[Federal Register Volume 79, Number 5 (Wednesday, January 8, 2014)]
[Rules and Regulations]
[Pages 1521-1550]
[FR Doc No: 2013-31426]

Vol. 79

Wednesday,

No. 5

January 8, 2014

Part III

Securities and Exchange Commission

-----------------------------------------------------------------------

17 CFR Parts 240 and 249

-----------------------------------------------------------------------

Removal of Certain References to Credit Ratings Under the Securities
Exchange Act of 1934; Final Rule

Federal Register / Vol. 79 , No. 5 / Wednesday, January 8, 2014 /
Rules and Regulations

-----------------------------------------------------------------------

SECURITIES AND EXCHANGE COMMISSION

17 CFR Parts 240 and 249

[Release No. 34-71194; File No. S7-15-11]
RIN 3235-AL14

Removal of Certain References to Credit Ratings Under the
Securities Exchange Act of 1934

AGENCY: Securities and Exchange Commission.

ACTION: Final rule.

-----------------------------------------------------------------------

SUMMARY: The Securities and Exchange Commission (the ``Commission'') is
adopting amendments that remove references to credit ratings in certain
rules and one form under the Securities Exchange Act of 1934 (the
``Exchange Act'') relating to broker-dealer financial responsibility
and confirmations of securities transactions. This action implements a
provision of the Dodd-Frank Wall Street Reform and Consumer Protection
Act (the ``Dodd-Frank Act'').

DATES: The amendments will become effective on July 7, 2014.

FOR FURTHER INFORMATION CONTACT: Michael A. Macchiaroli, Associate
Director, at<PHONE_NUMBER>; Thomas K. McGowan, Deputy Associate
Director, at<PHONE_NUMBER>; Randall W. Roy, Assistant Director, at
(202) 551-5522; Mark M. Attar, Branch Chief, at<PHONE_NUMBER>; Carrie
A. O'Brien, Special Counsel, at<PHONE_NUMBER>; and Rachel B. Yura,
Attorney, at<PHONE_NUMBER>, Office of Financial Responsibility (Net
Capital, Customer Protection, and Books and Records Requirements); and
Joseph M. Furey, Assistant Chief Counsel; and Brice D. Prince, Special
Counsel, Office of the Chief Counsel, at<PHONE_NUMBER> (Confirmations
of Securities Transactions); Division of Trading and Markets,
Securities and Exchange Commission, 100 F Street NE., Washington, DC
20549-7010.

SUPPLEMENTARY INFORMATION: The Commission is adopting amendments to
Rules 10b-10,\1\ 15c3-1,\2\ 15c3-1a,\3\ 15c3-1e,\4\ 15c3-1f,\5\ 15c3-
3,\6\ and 17a-4 \7\ under the Exchange Act and corresponding amendments
to the General Instructions to Form X-17A-5, Part IIB.\8\
---------------------------------------------------------------------------

    \1\ 17 CFR 240.10b-10.
    \2\ 17 CFR 240.15c3-1.
    \3\ 17 CFR 240.15c3-1a.
    \4\ 17 CFR 240.15c3-1e.
    \5\ 17 CFR 240.15c3-1f.
    \6\ 17 CFR 240.15c3-3.
    \7\ 17 CFR 240.17a-4.
    \8\ See the General Instructions to Form X-17A-5, Part IIB
(referenced in 17 CFR 249.617).
---------------------------------------------------------------------------

I. Introduction

    On July 21, 2010, the President signed the Dodd-Frank Act into
law.\9\ This legislation was enacted to, among other things, promote
the financial stability of the United States by improving
accountability and transparency in the financial system.\10\ Section
939A of the Dodd-Frank Act requires each Federal agency, including the
Commission, to review any regulation issued by such agency that
requires the use of an assessment of the creditworthiness of a security
or money market instrument and any references to or requirements in
such regulations regarding credit ratings.\11\ The section further
provides that each such agency shall ``modify any such regulations
identified by the review . . . to remove any reference to or
requirement of reliance on credit ratings, and to substitute in such
regulations such standard of creditworthiness as each respective agency
shall determine as appropriate for such regulations.'' \12\
---------------------------------------------------------------------------

    \9\ See Public Law 111-203, 124 Stat. 1376 (2010).
    \10\ Id. at Preamble.
    \11\ Public Law 111-203 Sec.  939A(a)(1)-(2). In July 2011, the
Commission published a report on the staff's review of Commission
regulations that relied on credit ratings. See Commission Staff,
Report on Review of Reliance on Credit Ratings: As Required by
Section 939A(c) of the Dodd-Frank Wall Street Reform and Consumer
Protection Act (July 2011). Section 939A of the Dodd-Frank Act
applies to all federal agencies.
    \12\ See Public Law 111-203 Sec.  939A(b).
---------------------------------------------------------------------------

II. Discussion

A. Background

    Prior to and after enactment of the Dodd-Frank Act, the Commission
has taken a number of steps toward removing references to credit
ratings from its regulations under the federal securities laws.\13\
These steps include a 2011 proposal to remove references to credit
ratings of nationally recognized statistical rating organizations
(``NRSROs'') from certain rules under the Exchange Act relating to
broker-dealer financial responsibility (Rule 15c3-1, Rule 15c3-3, and
Form X-17A-5, Part IIB), confirmations of securities transactions (Rule
10b-10), and distributions of securities (Rules 101 and 102 of
Regulation M).\14\ Today the Commission is adopting amendments to
remove references to credit ratings in the broker-dealer financial
responsibility and confirmations of transactions rules. In doing so,
the Commission considered its prior actions in this area. Regarding its
proposal to remove credit ratings from its rules under Regulation M
applicable to distributions of securities, the Commission is currently
reviewing comments and considering alternatives and intends to address
this proposal separately.\15\ In taking these actions, the Commission
has carefully considered the eleven comment letters it received in
response to the proposing release,\16\

five of which discussed the proposed amendments to the broker-dealer
financial responsibility rules,\17\ and four of which discussed the
proposed amendments to the confirmations of transactions rule.\18\
---------------------------------------------------------------------------

    \13\ See, e.g., Nationally Recognized Statistical Rating
Organizations, Exchange Act Release No. 34616 (Aug. 31, 1994), 59 FR
46314 (Sep. 7, 1994) (soliciting comment on, among other things,
whether references to NRSRO credit ratings should be eliminated from
Commission rules); Rating Agencies and the Use of Credit Ratings
under the Federal Securities Laws, Exchange Act Release No. 47972
(June 4, 2003), 68 FR 35258 (June 12, 2003) (soliciting comment on
whether to eliminate the use of NRSRO credit ratings, and, if so,
what alternative benchmarks could be used to meet the Commission's
regulatory objectives); References to Ratings of Nationally
Recognized Statistical Rating Organizations, Exchange Act Release
No. 58070 (July 1, 2008), 73 FR 40088 (July 11, 2008) (proposing
amendments to remove references to credit ratings from Commission
rules under the Securities Act of 1933 (``Securities Act''),
Exchange Act, and Investment Company Act of 1940 (``Investment
Company Act'')); References to Ratings of Nationally Recognized
Statistical Rating Organizations, Exchange Act Release No. 60789
(Oct. 5, 2009), 74 FR 52358 (Oct. 9, 2009) (adopting amendments to
remove references to credit ratings in certain Commission rules);
References to Ratings of Nationally Recognized Statistical Rating
Organizations, Exchange Act Release No. 60790 (Oct. 5, 2009), 74 FR
52374 (Oct. 9, 2009) (re-opening comment on proposals to remove
references to credit ratings in certain Commission rules); Security
Ratings, Securities Act Release No. 9186 (Feb. 9, 2011), 76 FR 8961
(Feb. 16, 2011) (proposing amendments to remove references to credit
ratings in certain Commission rules); References to Credit Ratings
in Certain Investment Company Act Rules and Forms, Securities Act
Release No. 9193 (Mar. 3, 2011), 76 FR 12896 (Mar. 9, 2011)
(proposing amendments to remove references to credit ratings in
certain Commission rules); Security Ratings, Securities Act Release
No. 9245 (July 27, 2011), 76 FR 46603 (Aug. 3, 2011) (adopting
amendments to remove references to credit ratings in certain
Commission rules).
    \14\ See Removal of Certain References to Credit Ratings under
the Securities Exchange Act of 1934, Exchange Act Release No. 64352
(Apr. 27, 2011), 76 FR 26550 (May 6, 2011). The Commission also
proposed amendments in 2011 to remove references to credit ratings
in rules under the Securities Act and the Investment Company Act.
See References to Credit Ratings in Certain Investment Company Act
Rules and Forms, 76 FR 12896; Security Ratings, 76 FR 8961.
    \15\ Regulation M is a set of anti-manipulation rules designed
to preserve the integrity of the securities market by prohibiting
activities that could artificially influence the market for an
offered security. See 17 CFR 242.100-105. The rules include an
exception for nonconvertible debt securities, nonconvertible
preferred securities, and asset-backed securities that are rated by
at least one NRSRO in one of its generic rating categories that
signifies investment grade. See 17 CFR 242.101(c)(2); 17 CFR
242.102(d)(2).
    \16\ Comment letter of Chris Barnard (June 6, 2011) (``Barnard
Letter''); comment letter of Creative Investment Research, Inc.
(July 4, 2011) (``Creative Investment Letter''); comment letter of
Rothwell Consulting LLC (July 5, 2011) (``Rothwell Consulting
Letter''); comment letter of Davis Polk & Wardwell LLP (July 5,
2011) (``Davis Polk Letter''); comment letter of Bond Dealers of
America (July 5, 2011) (``Bond Dealers Letter''); comment letter of
the Securities Industry and Financial Markets Association (July 5,
2011) (``SIFMA Letter''); comment letter of Better Markets, Inc.
(July 5, 2011) (``Better Markets Letter''); comment letter of
Sullivan & Cromwell LLP (July 5, 2011) (``Sullivan & Cromwell
Letter''); comment letter of the Securitization Group, Securities
Industry and Financial Markets Association (Sep. 23, 2011) (``SIFMA
Securitization Letter''); comment letter of the CFA Institute (Dec.
20, 2011) (``CFA Institute Letter''); and comment letter of the
Honorable Sean P. Duffy, U.S. House of Representatives (Oct. 4,
2013) (``Duffy Letter''). These comment letters are available at
http://www.sec.gov/comments/s7-15-11/s71511.shtml. Comments are also
available for Web site viewing and printing in the Commission's
Public Reference Room, 100 F Street NE., Washington, DC (File No.
S7-15-11).
    \17\ See Barnard Letter; Better Markets Letter; Bond Dealers
Letter; CFA Institute Letter; SIFMA Letter.
    \18\ See Better Markets Letter; CFA Institute Letter; SIFMA
Letter; Sullivan & Cromwell Letter. In addition, one letter
discussed the proposed amendments to Regulation M and one letter
discussed reference removal under section 939A generally. See
Rothwell Consulting Letter (Regulation M); Duffy Letter (section
939A generally).
---------------------------------------------------------------------------

    A number of other federal agencies have also taken action to
implement section 939A of the Dodd-Frank Act, including regulations
proposed or adopted by the Commodity Futures Trading Commission,\19\
the Office of the Comptroller of the Currency,\20\ the National Credit
Union Administration,\21\ the Federal Housing Finance Agency,\22\ the
Department of Labor,\23\ and jointly by the Office of the Comptroller
of the Currency and the Federal Reserve Board.\24\ The actions taken by
these other regulators were considered in adopting today's amendments.
---------------------------------------------------------------------------

    \19\ See Investment of Customer Funds and Funds Held in an
Account for Foreign Futures and Foreign Options Transactions, 76 FR
78776 (Dec. 19, 2011) (final rule); Removing Any Reference to or
Reliance on Credit Ratings in Commission Regulations; Proposing
Alternatives to the Use of Credit Ratings, 76 FR 44262 (July 25,
2011) (final rule).
    \20\ See Alternatives to the Use of External Credit Ratings in
the Regulations of the OCC, 77 FR 35253 (June 13, 2012) (final
rule).
    \21\ See Alternatives to the Use of Credit Ratings, 77 FR 74103
(Dec. 13, 2012) (final rule).
    \22\ See Removal of References to Credit Ratings in Certain
Regulations Governing the Federal Home Loan Banks, 78 FR 30784 (May
23, 2013) (proposed rule).
    \23\ See Proposed Amendments to Class Prohibited Transaction
Exemptions to Remove Credit Ratings Pursuant to the Dodd-Frank Wall
Street Reform and Consumer Protection Act, 78 FR 37572 (June 21,
2013) (proposed rule).
    \24\ See Regulatory Capital Rules: Regulatory Capital,
Implementation of Basel III, Capital Adequacy, Transition
Provisions, Prompt Corrective Action, Standardized Approach for
Risk-Weighted Assets, Market Discipline and Disclosure Requirements,
Advanced Approaches Risk-Based Capital Rule, and Market Risk Capital
Rule, 78 FR 62018 (Oct. 11, 2013) (interim final rule with request
for comment).
---------------------------------------------------------------------------

    The following discussion summarizes the Commission's proposals with
respect to the broker-dealer financial responsibility and confirmations
of transaction rules, the comments received by the Commission in
response to each of the proposals, and the amendments the Commission is
adopting today.\25\
---------------------------------------------------------------------------

    \25\ In a separate release, the Commission is adopting final
amendments to remove references to credit ratings in Rule 5b-3 and
Forms N-1A, N-2, and N-3 under the Investment Company Act.
---------------------------------------------------------------------------

