SEC Adopts Amendments to Remove References to Credit Ratings From Regulation M

The U.S. Securities and Exchange Commission, SEC, has announced its final rules amendments as regards the removal of the reference to credit rating requirements in Rules 101 and 102 of Regulation M under the Securities Exchange Act of 1934 following a corresponding consultation in April 2022.
To recall, Rules 101 and 102 of Regulation M stipulate provisions to prohibit the engagement in securities offerings by persons and firms with a financial interest in the offerings. Rule 101 thereby applies to intermediaries engaged in the distribution of securities and Rule 102 to issuers, security holders, and affiliated parties. The regulations also provide for several exemptions from that prohibition in connection with certain securities (nonconvertible debt, nonconvertible preferred, and asset-backed securities) provided that these securities are at least rated „investment grade“ by one nationally recognized rating organization (credit rating requirement).
In the aftermath of the financial crisis 2008/2009, U.S. regulators determined that any such references to credit ratings should be removed due to their „limited reliability“ and should be replaced by other measures of creditworthiness. That’s why the SEC proposed in its consultation in April 2022 to remove this rating requirement as an exemption criteria and – instead – provide that nonconvertible debt and nonconvertible preferred securities have a default probability of less than 0.055%, as measured over a 12-month period of time on the sixth business day preceeding the determination date and as determined and documented using a structural credit risk model as defined in the rule. With respect to asset-backed securities, such activities would qualify as being exempt under both Rules so long as the securities are offered under an existing shelf registration statement (Form SF-3).
In its final rule statement now, the SEC notes that based on the feedback received, it will proceed as proposed and remove the ratings in either rule and replace them with above noted conditions. This is important to note, because in its proposal, the SEC intended to remove the rating condition altogether without replacement for issuers, security holders, and affiliated parties (Rule 102).
The SEC will also proceed as proposed as regards the recordkeeping requirements of broker-dealers to ensure that it can effectively monitor the activities of such market participants relying on the Rule 101 exemption. The new requirement will oblige broker-dealers to store for at least three years written records of the computations made in relation to the probability of default determinations. During a period of two years, such records must be kept at an easily accessible place.