two alternative exceptions — one for nonconvertible debt and nonconvertible preferred securities (using a new “structural credit risk model” standard) and another for asset-backed securities (using a Form SF-3 standard); and
- eliminate the investment grade exception in Rule 102, based upon the SEC’s perception that issuers have little need for the exception and a greater incentive to manipulate.
The SEC is also proposing certain additional recordkeeping requirements for broker-dealers seeking to rely on the proposed alternative exception under Rule 101 for nonconvertible debt and nonconvertible preferred securities. If adopted, the SEC’s Proposal would eliminate the ability of issuers to conduct redemptions while still in distribution as well as increase the operational burdens on broker-dealers using the newly crafted structural credit risk model exception under Rule 101 for nonconvertible debt and nonconvertible preferred securities. By comparison, the asset-backed security exception under Rule 101 would have a very straightforward application but would be limited exclusively to asset-backed securities that are offered pursuant to an effective shelf registration statement filed on Form SF-3.
Comments on the Proposal are due on or before May 23, 2022.
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