B. Amendments

1. The Broker-Dealer Financial Responsibility Rules
a. The Net Capital Rule
i. Proposal
    In 1975, the Commission adopted the term nationally recognized
statistical rating organization as part of amendments to the broker-
dealer net capital rule (``Rule 15c3-1'').\26\ The Commission's initial
regulatory use of the term was intended to provide a method for
determining net capital charges on different grades of debt securities
under Rule 15c3-1.\27\ Rule 15c3-1 prescribes a net liquid assets test
that is designed to require a broker-dealer to maintain sufficient
liquid assets to meet all obligations to customers and counterparties
and have adequate additional resources to wind-down its business in an
orderly manner without the need for a formal proceeding if the firm
fails financially.\28\ Among other things, Rule 15c3-1 requires broker-
dealers to maintain specified minimum levels of net liquid assets, or
net capital.\29\ In particular, it requires that a broker-dealer
perform two calculations: (1) a computation of the minimum amount of
net capital the broker-dealer must maintain; \30\ and (2) a computation
of the amount of net capital the broker-dealer is maintaining.\31\ The
minimum net capital requirement is the greater of a fixed-dollar amount
specified in the rule or an amount determined by applying one of two
financial ratios.\32\
---------------------------------------------------------------------------

    \26\ See Adoption of Uniform Net Capital Rule and an Alternative
Net Capital Requirement for Certain Brokers and Dealers, Exchange
Act Release No. 11497 (June 26, 1975), 40 FR 29795 (July 16, 1975);
17 CFR 240.15c3-1.
    \27\ See 17 CFR 240.15c3-1.
    \28\ See Net Capital Rule, Exchange Act Release No. 38248 (Feb.
6, 1997), 62 FR 6474 (Feb. 12, 1997).
    \29\ See 17 CFR 240.15c3-1.
    \30\ See 17 CFR 240.15c3-1(a).
    \31\ See 17 CFR 240.15c3-1(c)(2). The computation of net capital
is based on the definition of net capital in paragraph (c)(2) of
Rule 15c3-1. Id.
    \32\ See 17 CFR 240.15c3-1(a).
---------------------------------------------------------------------------

    In computing net capital, a broker-dealer must, among other things,
make certain adjustments to net worth, including deducting illiquid
assets, taking other net capital charges, and adding qualifying
subordinated loans.\33\ The amount remaining after these adjustments is
defined as tentative net capital.\34\ The final step in computing net
capital is to take prescribed percentage deductions (``haircuts'') from
the mark-to-market value of proprietary positions (e.g., securities,
money market instruments, and commodities) that are included in the
broker-dealer's tentative net capital.\35\ The haircuts are designed to
account for the market risk inherent in these positions and create a
buffer of liquidity to protect against other risks associated with the
securities business.\36\
---------------------------------------------------------------------------

    \33\ See 17 CFR 240.15c3-1(c)(2)(i) through (xiii).
    \34\ See 17 CFR 240.15c3-1(c)(15).
    \35\ See 17 CFR 240.15c3-1(c)(2)(vi).
    \36\ See, e.g., Uniform Net Capital Rule, Exchange Act Release
No. 13635 (June 16, 1977), 42 FR 31778 (June 23, 1977) (``[Haircuts]
are intended to enable net capital computations to reflect the
market risk inherent in the positioning of the particular types of
securities enumerated in [the rule.]''); Net Capital Rule, Exchange
Act Release No. 22532 (Oct. 15, 1985), 50 FR 42961 (Oct. 23, 1985)
(``These percentage deductions, or `haircuts', take into account
elements of market and credit risk that the broker-dealer is exposed
to when holding a particular position.''); Net Capital Rule,
Exchange Act Release No. 39455 (Dec. 17, 1997), 62 FR 67996 (Dec.
30, 1997) (``Reducing the value of securities owned by broker-
dealers for net capital purposes provides a capital cushion against
adverse market movements and other risks faced by the firms,
including liquidity and operational risks.'') (footnote omitted).
---------------------------------------------------------------------------

    Rule 15c3-1 prescribes differing haircut amounts for a variety of
classes of securities.\37\ The rule also contains catchall provisions
to account for securities that are not included in the specified
classes of securities.\38\ Generally, the catchall provisions impose
higher deductions (15% or 40% of the mark-to-market value of the
positions) than the haircuts applicable to the specifically identified
classes of securities.\39\ Further, if a security does not have a ready
market, it is subject to a 100% deduction from net worth.\40\
---------------------------------------------------------------------------

    \37\ See 17 CFR 240.15c3-1(c)(2)(vi)(A) through (H).
    \38\ See 17 CFR 240.15c3-1(c)(2)(vi)(J) through (K).
    \39\ Compare 17 CFR 240.15c3-1(c)(2)(vi)(A) through (H), with 17
CFR 240.15c3-1(c)(2)(vi)(J) through (K).
    \40\ See 17 CFR 240.15c3-1(c)(2)(vii). The term ready market is
defined in Rule 15c3-1 as ``a market in which there exists
independent bona fide offers to buy and sell so that a price
reasonably related to the last sales price or current bona fide
competitive bid and offer quotations can be determined for a
particular security almost instantaneously and where payment will be
received in settlement of a sale at such price within a relatively
short time conforming to trade custom.'' 17 CFR 240.15c3-1(c)(11).

---------------------------------------------------------------------------

    Prior to today's amendments, commercial paper, nonconvertible debt,
and preferred stock rated in higher rating categories by at least two
NRSROs were included in the classes of securities that had lower
haircuts than securities subject to the catchall provisions.\41\
Specifically, to qualify for this treatment, among other things,
commercial paper needed to be rated in one of the three highest rating
categories by at least two NRSROs,\42\ nonconvertible debt needed to be
rated in one of the four highest rating categories by at least two
NRSROs,\43\ and preferred stock needed to be rated in one of the four
highest rating categories by at least two NRSROs.\44\ Broker-dealers
were not required to take as large a haircut for commercial paper,
nonconvertible debt, and preferred stock meeting these rating
conditions because the securities were considered to be less volatile
in price than securities that were rated in lower rating categories or
were unrated.
---------------------------------------------------------------------------

    \41\ See 17 CFR 240.15c3-1(c)(2)(vi)(E), (F), and (H).
Generally, the haircut requirements in Rule 15c3-1 prior to today's
amendments were based on the practice of many NRSROs having at least
eight categories of ratings for debt securities, with the top four
ratings commonly referred to in the industry as investment grade.
    \42\ See 17 CFR 240.15c3-1(c)(2)(vi)(E). The amount of the
haircut ranged from 0% to \1/2\ of 1% depending on the time to
maturity of the commercial paper. Id. Additional conditions to
qualify for this treatment were that the commercial paper had a
maturity at date of issuance not exceeding nine months exclusive of
days of grace, or any renewal thereof, the maturity of which was
likewise limited, and a fixed rate of interest or been sold at a
discount. Id.
    \43\ See 17 CFR 240.15c3-1(c)(2)(vi)(F). The amount of the
haircut ranged from 2% to 9% depending on the time to maturity of
the nonconvertible debt security. Id. Additional conditions to
qualify for this treatment were that the nonconvertible debt
security had a fixed rate of interest, a fixed maturity, and did not
trade flat and was not in default as to principal or interest. Id.
    \44\ See 17 CFR 240.15c3-1(c)(2)(vi)(H). The amount of the
haircut was 10%. Id. Additional conditions to qualify for this
treatment were that the preferred stock ranked prior to all other
classes of stock of the same issuer and was not in arrears as to
dividends. Id.
---------------------------------------------------------------------------

    The Commission proposed to remove references to credit ratings in
the provisions of Rule 15c3-1 establishing lower haircuts for higher
rated commercial paper, nonconvertible debt, and preferred stock and to
substitute an alternative standard of creditworthiness as a condition
for qualifying for the lower haircut treatment.\45\ The proposed
amendments retained the non-credit rating conditions for these classes
of securities to apply lower haircuts. Under the proposal, a broker-
dealer would have been permitted to apply the lower haircuts for
commercial paper (i.e., between zero and \1/2\ of 1%), nonconvertible
debt (i.e., between 2% and 9%), and preferred stock (i.e., 10%) if the
position had only a minimal amount of credit risk as determined by the
broker-dealer pursuant to written policies and procedures the broker-
dealer established, maintained, and enforced to assess
creditworthiness.\46\ Consequently, to use these lower haircuts for
commercial paper, nonconvertible debt, and preferred stock, a broker-
dealer would have been required to establish, maintain, and enforce
written policies and procedures designed to assess the credit risks
applicable to the position and, based on this process, would have had
to determine that the investment had only a minimal amount of credit
risk.\47\ A broker-dealer would have been required to take a larger
deduction, normally the 15% ``catchall'' haircut, on its proprietary
positions in commercial paper, nonconvertible debt, and preferred stock
if the firm did not have procedures to assess the creditworthiness of
the class of security or money market instrument or determined its
position was not of minimal credit risk.\48\ Moreover, if an issuance
of commercial paper, nonconvertible debt, or preferred stock did not
trade in a ready market, the broker-dealer would continue to apply a
100% haircut--meaning that the broker-dealer could not include the
value of the security in its net capital.\49\
---------------------------------------------------------------------------

    \45\ See Removal of Certain References to Credit Ratings under
the Securities Exchange Act of 1934, 76 FR at 26552-26554.
    \46\ Id. at 26552.
    \47\ Id.
    \48\ Id.
    \49\ Id.
---------------------------------------------------------------------------

    In the proposing release, the Commission identified the following
factors a broker-dealer could consider, to the extent appropriate, when
assessing credit risk for purposes of determining whether an issuance
of commercial paper, nonconvertible debt, or preferred stock was of
minimal credit risk: (1) Credit spreads; (2) securities-related
research; (3) internal or external credit risk assessments; (4) default
statistics; (5) inclusion in an index; (6) priorities and enhancements;
(7) price, yield and/or volume; and (8) asset class-specific
factors.\50\ The Commission stated that the list of factors was not
intended to be exhaustive nor mutually exclusive and that the range and
type of specific factors considered would vary depending on the
particular securities that were reviewed.\51\
---------------------------------------------------------------------------

    \50\ Id. at 26552-26553.
    \51\ Removal of Certain References to Credit Ratings under the
Securities Exchange Act of 1934, 76 FR at 26553.
---------------------------------------------------------------------------

    In addition, each broker-dealer would have been required to
preserve for a period of not less than three years (the first two years
in an easily accessible place) the written policies and procedures that
the broker-dealer established, maintained, and enforced for assessing
credit risk for commercial paper, nonconvertible debt, and preferred
stock.\52\ Broker-dealers would have been subject to this requirement
in the broker-dealer record retention rule (Rule 17a-4), which the
Commission proposed to amend in conjunction with the rulemaking.\53\
---------------------------------------------------------------------------

    \52\ Id. at 26553.
    \53\ Id.; see also 17 CFR 240.17a-4.
---------------------------------------------------------------------------

ii. Comments
    Five commenters responded to the Commission's request for comment
on the amendments to Rule 15c3-1.\54\ One additional commenter--writing
about section 939A generally--supported the goals of section 939A to
provide incentive for more information and diligence for investors and
to increase competition in the credit rating agency industry but also
cautioned that implementation of section 939A could be confusing to
smaller banks and investors.\55\ Two commenters raised concerns
generally about replacing credit ratings with a more subjective
standard of creditworthiness.\56\ Three other commenters suggested
modifications to the Commission's list of factors that a broker-dealer
could consider when assessing creditworthiness under the proposed
minimal amount of credit risk standard.\57\ Commenters also generally
supported the Commission's proposal that broker-dealers document and
retain their policies and procedures for assessing a position's
creditworthiness to determine whether it is of minimal credit risk.\58\
---------------------------------------------------------------------------

    \54\ See Barnard Letter; Better Markets Letter; Bond Dealers
Letter; CFA Institute Letter; SIFMA Letter; see also Removal of
Certain References to Credit Ratings under the Securities Exchange
Act of 1934, 76 FR at 26554.
    \55\ See Duffy Letter, at 1.
    \56\ See Bond Dealers Letter, at 2-3; SIFMA Letter, at 11.
    \57\ See Barnard Letter, at 1-2; Better Markets Letter, at 6-7;
CFA Institute Letter, at 4.
    \58\ See Barnard Letter, at 2; Better Markets Letter, at 6-8.
---------------------------------------------------------------------------

    Among commenters raising concerns about the Commission replacing
credit ratings with a more subjective approach for determining
haircuts, one commenter stated that the proposal contains an inherent
conflict of interest, is complicated, and would disproportionately
burden smaller

firms.\59\ This commenter also stated that the Commission's proposal
could result in inconsistent net capital treatment across broker-
dealers absent a mandatory list of factors or an objective standard
that a broker-dealer could apply when determining net capital
haircuts--``[f]or example, one firm may determine a security qualifies
for a 9% haircut, while another might determine the haircut for the
same security is 15%.'' \60\ This commenter also has concerns that a
subjective approach would reduce liquidity, increase volatility, and
could increase costs for issuers of securities.\61\
---------------------------------------------------------------------------

    \59\ Bond Dealers Letter, at 2. This commenter argued that the
proposed amendments disadvantage smaller broker-dealers that lack
the necessary internal resources to determine creditworthiness and,
as a result, will be unable to apply reduced haircuts.
    \60\ Id.
    \61\ Id.
---------------------------------------------------------------------------

