SEC Eliminates Credit Rating References from Rules on Market Manipulation

The SEC finalized amendments to rules on securities market manipulation ("Regulation M") that will remove references to reliance on credit rating agencies, in accordance with Section 939A ("Review of reliance on ratings") of Dodd-Frank.

Regulation M prevents certain parties engaged in the distribution of securities from manipulating the market for those securities. Currently, Rules 101(c)(2) ("Activities by distribution participants") and 102(d)(2) ("Activities by issuers and selling security holders during a distribution") exempt nonconvertible securities and asset-backed securities from Regulation M if a nationally recognized credit rating agency rates the security as investment grade. Under the final rule, the SEC is removing investment grade exceptions.

As previously covered, the SEC amendments will replace the current exemptions based on rating agency ratings by:

1. amending Rule 101(c)(2) to provide exemptions for: (i) nonconvertible securities of issuers determined to have a default probability of less than 0.055 percent using a structural credit risk model estimated from the offering price date over 12 calendar months and (ii) asset-backed securities that are issued according to an "effective shelf registration statement filed on the Commission's Form SF-3"; and
2. adding Rule 17a4(b)(17), which would require parties using the Rule 101 exception to keep written record of the probability of default determination for three years.

The SEC adopted the final amendments with several modifications to the original proposal by (i) requiring the probability of default determination to be made by the lead manager of a distribution, (ii) providing five additional business days before the price determination date in order to satisfy the exception's conditions and (iii) making clarifying changes to the definition of "structural credit risk model."

The final amendments will go into effect 60 days after publication in the Federal Register.

Statements

SEC staff provided the following statements on the final amendments:

• SEC Chair Gary Gensler. Mr. Gensler said the final amendments fulfill an "important mandate issued by Congress . . . to remove any reference to or requirement of reliance on credit ratings."
• SEC Commissioner Caroline A. Crenshaw. Ms. Crenshaw said the final amendments "preserve the integrity of the securities markets by prohibiting activities that could artificially influence the market for an offered security."
• SEC Commissioner Jaime Lizárraga. Mr. Lizárraga commended the alternative approach to determining creditworthiness by "minimiz[ing] the risk of evasion and manipulation of the new creditworthiness standard."
• SEC Commissioner Mark T. Uyeda. Mr. Uyeda called the final amendments "long overdue," and recommended that the SEC periodically re-evaluate whether the specific default standard (noted above) aligns with Regulation M principles.