    The second commenter expressed concern that Commission and self-
regulatory organization (``SRO'') examiners would ``second guess'' a
broker-dealer's policies and procedures and analysis under the new
standard and that examiners should, instead, focus on the
reasonableness of the policies and procedures.\62\ This commenter also
requested that examiners avoid duplicating the work of other regulators
who have already considered the adequacy of a broker-dealer's policies
and procedures for assessing the creditworthiness of securities
positions.\63\
---------------------------------------------------------------------------

    \62\ SIFMA Letter, at 19.
    \63\ Id. at 20-21.
---------------------------------------------------------------------------

    Regarding the Commission's proposed list of factors that broker-
dealers could consider when assessing creditworthiness under the
minimal amount of credit risk standard, one commenter recommended that
the Commission require broker-dealers to consider certain mandatory
factors and suggested they be codified in the final rule.\64\ In
contrast, another commenter did not believe that factors should be
codified in the rule.\65\ Another stated that a broker-dealer's
assessment of a security's creditworthiness should be based on ``hard''
factors, such as credit spreads and default statistics, rather than
``soft'' factors, such as securities-related research.\66\
---------------------------------------------------------------------------

    \64\ Better Markets Letter, at 5-6.
    \65\ SIFMA Letter, at 20.
    \66\ Barnard Letter, at 2.
---------------------------------------------------------------------------

    One commenter requested that ``term to maturity'' and
``concentration of credit risk'' be included as factors that a broker-
dealer could consider in assessing whether a position is of minimal
credit risk.\67\ Another suggested that a broker-dealer's policies and
procedures for assessing creditworthiness under the proposed standard
be permitted to take into account the ``size of the [broker-dealer's]
position and the purpose for which the position [was] acquired or held
by the broker-dealer.'' \68\ This commenter also stated that a broker-
dealer's obligation to monitor credit determinations should be based on
factors such as the volatility of business conditions within the
relevant industry and the frequency with which the securities
trade.\69\
---------------------------------------------------------------------------

    \67\ CFA Institute Letter, at 4.
    \68\ SIFMA Letter, at 10-11.
    \69\ Id. at 21.
---------------------------------------------------------------------------

    One commenter suggested that a broker-dealer be allowed to rely on
a parent's or an affiliate's credit determination.\70\ Another stated
that, to promote regulatory and market transparency, a broker-dealer
that develops internal credit ratings should be required to compare its
ratings to an external benchmark, such as NRSRO ratings, market data,
or other credit information sources.\71\ Another stated, however, that
a broker-dealer should be prohibited from considering internally or
externally developed credit ratings as part of its credit risk
assessment process and that permitting such use would conflict with
section 939A of the Dodd-Frank Act.\72\
---------------------------------------------------------------------------

    \70\ Id.
    \71\ CFA Institute Letter, at 4.
    \72\ Better Markets Letter, at 7.
---------------------------------------------------------------------------

    Commenters generally supported the Commission's proposal that
broker-dealers document their policies and procedures for determining
creditworthiness under the minimal amount of credit risk standard.\73\
One commenter suggested that such documentation be maintained
indefinitely.\74\ Another stated that the Commission should require a
broker-dealer to maintain a record for each assessment of
creditworthiness under the standard.\75\ Another stated that the
Commission should only require the retention of records for
determinations of credit risk when a broker-dealer is engaged in
``sophisticated credit analysis.'' \76\ This commenter stated that a
broker-dealer should not be required to document its credit analysis
with respect to a position if the analysis was based on a small number
of objective factors and could be easily reconstructed by the broker-
dealer.\77\
---------------------------------------------------------------------------

    \73\ One commenter stated that broker-dealers would otherwise
make self-interested determinations at the expense of customers.
Better Markets Letter, at 6-8. Another commenter stated that these
policies and procedures should be preserved for three years and
updated to reflect significant changes. Barnard Letter, at 2. This
commenter further argued that broker-dealers that create and enforce
procedures to determine creditworthiness be granted the lesser
haircut. Id.
    \74\ Barnard Letter, at 2.
    \75\ Better Markets Letter, at 7-8.
    \76\ SIFMA Letter, at 22.
    \77\ Id.
---------------------------------------------------------------------------

iii. Final Rule
    The Commission is amending Rule 15c3-1 to remove references to
NRSRO credit ratings in the provisions establishing lower haircuts for
commercial paper, nonconvertible debt, and preferred stock. The
Commission is adopting amendments to these provisions with
modifications from the proposal, discussed below, to address issues
raised by commenters.
    Under the final amendments and consistent with the proposal, when a
broker-dealer applies haircuts for commercial paper, nonconvertible
debt, and preferred stock that have a ready market for purposes of its
net capital computation, it will have the option of: (1) Using the
firm's own written policies and procedures to determine whether the
security has only a minimal amount credit risk and, if so, applying the
appropriate lower haircut if it meets the other conditions prescribed
in Rule 15c3-1; or (2) applying the greater deduction applicable to the
position, such as the 15% haircut under the catchall provision in
paragraph (c)(2)(vi)(J) of Rule 15c3-1.\78\ Commercial paper,
nonconvertible debt, and preferred stock without a ready market would
continue to be subject to a 100% haircut.\79\
---------------------------------------------------------------------------

    \78\ See paragraphs (c)(2)(vi)(E), (c)(2)(vi)(F), (c)(2)(vi)(H),
and (c)(2)(vi)(I) of Rule 15c3-1, as amended.
    \79\ See 17 CFR 240.15c3-1(c)(2)(vii).
---------------------------------------------------------------------------

    Unlike the objective approach of using NRSRO credit ratings, the
minimal amount of credit risk standard is a subjective approach because
it allows broker-dealers in the first instance to determine through
their credit assessments whether a lower haircut is applicable to a
given position. Further, whereas the rule prior to today's amendments
required that commercial paper, nonconvertible debt, and preferred
stock be given high credit ratings by an NRSRO before a reduced haircut
is permitted, the minimal amount of credit risk standard provides
flexibility to broker-dealers by allowing them to rely on a variety of
factors, both objective and subjective, in assessing the credit and
liquidity risks associated with their proprietary commercial paper,
nonconvertible debt, and preferred stock positions. However, the
Commission does not intend for the new standard to result in a more
liberal requirement that broadens the scope of

the rule by allowing more positions to qualify for the lower
haircuts.\80\ The Commission notes that credit ratings and market data
(such as credit spreads and yields) can serve as useful benchmarks for
evaluating whether a broker-dealer's policies and procedures, as
applied to the minimal amount of credit risk standard, are increasing
the types of commercial paper, nonconvertible debt, and preferred stock
positions to which it applies the lower haircuts as compared to the
eliminated NRSRO credit rating standard.
---------------------------------------------------------------------------

    \80\ As noted above, to qualify for the lower haircuts under the
NRSRO credit rating standard being replaced today, commercial paper
needed to be rated in one of the three highest rating categories by
at least two NRSROs, nonconvertible debt needed to be rated in one
of the four highest rating categories by at least two NRSROs, and
preferred stock needed to be rated in one of the four highest rating
categories by at least two NRSROs. For an example of one NRSRO's
definitions of its four highest credit rating categories, see
Standard & Poor's Ratings Definitions for long-term issuances
available at http://img.en25.com/Web/StandardandPoors/Ratings_Definitions.pdf. Information about the credit rating categories of
all the NRSROs can be obtained through the Forms NRSRO they file
with the Commission and make publicly available. Links to these
forms are available at http://www.sec.gov/about/offices/ocr.shtml.
---------------------------------------------------------------------------

    The Commission is amending paragraph (c)(2)(vi)(E) of Rule 15c3-1
(relating to commercial paper haircuts), paragraphs (c)(2)(vi)(F)(1)
and (c)(2)(vi)(F)(2) of Rule 15c3-1 (relating to nonconvertible debt
haircuts), and paragraph (c)(2)(vi)(H) of Rule 15c3-1 (relating to
preferred stock haircuts) by replacing references to NRSRO credit
ratings with the alternative minimal amount of credit risk
standard.\81\ Consistent with the proposal, the final rule provides
that a broker-dealer may apply the lower haircuts applicable to
commercial paper (i.e., between 0% and \1/2\ of 1%), nonconvertible
debt (i.e., between 2% and 9%), and preferred stock (i.e., 10%) if the
security has only a minimal amount of credit risk.\82\
---------------------------------------------------------------------------

    \81\ See paragraphs (c)(2)(vi)(E), (c)(2)(vi)(F), and
(c)(2)(vi)(H) of Rule 15c3-1, as amended.
    \82\ Id.
---------------------------------------------------------------------------

    The Commission has made several modifications to its proposed rule
text. First, the Commission has re-structured the rule by adding new
paragraph (c)(2)(vi)(I) to specify requirements for the policies and
procedures a broker-dealer must establish, document, maintain, and
enforce for purposes of assessing whether a position has only a minimal
amount credit risk under paragraphs (c)(2)(vi)(E), (c)(2)(vi)(F)(1),
(c)(2)(vi)(F)(2), and (c)(2)(vi)(H).\83\ Under the proposal, each of
the paragraphs (i.e., paragraphs (c)(2)(vi)(E), (c)(2)(vi)(F)(1),
(c)(2)(vi)(F)(2), and (c)(2)(vi)(H)) separately provided that a broker-
dealer must determine whether a position has only a minimal amount of
credit risk pursuant to ``written policies and procedures the broker-
dealer establishes, maintains, and enforces to assess
creditworthiness.'' \84\ Consistent with the proposal, each paragraph
still requires that the security or money market instrument have only a
minimal amount of credit risk before the lower haircut may be applied;
however the reference to policies and procedures in each paragraph has
been removed. Instead, new paragraph (c)(2)(vi)(I) of Rule 15c3-1
requires the broker-dealer to establish, document, maintain, and
enforce policies and procedures to assess and monitor the
creditworthiness of each security or money market instrument that are
reasonably designed for the purpose of determining whether the position
has only a minimal amount of credit risk.\85\ Securities or money
market instruments assessed to have only a minimal amount of credit
risk also must meet the other non-credit rating conditions prescribed
in Rule 15c3-1 in order to apply the lower haircuts under paragraphs
(c)(2)(vi)(E), (c)(2)(vi)(F)(1), (c)(2)(vi)(F)(2), or
(c)(2)(vi)(H).\86\
---------------------------------------------------------------------------

    \83\ See paragraph (c)(2)(vi)(I) of Rule 15c3-1, as amended.
    \84\ See Removal of Certain References to Credit Ratings under
the Securities Exchange Act of 1934, 76 FR at 26576.
    \85\ See paragraph (c)(2)(vi)(I) of Rule 15c3-1, as amended.
    \86\ Paragraph (c)(2)(vi)(E) of Rule 15c3-1, as amended, retains
the non-credit rating conditions that the commercial paper must have
a maturity at date of issuance not exceeding nine months exclusive
of days of grace, or any renewal thereof, the maturity of which is
likewise limited, and a fixed rate of interest, or be sold at a
discount. See 17 CFR 240.15c3-1(c)(2)(vi)(E). Paragraph
(c)(2)(vi)(F) of Rule 15c3-1, as amended, retains the non-credit
rating conditions that the nonconvertible debt security must have a
fixed rate of interest, a fixed maturity, and not be traded flat or
in default as to principal or interest. See 17 CFR 240.15c3-
1(c)(2)(vi)(F). Paragraph (c)(2)(vi)(H) of Rule 15c3-1, as amended,
retains the non-credit rating conditions that the preferred stock
must rank prior to all other classes of stock of the same issuer and
not be in arrears as to dividends. See 17 CFR 240.15c3-
1(c)(2)(vi)(H). See also 17 CFR 240.15c3-1(c)(2)(vii) (establishing
a 100% deduction for securities for which there is no ready market).
---------------------------------------------------------------------------

    Under the final rule, new paragraph (c)(2)(vi)(I) of Rule 15c3-1
provides that in order to apply a deduction under paragraphs
(c)(2)(vi)(E), (c)(2)(vi)(F)(1), (c)(2)(vi)(F)(2), or (c)(2)(vi)(H),
the broker-dealer must assess the creditworthiness of the security or
money market instrument pursuant to policies and procedures for
assessing and monitoring creditworthiness that the broker-dealer
establishes, documents, maintains, and enforces.\87\ The Commission
added the word ``monitoring'' to clarify that, after the initial
determination by a broker-dealer, a position must continue to have only
a minimal amount of credit risk in order to remain qualified for the
lower haircut and that monitoring must be done in accordance with the
firm's policies and procedures. Under Rule 15c3-1, a broker-dealer must
at ``all times'' have and maintain an amount of net capital that is at
least equal to the minimum amount of net capital required by the
rule.\88\ Consequently, the broker-dealer must monitor its securities
and money market instrument positions in order to ensure that it is
applying the appropriate haircuts to those positions. For example,
under the NRSRO credit rating standard being eliminated today, a
broker-dealer needed to monitor whether the positions it held continued
to have the required credit ratings to apply the lower haircuts because
credit rating agencies may adjust (e.g., downgrade) their credit
ratings. The same is true under the new minimal credit risk standard
because the creditworthiness of a security or money market instrument
can change over time and, consequently, a position that has only a
minimal amount of credit risk at one point in time may not retain that
status.
---------------------------------------------------------------------------

    \87\ See paragraph (c)(2)(vi)(I) of Rule 15c3-1, as amended.
    \88\ See 17 CFR 240.15c3-1(a).
---------------------------------------------------------------------------

    In the proposing release, the Commission requested comment on how
often a broker-dealer should be required to update its assessments.\89\
The Commission received one comment in response to this request.\90\
The commenter stated that the frequency of review ``should be a
function of a number of factors, including, e.g., the size and purpose
of the broker-dealer's position in the fixed-income security, the
volatility of business conditions within the relevant industry, the
amount of fixed-income securities issued, and the frequency with which
the securities trade.'' \91\ The Commission generally agrees with the
commenter that the frequency of review should depend on a variety
factors such as those identified by the commenter. However, as
discussed above, the requirement for a broker-dealer to maintain its
required minimum amount of net capital is moment-to-moment.
Consequently, a broker-dealer's policies and procedures for assessing
whether an issuance of commercial paper, nonconvertible debt, or
preferred stock

has only a minimal amount of credit risk must include a process that is
designed to ensure that its credit determinations are current, and
address the frequency with which the broker-dealer reviews and
reassesses its credit determinations. For example, a broker-dealer's
policies and procedures could require more frequent reassessments in
the case of securities or money market instruments that are close to
the line between having only a minimal amount of credit risk and having
a greater level of credit risk or that are subject to macroeconomic
conditions or issuer specific events that could have an impact on
credit risk. In addition, a higher haircut must be taken when a
security or money market instrument no longer has only a minimal amount
of credit risk. The Commission expects that a broker-dealer's process
for monitoring its credit determinations will be customized to the size
and activities of the firm to ensure that it maintains the required
amount of net capital at ``all times.'' \92\
---------------------------------------------------------------------------

    \89\ See Removal of Certain References to Credit Ratings under
the Securities Exchange Act of 1934, 76 FR at 26554.
    \90\ See SIFMA Letter.
    \91\ Id. at 21.
    \92\ See 17 CFR 240.15c3-1(a).
---------------------------------------------------------------------------

    The Commission also modified the proposed rule text relating to
policies and procedures by including in new paragraph (c)(2)(vi)(I) of
Rule 15c3-1 the qualifier that the policies and procedures must be
``reasonably designed'' for the purpose of assessing
creditworthiness.\93\ As noted above, one commenter raised a concern
that Commission and SRO examiners would ``second guess'' broker-dealer
credit assessments and stated that the regulatory focus on compliance
with the rule should be on the ``reasonableness'' of a firm's policies
and procedures for assessing creditworthiness.\94\ The Commission
agrees that the starting point for reviewing whether a firm is in
compliance with the amendments should be to evaluate the reasonableness
of the firm's policies and procedures in light of the firm's
circumstances (e.g., the size of the broker-dealer and the types and
sizes of the positions typically held by the broker-dealer). In this
regard, the policies and procedures must specify with sufficient detail
the steps the broker-dealer will take in performing a credit assessment
so that Commission and SRO examiners can evaluate them.
---------------------------------------------------------------------------

    \93\ See paragraph (c)(2)(vi)(I) of Rule 15c3-1, as amended.
    \94\ SIFMA Letter, at 19.
---------------------------------------------------------------------------

    However, the Commission also modified the final rule to add new
text that provides that policies and procedures that are reasonably
designed ``should result in assessments of creditworthiness that
typically are consistent with market data.'' \95\ In particular, this
standard for evaluating the reasonableness of a broker-dealer's
policies and procedures will require examiners to compare market data
(e.g., external factors such as credit spreads or yields) with the
broker-dealer's determinations that a security or money market
instrument has only a minimal amount of credit risk. This provision is
designed to address concerns raised by commenters that the proposed
minimal amount of credit risk standard was too subjective.\96\
Commenters raised concerns about requiring the use of a subjective
standard because, among other things, it presents an inherent conflict
of interest, is complicated, could reduce liquidity, and could result
in uncertainty on the part of market participants.\97\ Requiring a
broker-dealer's policies and procedures to produce credit risk
determinations that typically are consistent with market data should
mitigate concerns about potential consequences of the subjectivity
inherent in the final rule. Furthermore, as explained throughout this
release, a broker-dealer can make its credit risk determination
pursuant to policies and procedures that specify the use of a small
number of objective factors and, if a broker-dealer avails itself of
this option, it should help the broker-dealer create a less-complicated
methodology that aligns with market data, therefore easing the concerns
of commenters.
---------------------------------------------------------------------------

    \95\ See paragraph (c)(2)(vi)(I) of Rule 15c3-1, as amended.
    \96\ Bond Dealers Letter, at 2-3; SIFMA Letter, at 3.
    \97\ Bond Dealers Letter, at 2; SIFMA Letter, at 3.
---------------------------------------------------------------------------

    Notwithstanding the reasonableness of a broker-dealer's policies
and procedures, examiners may still question a broker-dealer's credit
risk determination, and are particularly likely to question a
determination related to large concentrated positions or that is not
consistent with market data. In addition, if a broker-dealer
incorrectly determines pursuant to paragraph (c)(2)(vi)(I) of Rule
15c3-1 that a security has only a minimal amount of credit risk, the
broker-dealer could be in violation of Rule 15c3-1 to the extent the
appropriate larger haircut would put the broker-dealer below the
required minimum amount of net capital.\98\ Thus, a broker-dealer would
need to be able to support each credit determination it makes in the
context of a Commission or SRO examination. If the broker-dealer's
determination that a position has only a minimal amount of credit risk
is not consistent with market data, that result would not necessarily
be dispositive that the position is not entitled to the lower haircut.
However, the broker-dealer would have a high burden to demonstrate to
examiners that the position has only a minimal amount of credit risk.
---------------------------------------------------------------------------

    \98\ Calculating a haircut incorrectly also could cause the
broker-dealer to file incorrect reports with the Commission under
Rule 17a-5. See 17 CFR 240.17a-5 (requiring broker-dealers to
periodically file financial reports that, among other things,
contain computations of net capital).
---------------------------------------------------------------------------

    When assessing whether a security or money market instrument has
only a minimal amount of credit risk for purposes of Rule 15c3-1, a
broker-dealer could consider pursuant to the policies and procedures it
establishes, documents, maintains, and enforces the following factors,
to the extent appropriate:
     Credit spreads (i.e., whether it is possible to
demonstrate that a position in commercial paper, nonconvertible debt,
and preferred stock has only a minimal amount of credit risk based on
the spread between the security's yield and the yield on Treasury or
other securities, or based on the spreads of credit default swaps that
reference the security or money market instrument);
     Securities-related research (i.e., whether providers of
research about securities or money market instruments believe the
issuer of the security or money market instrument will be able to meet
its financial commitments, generally, or specifically, with respect to
securities or money market instruments held by the broker-dealer);
     Internal or external credit risk assessments (i.e.,
whether credit assessments developed internally by the broker-dealer or
externally by a credit rating agency, irrespective of its status as an
NRSRO, express a view as to the credit risk associated with a
particular security or money market instrument of the issuer thereof);
     Default statistics (i.e., whether providers of credit
information relating to securities or money market instruments express
a view that specific securities or money market instruments (or their
issuers) have a probability of default consistent with other securities
or money market instruments that have only a minimal amount of credit
risk);
     Inclusion in an index (i.e., whether a security, money
market instrument, or the issuer of a security or money market
instrument, is included as a component of a recognized index of
instruments that have only a minimal amount of credit risk);
     Enhancements and priorities (i.e., the extent to which a
security or money market instrument is covered by credit enhancements,
such as overcollateralization and reserve accounts, or has priority
under

applicable bankruptcy or creditors' rights provisions);
     Price, yield and/or volume (i.e., whether the price and
yield of a security or money market instrument or a credit default swap
that references the security or money market instrument are consistent
with other securities or money market instruments that the broker-
dealer has determined have only a minimal amount of credit risk and
whether the price resulted from active trading); and
     Asset class-specific factors (e.g., in the case of
structured finance products, the quality of the underlying assets).
    The Commission does not intend this list of factors to be
exhaustive or mutually exclusive. For example, other factors may be
appropriate for assessing creditworthiness and, in particular, whether
a position has only a minimal amount of credit risk.
    As noted above, several commenters identified additional factors
that they believe would be appropriate for purposes of assessing
whether a security or money market instrument has only a minimal amount
of credit risk and one commenter suggested making certain factors
mandatory.\99\ Some of these factors, such as the term to maturity of
the security or money market instrument, are already factored into Rule
15c3-1 and therefore do not need to be specifically added to the
list.\100\ The Commission does not believe other factors should be
added because the list is not meant to be exhaustive and broker-dealers
should tailor their policies and procedures for assessing credit risk
to their particular circumstances and specify in their policies and
procedures those factors they deem appropriate, which may include
factors that are not on the list above.\101\ In addition, the
Commission recognizes that a broker-dealer's policies and procedures
may specify the use of different factors, different sets of factors, or
different combinations of factors depending on the characteristics of
the security or money market instrument being assessed, the amount of
time the broker-dealer intends to hold the position, and the size of
the position, among other things. Further, the Commission does not
expect that in order for a broker-dealer's policies and procedures to
be ``reasonably designed'' that they must specify the use of every
factor, or any particular factor, on the list. Certain factors, such as
credit spreads, may not be applicable for bonds that are thinly traded.
Thus, mandating that factor, or any other factor, would not necessarily
help a broker-dealer make a creditworthiness determination. Instead,
each broker-dealer should analyze its unique situation when designing
its policies and procedures, including, for example, its size, the
amount of proprietary trading by the broker-dealer in commercial paper,
nonconvertible debt, and preferred stock, and the size and
characteristics of the positions the firm typically holds, among other
things.
---------------------------------------------------------------------------

    \99\ Better Markets Letter, at 6 (suggesting that the list ``be
more comprehensive'' and include factors such as the nature of the
issuer, the terms of the security, and the financial and regulatory
context in which the issuer is operating); Id. at 3 (``the use of
credit spreads and/or inclusion of an index should be the objective
standard used to determine creditworthiness of these securities'');
CFA Institute Letter, at 4 (suggesting the addition of ``term to
maturity'' and ``concentration of credit risk'' as factors on the
list).
    \100\ See, e.g., 17 CFR 15c3-1(c)(2)(vi)(F)(1) (nonconvertible
debt securities must have a ``fixed maturity date,'' among other
factors, in order to qualify for a reduced haircut).
    \101\ One commenter agreed with the Commission. SIFMA Letter, at
20.
---------------------------------------------------------------------------

    Under the amendments, a broker-dealer must apply a higher
deduction, such as the 15% ``catchall'' haircut, on a proprietary
position in commercial paper, nonconvertible debt, and preferred stock
if the firm determines the security has more than a minimal amount of
credit risk or the firm opts not to have policies and procedures to
assess the creditworthiness of the class of security or money market
instrument.\102\ Moreover, if the commercial paper, nonconvertible
debt, or preferred stock held by the broker-dealer does not trade in a
ready market, the broker-dealer must apply a 100% haircut irrespective
of the firm's credit risk determination.\103\
---------------------------------------------------------------------------

    \102\ See paragraph (c)(2)(vi)(I) of Rule 15c3-1, as amended; 17
CFR 240.15c3-1(c)(2)(vi)(J). If a broker-dealer chooses to apply the
net capital deduction under paragraph (c)(2)(vi)(J) of Rule 15c3-1
instead of making an assessment of the creditworthiness of each
security, the broker-dealer will not be required to have policies
and procedures to assess a security's creditworthiness for purposes
of applying the haircuts prescribed in paragraphs (c)(2)(vi)(E),
(c)(2)(vi)(F)(1), (c)(2)(vi)(F)(2), or (c)(2)(vi)(H) of Rule 15c3-1.
    \103\ See 17 CFR 240.15c3-1(c)(2)(vii). As noted above, the term
ready market is defined in Rule 15c3-1 as ``a market in which there
exists independent bona fide offers to buy and sell so that a price
reasonably related to the last sales price or current bona fide
competitive bid and offer quotations can be determined for a
particular security almost instantaneously and where payment will be
received in settlement of a sale at such price within a relatively
short time conforming to trade custom.'' 17 CFR 240.15c3-1(c)(11).
---------------------------------------------------------------------------

    Under today's amendments, and consistent with the proposed
amendments, a broker-dealer must preserve for a period of not less than
three years, the first two years in an easily accessible place, the
policies and procedures that the broker-dealer establishes, documents,
maintains, and enforces for assessing and monitoring the credit risk of
commercial paper, nonconvertible debt, and preferred stock. This
requirement is codified in new paragraph (b)(13) of Rule 17a-4.\104\
---------------------------------------------------------------------------

    \104\ See paragraph (b)(13) of Rule 17a-4, as amended.
---------------------------------------------------------------------------

    The amendments do not require a broker-dealer to maintain a record
of each of its credit risk determinations for purposes of Rule 15c3-
1.\105\ However, a broker-dealer would need to be able to support each
of its credit risk determinations both for internal risk management
purposes and in the context of a Commission or SRO examination. A
broker-dealer should maintain documentation of its credit risk
determinations for this purpose. Alternatively, a firm that maintains
or can access the data, information, and inputs used to make a credit
risk determination could be in a position to replicate the original
credit risk determination using the same process, information, and
inputs employed to make the original determination.\106\ For example,
if a broker-dealer uses market data to assess creditworthiness, it
should be able to access information showing the data as of the date
the credit risk determination was made.\107\ A broker-dealer that uses
a model with multiple inputs should be able to replicate the model
output upon request or maintain a record of the model output as of the
date of the original credit risk determination.
---------------------------------------------------------------------------

    \105\ Paragraph (b)(5) of Rule 17a-4 provides, in pertinent
part, that a broker-dealer shall preserve for a period of not less
than three years (the first two years in an easily accessible place)
all trial balances and computations of aggregate indebtedness and
net capital (and working papers in connection therewith). See 17 CFR
240.17a-4(b)(5). Working papers relating to credit risk
determinations made for the purposes of computing net capital under
Rule 15c3-1 will need to be preserved under this provision of Rule
17a-4. Id.
    \106\ See SIFMA Letter, at 22.
    \107\ Although not required by today's amendments, a broker-
dealer could choose to keep a record of the market data it used to
make the creditworthiness determination.
---------------------------------------------------------------------------

    The Commission recognizes that requiring a broker-dealer to make
and maintain a record of each credit risk determination, as suggested
by one commenter,\108\ may help facilitate examinations of broker-
dealers, but the Commission believes at this time that requiring
broker-dealers to maintain a record of every credit risk determination
could be burdensome in light of the benefits expected to be obtained.
For example, a broker-dealer may make multiple determinations while
assessing and monitoring the creditworthiness of a particular security.
If the broker-dealer reaches the same result time after time

showing that the security in question has only a minimal amount of
credit risk, the benefits of keeping every determination for three
years, when the broker-dealer has the ability to replicate the relevant
determination for an examiner, could create costs that provide little
benefits, given the examiner will have access to the replicated credit
risk determinations. Furthermore, if market data and other external
factors (e.g., external credit assessments and analysis), strongly
support the broker-dealer's assessment that a security has only a
minimal amount of credit risk, retaining a record of the credit risk
determination may not provide any incremental benefit to examiners. A
broker-dealer that can replicate through application of its policies
and procedures its original analysis to explain the basis of a credit
risk determination should be in a position to demonstrate to examiners
whether it is following its policies and procedures, and whether those
policies and procedures are reasonably designed and effective in
producing credit assessments that typically are consistent with market
data.
---------------------------------------------------------------------------

    \108\ See Better Markets Letter, at 7-8.
---------------------------------------------------------------------------

    The Commission is cognizant of the potential conflict of interest
inherent in a requirement that relies to some extent on the subjective
judgment of the broker-dealer to determine whether a lower haircut
should apply to a commercial paper, nonconvertible debt, or preferred
stock position, as noted by some commenters.\109\ For example, a
broker-dealer may want to hold securities with higher yields to earn
more interest but at the same time apply lower haircuts to the
positions to increase its net capital. This could bias the broker-
dealer's credit assessment towards finding the security has only a
minimal amount of credit risk. As an initial matter, if a broker-dealer
incorrectly determines a position has only a minimal amount of credit
risk and applies a lower haircut, it could lead to the firm failing to
maintain the minimum amount of required net capital in violation of the
rule. As discussed above, the final rule provides that policies and
procedures that are reasonably designed should result in assessments of
creditworthiness that typically are consistent with market data.\110\
This provides objective benchmarks (i.e., market data) to use to
evaluate the broker-dealer's policies and procedures. If a broker-
dealer has policies and procedures in place that are reasonably
designed under the rule, and those policies and procedures are
followed, the potential for bias to be a part of the assessment process
should be mitigated. The Commission also expects that this potential
conflict of interest will be mitigated by the Commission and SRO
examination process, during which Commission and SRO examiners will
review the reasonableness of broker-dealers' policies and procedures,
the assessments that result from those policies and procedures, and the
firms' adherence to the policies and procedures.\111\
---------------------------------------------------------------------------

    \109\ Better Markets Letter, at 5-6; Bond Dealers Letter, at 2;
CFA Institute Letter, at 4.
    \110\ See paragraph (c)(2)(vi)(I) of Rule 15c3-1, as amended.
    \111\ As noted above, broker-dealers that do not keep detailed
records of their credit risk determinations can replicate those
determinations for Commission and SRO examiners to demonstrate that
they followed their policies and procedures for assessing and
monitoring creditworthiness.
---------------------------------------------------------------------------

    The Commission also is aware of the likelihood that broker-dealers
may reach different conclusions when assessing whether a particular
position has only a minimal amount of credit risk,\112\ or may reach
conclusions that are contrary to market data. The Commission expects
that Commission and SRO staff will examine for these types of
differences and raise questions when a broker-dealer consistently
determines that positions have only a minimal amount of credit risk
notwithstanding the fact that external benchmarks (e.g., market data)
in the factors listed above indicate otherwise. A determination that a
position has only a minimal amount of credit risk that is contrary to
some market data points and factors would not necessarily mean that the
broker-dealer has failed to comply with the rule, but the broker-dealer
would have a higher hurdle to overcome to demonstrate that its credit
risk determination is correct. The Commission also notes that if a
broker-dealer determines that a security or money market instrument has
only a minimal amount of credit risk when the position actually does
not meet that standard, and applies a lower haircut, the broker-
dealer's net capital may be less than its minimum net capital
requirement in which case the broker-dealer would be in violation of
the rule.\113\
---------------------------------------------------------------------------

    \112\ Bond Dealers Letter, at 3; SIFMA Letter, at 20.
    \113\ As noted above, applying an incorrect haircut also could
cause the broker-dealer to file incorrect reports with the
Commission under Rule 17a-5. See 17 CFR 240.17a-5 (requiring broker-
dealers to periodically file financial reports that, among other
things, contain computations of net capital).
---------------------------------------------------------------------------

    The Commission understands, as noted by commenters, that the amount
of resources broker-dealers can allocate toward making assessments of
creditworthiness for purposes of Rule 15c3-1 will differ across broker-
dealers and expects that this difference will be reflected in the
policies and procedures for assessing creditworthiness established by
the firms.\114\ For example, a small broker-dealer may not have the
resources to support a credit risk department comprised of analysts
that perform internal credit assessments. In this case, the firm may
establish a process for assessing creditworthiness that relies more on
external factors, such as credit spreads, default statistics, and
credit analysis. A broker-dealer with a large portfolio of debt
securities may instead use an internal approach for assessing
creditworthiness, which takes into consideration a multitude of
factors, such as default probabilities, expected and unexpected losses,
time effects, default correlations, and loss distributions, among other
things. The Commission also anticipates that some broker-dealers,
particularly those that hold few positions, may elect not to devote
resources toward performing credit risk analysis and maintaining
policies and procedures, and instead will apply a greater haircut to
their proprietary positions in commercial paper, nonconvertible debt,
and preferred stock, as permitted by the rule.
---------------------------------------------------------------------------

    \114\ See Bond Dealers Letter, at 3; SIFMA Letter, at 18.
---------------------------------------------------------------------------

    Finally, as discussed above, a broker-dealer (rather than its
parent or an affiliate) must establish, document, maintain, and enforce
the policies and procedures for assessing whether a position has only a
minimal amount of credit risk.\115\ This does not mean that a broker-
dealer cannot incorporate into its own policies and procedures the
credit policies and procedures used by its parent or an affiliate.
However, the broker-dealer must establish, document, maintain, and
enforce its own policies and procedures and apply them itself in making
creditworthiness determinations. It may not simply rely on
determinations made by its parent or an affiliate.
---------------------------------------------------------------------------

    \115\ See SIFMA Letter, at 21.
---------------------------------------------------------------------------

b. Appendix A to Rule 15c3-1
i. Proposal
    Appendix A to Rule 15c3-1 permits broker-dealers to employ a
standardized theoretical option pricing model to determine a potential
loss for a portfolio of listed options positions and related positions
to compute a single haircut for the group of positions.\116\ Under
Appendix A, a broker-dealer groups the options and related positions in
a portfolio and stresses the current market

price for each position at various equidistant points along a range of
positive and negative potential future market movements, using an
approved theoretical option pricing model that satisfies certain
conditions specified in the rule.\117\ Positions that have more
potential price volatility must be stressed across a wider range of
positive and negative potential future market movements than positions
with lower price volatility.\118\ For example, a broker-dealer other
than a non-clearing option specialist or market maker must employ a
range of potential future market movements for major market foreign
currencies of () 6%, whereas the range for all other
foreign currencies is () 20%.\119\ Thus, major market
foreign currency options receive more favorable treatment than options
on all other currencies when using theoretical option pricing models to
compute net capital deductions.\120\
---------------------------------------------------------------------------

    \116\ See 17 CFR 240.15c3-1a(b)(1). Broker-dealers also may
elect a strategy-based methodology. See 17 CFR 240.15c3-1a(b)(2).
    \117\ See 17 CFR 240.15c3-1a(b)(1). Presently, there is only one
theoretical options pricing model that has been approved for this
purpose.
    \118\ See 17 CFR 240.15c3-1a(b)(1)(iii).
    \119\ See 17 CFR 240.15c3-1a(b)(1)(iii)(B) through (C). A
broker-dealer that is a non-clearing option specialist or market
maker must employ a range of potential future market movements for
major market foreign currencies of () 4% (i.e., less
than the () 6% required of other broker-dealers). 17 CFR
240.15c3-1a(b)(1)(iv)(A).
    \120\ See 17 CFR 240.15c3-1a(b)(1)(iii)(B) through (C) and
(b)(1)(iv)(A).
---------------------------------------------------------------------------

    Prior to today's amendments, the rule defined the term major market
foreign currency to mean ``the currency of a sovereign nation whose
short term debt is rated in one of the two highest categories by at
least two nationally recognized statistical rating organizations and
for which there is a substantial inter-bank forward currency market.''
\121\ Further, the rule provided that ``the European Currency Unit
(ECU) shall be deemed a major market foreign currency.'' \122\
---------------------------------------------------------------------------

    \121\ Removal of Certain References to Credit Ratings under the
Securities Exchange Act of 1934, 76 FR at 26554-26555.
    \122\ Id.
---------------------------------------------------------------------------

    With respect to the definition of major market foreign currency,
the Commission proposed to remove the phrase ``whose short-term debt is
rated in one of the two highest categories by at least two nationally
recognized statistical rating organizations.'' \123\ The proposed
change would modify the definition to include foreign currencies only
``for which there is a substantial inter-bank forward currency
market.'' \124\ The Commission also proposed to eliminate the specific
reference in the rule to the European Currency Unit (``ECU''), which
was the only currency explicitly identified in the rule as a major
market foreign currency for the purposes of Appendix A.\125\ As the
Commission stated in the proposing release, because of the
establishment of the euro as the official currency of the euro-zone, a
specific reference to the ECU was no longer needed.\126\ The Commission
also stated that a specific reference to the euro was not necessary, as
it is a foreign currency with a substantial inter-bank forward currency
market.\127\
---------------------------------------------------------------------------

    \123\ Id.
    \124\ Id.
    \125\ Id.
    \126\ Id.
    \127\ Id.
---------------------------------------------------------------------------

ii. Comments
    The Commission received two comment letters in response to its
request for comment.\128\ One commenter supported the proposed
definition of the term major market foreign currency, stating that
``the proposed definition is sufficient to allow broker-dealers to
determine what currencies are `major market foreign currencies.' ''
\129\ Both commenters stated that the Commission should create a list
of major market foreign currencies and update it periodically to
clarify the new definition in Appendix A.\130\ One commenter suggested
that if the Commission chooses not to create a list of major market
foreign currencies, it should propose an alternative measure of
creditworthiness and define the term as one where the currency is
issued by a nation whose sovereign debt presents ``minimal credit
risk.'' \131\
---------------------------------------------------------------------------

    \128\ See Better Markets Letter; CFA Institute Letter; see also
Removal of Certain References to Credit Ratings under the Securities
Exchange Act of 1934, 76 FR at 26555.
    \129\ See CFA Institute Letter, at 4 (``[T]he existence of a
substantial inter-bank forward currency market indicates market
interest and the existence of market oversight and thus provides a
strong indication of market sentiment about the quality of
currencies within that definition.'').
    \130\ Better Markets Letter, at 9; CFA Institute Letter, at 5.
    \131\ See Better Markets Letter, at 9.
---------------------------------------------------------------------------

iii. Final Rule
    For the reasons described below, the Commission is adopting the
amendments to Appendix A as proposed.\132\ Specifically, the Commission
is removing from the definition of major market foreign currency the
phrase ``whose short-term debt is rated in one of the two highest
categories by at least two nationally recognized statistical rating
organizations.'' \133\ The change modifies the definition to include
foreign currencies only ``for which there is a substantial inter-bank
forward currency market.'' \134\ Also, the Commission is eliminating
the specific reference in the rule to the ECU, which was identified, by
rule, as the only major market foreign currency for the purposes of
Appendix A.\135\ As the Commission noted in the proposing release,
specific reference to the ECU is no longer needed because the euro has
been established as the official currency of the euro-zone.\136\
Further, the specific reference to the euro is not necessary as it is a
foreign currency with a substantial inter-bank forward currency market,
consistent with the rule as amended.
---------------------------------------------------------------------------

    \132\ See paragraph (b)(1)(i)(C) of Rule 15c3-1a, as amended.
    \133\ Id.
    \134\ Id.
    \135\ Id.
    \136\ Removal of Certain References to Credit Ratings under the
Securities Exchange Act of 1934, 76 FR at 26555.
---------------------------------------------------------------------------

    In order to retain a degree of flexibility, the Commission is not
codifying in the rule a list of currencies that meet the definition of
major market foreign currency though some commenters requested such a
list. However, broker-dealers may treat a foreign currency as a major
market foreign currency for the purposes of Appendix A if the currency
is a major foreign currency for purposes of applying a 6% (rather than
20%) haircut under Rule 15c3-1. Currently, under a staff
interpretation, broker-dealers are subject to a 6% (rather than 20%)
unhedged currency risk exposure haircut on foreign currency balances
and positions in the euro, the British pound, the Swiss franc, the
Canadian dollar, and the Japanese yen.\137\ The Commission believes the
staff interpretation identifies currencies that all meet the definition
of major market foreign currency for the purposes of Appendix A as they
all have a substantial inter-bank forward currency market.
Consequently, broker-dealers may treat these currencies as major market
foreign currencies under Appendix A. By treating these currencies as
major market foreign currencies, the haircuts applicable to foreign
currencies under Rule 15c3-1 are more closely aligned with the haircuts
applicable to options on the same foreign currencies under

Appendix A.\138\ Given this interpretation identifying certain foreign
currencies that meet the definition of major market foreign currency,
the Commission believes it has addressed the concern raised by one
commenter that, in the absence of a list, the Commission should define
the term as one where the currency is issued by a nation whose
sovereign debt presents minimal credit risk.\139\
---------------------------------------------------------------------------

    \137\ See FINRA Interpretations of Financial and Operational
Rules, Rule 15c3-1(c)(2)(vi)/08, available at http://www.finra.org/web/groups/industry/@ip/<EMAIL_ADDRESS>p. 406 (publishing the staff's interpretation). A 20%
haircut applies to unhedged currency risk exposure on all other
foreign currency balances and positions. Id. These interpretations
are provided to FINRA from the Commission staff in the Division of
Trading and Markets. Broker-dealers can also seek assurance as to
whether another foreign currency meets the definition of major
market foreign currency by, for example, requesting guidance from
the staff.
    \138\ Treating the option consistently with the instrument
underlying the option is supported by Appendix A. For example, under
Appendix A, the range of potential future market movements that must
be employed for a portfolio of equity positions with a ready market
is () 15%. See 17 CFR 240.15c3-1a(b)(1)(iii)(A). Under
Rule 15c3-1, the haircut that must be applied to an equity security
with a ready market is 15%. See 17 CFR 240.15c3-1(c)(2)(vi)(J).
    \139\ See Better Markets Letter, at 9.
---------------------------------------------------------------------------

c. Appendix E to Rule 15c3-1
i. Proposal
    Certain broker-dealers (``ANC broker-dealers'') are approved by the
Commission to use internal value-at-risk (``VaR'') models to determine
market risk charges for proprietary securities and derivatives
positions and to take a credit risk charge in lieu of a 100% charge for
unsecured receivables related to OTC derivatives transactions.\140\
Specifically, under Appendix E to Rule 15c3-1, ANC broker-dealers are
permitted to add back to net worth uncollateralized receivables from
counterparties arising from OTC derivatives transactions (i.e., they
can add back the amount of the uncollateralized current exposure).\141\
Instead of the 100% deduction that applies to most unsecured
receivables under Rule 15c3-1, ANC broker-dealers are permitted to take
a credit risk charge based on the uncollateralized credit exposure to
the counterparty.\142\ In most cases, the credit risk charge is
significantly less than a 100% deduction, since it is a percentage of
the amount of the receivable that otherwise would be deducted in full.
ANC broker-dealers are permitted to use this approach because they are
required to implement processes for analyzing credit risk to OTC
derivative counterparties and to develop mathematical models for
estimating credit exposures arising from OTC derivatives transactions.
---------------------------------------------------------------------------

    \140\ See 17 CFR 240.15c3-1(a)(7); 17 CFR 240.15c3-1e. As part
of the application to use internal models, an entity seeking to
become an ANC broker-dealer must identify the types of positions it
intends to include in its model calculation. See 17 CFR 240.15c3-
1e(a)(1)(iii). After approval, an ANC broker-dealer must obtain
Commission approval to make a material change to the model,
including a change to the types of positions included in the model.
See 17 CFR 240.15c3-1e(a)(8). An ANC broker-dealer must maintain
minimum tentative net capital of at least $1 billion and minimum net
capital of at least $500 million. See 17 CFR 240.15c3-1(a)(7)(i).
The Commission has proposed raising these requirements to $5 billion
and $1 billion, respectively. See Capital, Margin, and Segregation
Requirements for Security-Based Swap Dealers and Major Security-
Based Swap Participants and Capital Requirements for Broker-Dealers,
Exchange Act Release No. 68071 (Oct. 18, 2012), 77 FR 70213 (Nov.
23, 2012).
    \141\ See 17 CFR 240.15c3-1e(c).
    \142\ See 17 CFR 240.15c3-1e(c); 17 CFR 240.15c3-1(a)(7). The
Commission has proposed narrowing this treatment of OTC derivatives
exposures so that it would apply only to uncollateralized
receivables from commercial end users arising from security-based
swaps (i.e., uncollateralized receivables from other types of
counterparties would be subject to the 100% deduction from net
worth). See Capital, Margin, and Segregation Requirements for
Security-Based Swap Dealers and Major Security-Based Swap
Participants and Capital Requirements for Broker-Dealers, 77 FR at
70240-70244.
---------------------------------------------------------------------------

    Under Appendix E, the credit risk charge is the sum of three
calculated amounts: (1) A counterparty exposure charge; (2) a
concentration charge if the current exposure to a single counterparty
exceeds certain thresholds; and (3) a portfolio concentration charge if
aggregate current exposure to all counterparties exceeds certain
thresholds.\143\ The first component of the credit risk charge is the
counterparty exposure charge.\144\ The exposure charge for a given
counterparty (other than a counterparty that is insolvent, in a
bankruptcy proceeding, or in default of an obligation on its senior
debt) is the credit equivalent amount of the ANC broker-dealer's
exposure to the counterparty multiplied by an applicable credit risk
weight factor and then multiplied by 8%.\145\ The credit equivalent
amount is the sum of the ANC broker-dealer's: (1) Maximum potential
exposure (``MPE'') to the counterparty multiplied by a back-testing
determined factor; and (2) current exposure to the counterparty.\146\
The MPE amount is a charge to address potential future exposure and is
calculated using the ANC broker-dealer's VaR model as applied to the
counterparty's positions after giving effect to a netting agreement
with the counterparty, taking into account collateral received from the
counterparty, and taking into account the current replacement value of
the counterparty's positions.\147\ The current exposure amount is the
current replacement value of the counterparty's positions after giving
effect to a netting agreement with the counterparty and taking into
account collateral received from the counterparty.\148\ The
counterparty exposure charge is the sum of the MPE and current exposure
amounts multiplied by an applicable credit risk weight factor and then
multiplied by 8%.\149\ Appendix E to Rule 15c3-1 prescribes three
standardized credit risk weight factors (20%, 50%, and 150%) for
transactions with counterparties and, as an alternative, permits an ANC
broker-dealer with Commission approval to use internal methodologies to
determine appropriate credit risk weights to apply to
counterparties.\150\ A higher percentage credit risk weight factor
results in a larger counterparty exposure charge amount. Prior to
today's amendments, ANC broker-dealers were permitted to use NRSRO
credit ratings or internally derived credit ratings to determine the
appropriate risk weight factor.
---------------------------------------------------------------------------

    \143\ 17 CFR 240.15c3-1e(c).
    \144\ 17 CFR 240.15c3-1e(c)(1).
    \145\ See 17 CFR 240.15c3-1e(c)(1)(ii).
    \146\ See 17 CFR 240.15c3-1e(c)(4)(i). The amount of the factor
is based on back-testing exceptions.
    \147\ See 17 CFR 240.15c3-1e(c)(4)(ii).
    \148\ See 17 CFR 240.15c3-1e(c)(4)(iii).
    \149\ See 17 CFR 240.15c3-1e(c)(1)(ii).
    \150\ See 17 CFR 240.15c3-1e(c)(4)(vi).
---------------------------------------------------------------------------

    The Commission proposed removing paragraphs (c)(4)(vi)(A) through
(c)(4)(vi)(D) of Appendix E, which specify the appropriate risk weight
factor of counterparties based on NRSRO credit ratings.\151\
Consequently, under the proposal, an ANC broker-dealer would need to
determine credit risk charges using internal credit ratings or to take
a 100% capital charge with respect to the exposure to the
counterparty.\152\ By removing the option to use NRSRO credit ratings,
a broker-dealer that applies to use the approach set forth in Appendix
E would need to describe how it will determine the applicable
counterparty credit risk charge based on internal credit ratings as
part of its initial application to the Commission.\153\
---------------------------------------------------------------------------

    \151\ See Removal of Certain References to Credit Ratings under
the Securities Exchange Act of 1934, 76 FR at 26555-26556.
    \152\ Id.
    \153\ Id. at 26555.
---------------------------------------------------------------------------

ii. Comments
    The Commission received two comments in response to its request for
comment.\154\ One commenter supported the proposed removal of NRSRO
credit ratings as an option but raised two concerns.\155\ The commenter
stated first that an internal model may not take into account
concentration of risk with a specific counterparty, and second that ANC
firms will apply low risk weights

to all but the most illiquid instruments.\156\
---------------------------------------------------------------------------

    \154\ Better Markets Letter; CFA Institute Letter; see also
Removal of Certain References to Credit Ratings under the Securities
Exchange Act of 1934, 76 FR at 26555-26556.
    \155\ CFA Institute Letter, at 5-6.
    \156\ Id.
---------------------------------------------------------------------------

    Another commenter suggested that the factors listed in the
proposing release with respect to determining creditworthiness under
Rule 15c3-1 should become part of Appendix E.\157\ This commenter
further argued that the factors each broker-dealer needed to use to
make the determination should be explicitly stated in the rule.\158\
---------------------------------------------------------------------------

    \157\ Better Markets Letter, at 10.
    \158\ Id.
---------------------------------------------------------------------------

iii. Final Rule
    The Commission is adopting the amendments to Appendix E to Rule
15c3-1 as proposed.\159\ The amendments remove paragraphs (c)(4)(vi)(A)
through (c)(4)(vi)(D) of Appendix E to Rule 15c3-1, which specify the
appropriate risk weight factor based on NRSRO credit ratings.\160\ By
removing the provisions utilizing NRSRO credit ratings, the final rule
requires an ANC broker-dealer to determine the appropriate risk weight
factor using internal credit ratings or to take a 100% capital charge
with respect to the exposure to the counterparty.\161\
---------------------------------------------------------------------------

    \159\ See paragraph (c)(4)(vi) of Rule 15c3-1e, as amended.
    \160\ Id.
    \161\ Id.
---------------------------------------------------------------------------

    All ANC broker-dealers calculate credit risk charges using internal
credit ratings (rather than using NRSRO credit ratings approach) or
take a 100% capital charge with respect to the exposure to the
counterparty risk.\162\ Consequently, removing the option to use NRSRO
credit ratings will not have an immediate effect on these broker-
dealers. A broker-dealer that applies to become an ANC broker-dealer
will need to describe how it will determine internal credit ratings for
the purpose of determining the applicable credit charges for
counterparty risk in its application to the Commission.
---------------------------------------------------------------------------

    \162\ Currently, there are six ANC broker-dealers: Barclays
Capital Inc.; Citigroup Global Markets, Inc.; Goldman Sachs & Co.;
J.P. Morgan Chase Securities LLC; Merrill Lynch Pierce Fenner &
Smith Incorporated; and Morgan Stanley & Co. Incorporated.
---------------------------------------------------------------------------

    In taking this action, the Commission has considered the views of
commenters \163\ and determined that whether a model adequately
considers risks associated with a counterparty or a specific instrument
is a concern that should be addressed during the initial review of the
ANC broker-dealer's model, as well as during the monitoring and
examination of the firm.\164\ The amendments also do not incorporate
the minimal amount of credit risk standard from Rule 15c3-1 into
Appendix E, as suggested by one commenter.\165\ This standard is
replacing a binary NRSRO credit rating standard under which the
application of a lower or higher haircut amount depends on whether the
commercial paper is rated in the top three rating categories and the
nonconvertible debt and preferred stock is rated in the top four rating
categories. Consequently, a given instrument either meets the
requirement to apply a lower haircut amount or is subject to the higher
amount. The NRSRO credit rating standard in Appendix E to Rule 15c3-1
is not binary in that there are three different credit risk weights
(20%, 50%, and 150%) that are determined by three different levels of
credit rating: The two highest rating categories; the third and fourth
highest rating categories; and below the fourth highest rating. Thus,
the minimal amount of credit risk standard would not be a suitable
replacement for the NRSRO credit ratings standard because the minimal
amount of credit risk standard, as drafted for Rule 15c3-1, would apply
only to the second gradation (the third and fourth highest rating
categories).\166\
---------------------------------------------------------------------------

    \163\ CFA Institute Letter, at 5; Better Markets Letter, at 10.
    \164\ See, e.g., 17 CFR 15c3-1e(a)(1)(iv).
    \165\ Better Markets Letter, at 10.
    \166\ See 15 CFR 15c3-1e(c)(4)(vi)(B).
---------------------------------------------------------------------------

    In addition, as stated throughout this release, the Commission has
determined not to mandate that a broker-dealer use any specific factor
in its credit analysis. Consequently, the Commission does not believe
it would be appropriate to codify the list of factors in the rule as
suggested by one commenter.
d. Appendix F to Rule 15c3-1 and Form X-17A-5, Part IIB
i. Proposal
    Similar to ANC broker-dealers, a type of limited purpose broker-
dealer that deals solely in OTC derivatives (an ``OTC derivatives
dealer'') is permitted, with Commission approval, to calculate net
capital using internal models as the basis for taking market risk and
credit risk charges in lieu of the standardized haircuts for classes of
positions for which they have been approved to use VaR models.\167\
Specifically, under Appendix F to Rule 15c3-1, OTC derivatives dealers
are permitted to add back to net worth uncollateralized receivables
from counterparties arising from OTC derivatives transactions (i.e.,
they can add back the amount of the uncollateralized current exposure).
Instead of the 100% deduction that applies to most unsecured
receivables under Rule 15c3-1, OTC derivatives dealers are permitted to
take a credit risk charge based on counterparty factors and
concentration charges.\168\ In most cases, the counterparty factors and
concentration charges are significantly less than a 100% deduction,
since the charges are a percentage of the amount of the receivable that
otherwise would be deducted in full. OTC derivatives dealers are
permitted to use this approach because they are required to implement
processes for analyzing credit risk to OTC derivative counterparties
and to develop mathematical models for estimating credit exposures
arising from OTC derivative transactions.
---------------------------------------------------------------------------

    \167\ See 17 CFR 240.15c3-1(a)(5); 17 CFR 240.15c3-1f. As part
of the application to use internal models, an entity seeking to
become an OTC derivatives dealer must identify the types of
positions it intends to include in its model calculation. See 17 CFR
240.15c3-1f(a)(1)(ii). After approval, an OTC derivatives dealer
must obtain Commission approval to make a material change to the
model, including a change to the types of positions included in the
model. See 17 CFR 240.15c3-f(a)(3). OTC derivatives dealers are
exempt from certain broker-dealer requirements, including membership
in an SRO (17 CFR 240.15b9-2), broker-dealer margin rules (17 CFR
240.36a1-1), and application of the Securities Investor Protection
Act of 1970 (17 CFR 240.36a1-2). OTC derivatives dealers are subject
to special requirements, including limitations on the scope of their
securities activities (17 CFR 240.15a-1), specified internal risk
management control systems (17 CFR 240.15c3-4), recordkeeping
obligations (17 CFR 240.17a-3(a)(10)), and reporting
responsibilities (17 CFR 240.17a-12). They are also subject to
alternative net capital treatment (17 CFR 240.15c3-1(a)(5)). See 17
CFR 240.15a-1, Preliminary Note. The minimum net capital
requirements for an OTC derivatives dealer are tentative net capital
of at least $100 million and net capital of at least $20 million.
See 17 CFR 240.15c3-1(a)(5) and (c)(15).
    \168\ See 17 CFR 240.15c3-1f(d); 17 CFR 240.15c3-1(a)(5).
---------------------------------------------------------------------------

    Under Appendix F to Rule 15c3-1, OTC derivatives dealers are
required to deduct from their net capital credit risk charges that take
counterparty risk into consideration.\169\ This charge has two parts
and is computed on a counterparty-by-counterparty basis. First, for
each counterparty with an investment or speculative grade rating, an
OTC derivatives dealer must take a net capital charge equal to the net
replacement value in the account of the counterparty (``net replacement
value'') multiplied by 8%, and further multiplied by a counterparty
factor.\170\ As part of this deduction, the OTC derivatives dealer must
apply a counterparty risk weight factor of either 20%, 50%, or
100%.\171\ Prior to today's amendments, the counterparty risk weight
factor (i.e., 20%, 50%, or 100%) was determined using either NRSRO

credit ratings or the firm's internal credit ratings.\172\
---------------------------------------------------------------------------

    \169\ See 17 CFR 240.15c3-1f(d).
    \170\ See 17 CFR 240.15c3-1f(d)(2).
    \171\ See 17 CFR 240.15c3-1f(d)(2)(i) through (iii).
    \172\ See 17 CFR 240.15c3-1f(d)(2) and (4).
---------------------------------------------------------------------------

    The second part of the credit risk charge consists of a
concentration charge that applies when the net replacement value in the
account of any one counterparty exceeds 25% of the OTC derivatives
dealer's tentative net capital.\173\ The concentration charge increases
in relation to the OTC derivatives dealer's exposure to lower rated
counterparties.\174\ Prior to today's amendments, this concentration
charge was also determined using either NRSRO credit ratings or the
firm's internal credit ratings. Currently, OTC derivatives dealers do
not use NRSRO credit ratings to determine their counterparty factors
and concentration charges.
---------------------------------------------------------------------------

    \173\ See 17 CFR 240.15c3-1f(d)(3).
    \174\ For counterparties that are highly rated, the
concentration charge equals 5% of the amount of the net replacement
value in excess of 25% of the OTC derivatives dealer's tentative net
capital. 17 CFR 240.15c3-1f(d)(3)(i). The concentration charge for
counterparties with ratings among the lowest rating categories would
equal 50% of the amount of the net replacement value in excess of
25% of the OTC derivatives dealer's tentative net capital. 17 CFR
240.15c3-1f(d)(3)(iii).
---------------------------------------------------------------------------

    The Commission proposed to amend paragraphs (d)(2), (d)(3)(i),
(d)(3)(ii), (d)(3)(iii), and (d)(4) of Appendix F to Rule 15c3-1, which
permit the use of NRSRO ratings (as an alternative to internal credit
ratings) to determine an OTC derivatives dealer's counterparty factors
and concentration charges. Because the proposal would eliminate the
option to use NRSRO credit ratings, a broker-dealer that applies to
become an OTC derivatives dealer and operate under Appendix F will
need, as part of its initial application, to request Commission
approval to use internal credit ratings (as the option to use NRSRO
credit ratings is being eliminated). The OTC derivatives dealer would
need to describe how it will determine the applicable counterparty
factors and concentration charges as part of its initial application to
the Commission.
    As part of its proposal, the Commission also proposed conforming
amendments to the General Instructions to Form X-17A-5, Part IIB. This
form constitutes the basic financial and operational report OTC
derivatives dealers are required to file with the Commission. Under the
heading ``Computation of Net Capital and Required Net Capital,'' the
Commission proposed making conforming changes to the section ``Credit
risk exposure.'' This section instructs an OTC derivatives dealer on
how to compute the counterparty credit risk charges for purposes of the
dealer's net capital computation. The proposed amendments to the
instructions would eliminate references to NRSRO credit ratings for
purposes of determining these charges.
ii. Comments
    The Commission received two comments in response to its request for
comment.\175\ One commenter suggested that the Commission require OTC
derivatives dealers to use counterparty factors similar to those
proposed under Appendix E discussed above (e.g., 20%, 50% or 150% risk
weights based on internal credit ratings to determine capital
deductions) and argued against requiring OTC derivatives dealers to
reapply to the Commission to use internal credit ratings.\176\ This
commenter also expressed concern that an OTC derivatives dealer's
internal model may not take into account concentration of risk with a
specific counterparty.\177\
---------------------------------------------------------------------------

    \175\ CFA Institute Letter; Better Markets Letter; see also
Removal of Certain References to Credit Ratings under the Securities
Exchange Act of 1934, 76 FR at 26556.
    \176\ CFA Institute Letter, at 6.
    \177\ Id.
---------------------------------------------------------------------------

    The second commenter suggested that the Commission ``supply an
appropriate alternative standard of creditworthiness that derivatives
dealers must apply'' such as ``an explicit set of factors that will
appropriately gauge the credit risk associated with counterparties in
derivatives transactions.'' \178\
---------------------------------------------------------------------------

    \178\ Better Markets Letter, at 10, n.15.
---------------------------------------------------------------------------

iii. Final Rule
    The Commission is adopting the amendments to Appendix F to Rule
15c3-1 as proposed.\179\ Specifically, the amendments remove the use of
NRSRO credit ratings from paragraphs (d)(2), (d)(3)(i), (d)(3)(ii),
(d)(3)(iii), and (d)(4) of Appendix F to Rule 15c3-1, which, prior to
today's amendments, permitted the use of NRSRO ratings when determining
counterparty credit risk and concentration charges.\180\ Because the
amendments remove the option to use NRSRO credit ratings, a broker-
dealer that applies to become an OTC derivatives dealer will need, as
part of its initial application, to request Commission approval to use
internal credit ratings (as the option to use NRSRO credit ratings is
being eliminated). The applicant will need to describe how it will use
internal credit ratings to determine the applicable credit risk charges
for counterparty risk in its application to the Commission. The current
OTC derivatives dealers will not need to seek new approval from the
Commission.\181\
---------------------------------------------------------------------------

    \179\ See paragraph (d) of Rule 15c3-1f, as amended.
    \180\ See paragraphs (d)(2), (d)(3)(i), (d)(3)(ii), (d)(3)(iii),
and (d)(4) of Rule 15c3-1f, as amended.
    \181\ Currently, four firms are operating pursuant to Appendix F
to Rule 15c3-1. These firms are: Credit Suisse Capital LLC; Goldman
Sachs Financial Markets, L.P.; Merrill Lynch Financial Markets,
Inc.; and Natixis Derivatives Inc. Natixis Derivatives, Inc. filed a
Form BDW on October 17, 2013.
---------------------------------------------------------------------------

    The Commission also is adopting the conforming amendments to the
General Instructions to Form X-17A-5, Part IIB as proposed.
    Consistent with the discussion above relating to Appendix E to Rule
15c3-1, the Commission has determined that whether a model adequately
considers concentration risk with a specific counterparty is a concern
that is best addressed during the initial review of, or an amendment
to, an OTC derivatives dealer's model as well as during the monitoring
and examination of the OTC derivatives dealer.\182\ Further, as stated
above, the current OTC derivatives dealers do not use NRSRO ratings to
compute the credit risk and concentration charges under Appendix F.
Thus, the amendments will not impact these firms.
---------------------------------------------------------------------------

    \182\ See, e.g., 17 CFR 15c3-1f(a)(1)(ii); see also CFA
Institute Letter, at 6.
---------------------------------------------------------------------------

    The Commission is not adopting an alternative standard in the rule,
such as the minimal amount of credit risk standard. As discussed above,
the minimal amount of credit risk standard is replacing a binary NRSRO
credit rating standard under which the application of a lower or higher
haircut amount depends on whether the commercial paper is rated in the
top three rating categories and the nonconvertible debt and preferred
stock is rated in the top four rating categories. Consequently, a given
instrument either meets the requirement to apply a lower haircut amount
or is subject to the higher amount. The NRSRO credit rating standard in
Appendix F to Rule 15c3-1 is not binary in that there are three ranges
of credit ratings to determine the applicable risk weight factors and
concentration charges: The two highest rating categories; the third and
fourth highest rating categories; and below the fourth highest rating
category. Thus, the minimal amount of credit risk standard would not be
a suitable replacement for the credit risk charges required under
Appendix F to Rule 15c3-1 because the minimal amount of credit risk
standard, as drafted for Rule 15c3-1, would apply only to the second

range (the third and fourth highest rating categories).\183\
---------------------------------------------------------------------------

    \183\ See 17 CFR 240.15c3-1f(d)(2)(ii); 17 CFR 240.15c3-
1f(d)(3)(ii).
---------------------------------------------------------------------------

    In addition, as stated throughout this release, the Commission has
determined not to mandate that a broker-dealer use any specific factor
in its credit analysis; instead, each firm will need to tailor its
procedures for determining credit risk to the broker-dealer's business
model.\184\
---------------------------------------------------------------------------

    \184\ Better Markets Letter, at 10, n.15.
---------------------------------------------------------------------------

e. Appendix G to Rule 15c3-1
    Appendix G to Rule 15c3-1 provides that broker-dealers may use the
ANC computation only if their ultimate holding companies agree to
provide the Commission with additional information about the financial
condition of the holding company and its affiliates.\185\ Appendix G is
intended to provide the Commission with certain information to assess
the financial and operational health of the ultimate holding company
and its potential impact on the risk exposure of the broker-
dealer.\186\ Paragraph (a) of Appendix G sets forth a methodology for
computing allowable capital and allowances for market and credit risk
at the consolidated holding company level. One aspect of calculating
credit risk in Appendix G provided that those firms must use credit
ratings in accordance with the applicable provisions of Appendix E.
Since those provisions in Appendix E are being deleted, the Commission
proposed deleting the corresponding references to those provisions in
Appendix G.\187\ Specifically, the Commission proposed to delete
references in paragraph (a)(3)(i)(F) of Appendix G that correspond to
the provisions of Appendix E that the Commission is deleting as
described above.\188\
---------------------------------------------------------------------------

    \185\ 17 CFR 240.15c3-1g.
    \186\ Id. Currently, each broker-dealer that uses the ANC
computation has an ultimate holding company that has a principal
regulator.
    \187\ See Removal of Certain References to Credit Ratings under
the Securities Exchange Act of 1934, 76 FR at 26556-26557.
    \188\ Id.
---------------------------------------------------------------------------

    The Commission received no comments addressing these changes.\189\
The Commission is amending Appendix G to Rule 15c3-1 as proposed.\190\
Accordingly, the Commission is adopting a conforming amendment to
Appendix G that deletes references in paragraph (a)(3)(i)(F) of
Appendix G that correspond to the provisions of Appendix E that the
Commission is deleting as described above.\191\
---------------------------------------------------------------------------

    \189\ Id. at 26557.
    \190\ See paragraph (a)(3)(i)(F) of Rule 15c3-1g, as amended.
    \191\ Id.
---------------------------------------------------------------------------

f. Exhibit A to Rule 15c3-3
    Rule 15c3-3 (the ``Customer Protection Rule'') under the Exchange
Act is designed to protect customer funds and securities held by
broker-dealers.\192\ To meet this objective, Rule 15c3-3 requires a
broker-dealer that maintains custody of customer securities and cash (a
``carrying broker-dealer'') to take two primary steps to safeguard
these assets. The steps are designed to protect customers by
segregating their securities and cash from the broker-dealer's
proprietary business activities. If the broker-dealer fails
financially, the securities and cash should be readily available to be
returned to the customers. In addition, if the failed broker-dealer is
liquidated in a formal proceeding under the Securities Investor
Protection Act of 1970, the securities and cash should be isolated and
readily identifiable as customer property and, consequently, available
to be distributed to customers ahead of other creditors.\193\
---------------------------------------------------------------------------

    \192\ 17 CFR 240.15c3-3.
    \193\ See 15 U.S.C. 78aaa et seq.
---------------------------------------------------------------------------

    The first step to safeguard customer assets under Rule 15c3-3
requires a carrying broker-dealer to maintain possession or control of
all fully paid and excess margin securities of its customers.\194\
Physical possession or control means the broker-dealer must hold these
securities in one of several locations specified in Rule 15c3-3 and
free of liens or any other interest that could be exercised by a third
party to secure an obligation of the broker-dealer.\195\ Permissible
locations include a bank, as defined in section 3(a)(6) of the Exchange
Act, and a clearing agency.\196\ A broker-dealer must make a daily
determination of the amount of fully paid and excess margin securities
it holds for customers and compare it to the amount actually held in
the permissible locations in order to comply with this aspect of the
rule.\197\
---------------------------------------------------------------------------

    \194\ 17 CFR 240.15c3-3(b)(1).
    \195\ 17 CFR 240.15c3-3(c).
    \196\ 17 CFR 240.15c3-3(c).
    \197\ 17 CFR 240.15c3-3(d).
---------------------------------------------------------------------------

    The second step covers customer funds and requires that a carrying
broker-dealer must maintain a reserve of cash or qualified securities
in one or more accounts at a bank that is at least equal in value to
the net cash owed to customers and the amount of cash obtained from the
use of customer securities.\198\ The account must be titled ``Special
Account for the Exclusive Benefit of Customers of the Broker-Dealer''
(``customer reserve account'').\199\ The amount of cash and/or
qualified securities that must be kept in the customer reserve account
is computed pursuant to a formula set forth in Exhibit A to Rule 15c3-
3.\200\ Under the Exhibit A formula, the broker-dealer adds customer
credit items (e.g., cash in customer securities accounts) and then
subtracts from that amount customer debit items (e.g., margin
loans).\201\ If credit items exceed debit items, the net amount must be
on deposit in the customer reserve account in the form of cash and/or
qualified securities.\202\ If the debits exceed credits, no deposit is
necessary. Funds deposited in a customer reserve account cannot be
withdrawn until the broker-dealer completes another computation that
shows that the broker-dealer has on deposit more funds than the reserve
formula requires.
---------------------------------------------------------------------------

    \198\ 17 CFR 240.15c3-3(e).
    \199\ 17 CFR 240.15c3-3(e)(1).
    \200\ 17 CFR 240.15c3-3a.
    \201\ 17 CFR 240.15c3-3a.
    \202\ 17 CFR 240.15c3-3(e).
---------------------------------------------------------------------------

    Under Note G to Exhibit A, a carrying broker-dealer may include
margin collateral for transactions in security futures products as a
debit in its reserve formula computation if that margin collateral is
required and on deposit at a clearing agency or derivatives clearing
organization that meets at least one of four conditions: (1) The
clearing agency or derivatives clearing organization maintains the
highest investment-grade rating from an NRSRO; (2) the clearing agency
or derivatives clearing organization maintains security deposits from
clearing members in connection with regulated options or futures
transactions and assessment power over member firms that equal a
combined total of at least $2 billion, at least $500 million of which
must be in the form of security deposits; (3) the clearing agency or
derivatives clearing organization maintains at least $3 billion in
margin deposits; or (4) the clearing agency or derivatives clearing
organization obtains an exemption from the Commission.
    Margin collateral that is posted for customer positions in security
futures products constitutes an unsecured receivable from the clearing
agency or derivatives clearing organization. Therefore, requiring a
clearing agency or a derivatives clearing organization to meet certain
minimum creditworthiness criteria before margin collateral deposited
with that entity may be included as a debit in a broker-dealer's
customer reserve formula is consistent with the customer protection
function of Rule 15c3-3 because the debit offsets any credits when
computing the customer reserve deposit requirement.

Accordingly, this requirement is intended to provide reasonable
assurance that customer margin collateral deposited with a clearing
agency or derivatives clearing organization related to security futures
products will be available to be returned to the broker-dealer and,
therefore, can serve as an appropriate offset to customer credits in
the reserve formula.
    The Commission proposed to remove the first criterion described
above (i.e., the highest investment-grade rating from an NRSRO).\203\
The criteria are disjunctive and, therefore, a clearing agency or
derivatives clearing organization needs to satisfy only one criterion
to permit a broker-dealer to treat posted customer margin collateral as
a reserve formula debit. In the proposing release, the Commission
stated that the proposed amendment would not lessen the protections for
customer funds and securities.\204\ While one potential criterion would
be removed, currently, only the Options Clearing Corporation (``OCC'')
clears and accepts margin on security futures products. The OCC
qualifies under two of the other criteria in Note G.\205\ If at a later
date another clearing entity accepts margin on security futures
products, and it did not meet one of the remaining criteria, a broker-
dealer may request an exemption for that clearing entity under Note G
to Appendix A to Rule 15c3-3.\206\ Thus, the proposed amendment does
not disqualify any current clearing entities, nor require a broker-
dealer to obtain new clearing memberships to comply with Rule 15c3-3.
---------------------------------------------------------------------------

    \203\ See Removal of Certain References to Credit Ratings under
the Securities Exchange Act of 1934, 76 FR at 26557.
    \204\ Id.
    \205\ At the end of 2012, OCC maintained $78.8 billion in margin
deposits, well in excess of the $3 billion threshold set forth in
paragraph (b)(1)(iii) of Note G. The OCC also maintained $2.7
billion in clearing member deposits, well in excess of the $500
million threshold set forth in paragraph (b)(1)(ii) of Note G. See
OCC, 2012 Annual Report (2012) (Notes 3 and 4 to the Financial
Statements).
    \206\ The Commission may, in its sole discretion, grant such an
exemption subject to such conditions as are appropriate under the
circumstances if the Commission determines that such conditional or
unconditional exemption is necessary or appropriate in the public
interest and is consistent with the protection of investors. See 17
CFR 240.15c3-3a(b)(1)(iv), Note G.
---------------------------------------------------------------------------

    The Commission received no comments on the proposed amendment to
Rule 15c3-3. The Commission is adopting the amendment to Note G to
Exhibit A to Rule 15c3-3 as proposed by removing paragraph (b)(1)(i).
2. Rule 10b-10
a. Proposal
    Rule 10b-10 under the Exchange Act, the Commission's customer
confirmation rule, generally requires broker-dealers effecting
transactions for customers in securities, other than U.S. savings bonds
or municipal securities, to provide those customers with a written
notification, at or before completion of the securities transaction,
disclosing certain information about the terms of the transaction.\207\
This required disclosure includes, among other things, the date, time,
identity, and number of securities bought or sold; the capacity in
which the broker-dealer acted (e.g., as agent or principal); yields on
debt securities; and, under special circumstances, the amount of
compensation the broker-dealer will receive from the customer and any
other parties.\208\ By requiring these disclosures, the rule serves a
basic customer protection function by conveying information that: (1)
Allows customers to verify the terms of their transactions; (2) alerts
customers to potential conflicts of interest; (3) acts as a safeguard
against fraud; and (4) allows customers a means of evaluating the costs
of their transactions and the quality of the broker-dealer's execution.
---------------------------------------------------------------------------

    \207\ See 17 CFR 240.10b-10.
    \208\ Id.
---------------------------------------------------------------------------

    The Commission proposed to delete paragraph (a)(8) from Rule 10b-
10.\209\ Paragraph (a)(8), which the Commission adopted in 1994,
requires a broker-dealer to inform the customer in the confirmation if
a debt security, other than a government security, is unrated by an
NRSRO.\210\ As explained when it was added to Rule 10b-10 in 1994,
paragraph (a)(8) was intended to alert customers to the potential need
to obtain more information about a security from a broker-dealer; it
was not intended to suggest that an unrated security is inherently
riskier than a rated security.\211\
---------------------------------------------------------------------------

    \209\ See Removal of Certain References to Credit Ratings under
the Securities Exchange Act of 1934, 76 FR at 26563-26564 & n.80.
Consistent with this proposed change, the Commission also proposed
to re-designate paragraph (a)(9) of the rule, under which a broker-
dealer that is not a member of the Securities Investor Protection
Corporation generally must disclose that fact, as paragraph (a)(8).
Id. at 26564 n.89, 26576.
    \210\ See 17 CFR 240.10b-10(a)(8); Confirmation of Transactions,
Exchange Act Release No. 34962 (Nov. 10, 1994), 59 FR 59612, 59617
(Nov. 17, 1994), corrected, Securities Exchange Act Release No.
34962A (Nov. 18, 1994), 59 FR 60555 (Nov. 25, 1994).
    \211\ Id. (stating, ``In most cases, this disclosure should
verify information that was disclosed to the investor prior to the
transaction. If the customer was not previously informed of the
security's unrated status, then confirmation disclosure may prompt a
dialogue between the customer and the broker-dealer,'' and noting
that the disclosure was ``not intended to suggest that an unrated
security is inherently riskier than a rated security.'').
---------------------------------------------------------------------------

    The Commission had previously proposed, and re-proposed, the
deletion of paragraph (a)(8) from Rule 10b-10.\212\ These previous
proposals, however, were prompted by concerns regarding the undue
reliance on NRSRO ratings and confusion about the significance of those
ratings. Because paragraph (a)(8) of Rule 10b-10 does not refer to
NRSRO ratings as a means of determining creditworthiness, it arguably
does not come strictly within section 939A. Nevertheless, to the extent
that the provision may focus investor attention on ratings issued by
NRSROs, as distinct from other items of information, the Commission
believed deleting it would be consistent with the intent of the Dodd-
Frank Act.
b. Comments
---------------------------------------------------------------------------

    \212\ See References to Ratings of Nationally Recognized
Statistical Rating Organizations, 74 FR 52374; References to Ratings
of Nationally Recognized Statistical Rating Organizations, 73 FR
40088.
---------------------------------------------------------------------------

    The Commission received four comments regarding the proposed
removal of paragraph (a)(8) from Rule 10b-10. One commenter was
supportive of the deletion, without providing any additional
comment.\213\ Another commenter recommended that in place of the
deletion, the proposed rules should require Rule 10b-10 confirmations
to include information that would ensure that investors understand the
potential need to learn more about the debt securities that they have
acquired from their broker-dealers.\214\ The commenter recommended
requiring broker-dealers to inform investors that debt securities vary
in terms of their creditworthiness; that investors should understand
the credit quality of the specific debt securities acquired through
their broker-dealer; and that credit quality can affect not only the
value of the debt securities, but also their liquidity and price
stability.\215\ In contrast, a third commenter believed that the
removal of paragraph (a)(8) serves no useful purpose, stating: ``We do
not see how requiring disclosure of the absence of a credit rating in
any way encourages greater reliance on credit ratings.'' \216\ The
commenter further recommended that if paragraph (a)(8) were deleted,
the Commission should not replace it with

any further required disclosures.\217\ A fourth commenter recommended
that paragraph (a)(8) of Rule 10b-10 should be retained.\218\ The
commenter stated that, given that the types of securities that are
unrated by NRSROs typically include small offerings, the required
broker-dealer disclosures may no longer signal to investors any need to
investigate the quality of the securities being purchased.\219\ The
commenter added that the required notification that certain securities
are unrated serves to encourage investors to evaluate the securities in
which they are investing without undermining the overall intent to
eliminate reliance upon ratings bestowed by NRSROs.\220\
---------------------------------------------------------------------------

    \213\ See SIFMA Letter, n.3 (``SIFMA endorses the Commission's
proposed changes to Rules 15c3-3 and Rule 10b-10.'').
    \214\ See Better Markets Letter.
    \215\ Id.
    \216\ See Sullivan & Cromwell Letter.
    \217\ Id.
    \218\ See CFA Institute Letter.
    \219\ Id.
    \220\ Id.
---------------------------------------------------------------------------

c. Final Rule
    After careful consideration of the received comments, the
Commission has decided to delete paragraph (a)(8) from Rule 10b-10, as
proposed. The Commission acknowledges that, to some extent, the
paragraph may have served the purpose for which it was added to the
rule in 1994 by prompting investors to investigate or question a
broker-dealer about the quality of certain securities. Based on the
comments received in response to the proposing release, however, the
Commission believes it is likely that the paragraph's disclosure
requirement has to a greater extent added to investors' undue reliance
on credit ratings, and that the deletion of the paragraph is consistent
with the intent of section 939A of the Dodd-Frank Act to reduce
reliance on NRSRO credit ratings. In addition, requiring broker-dealers
to use customer confirmations as a means of providing investors with
general information related to credit risk and debt securities as
suggested by commenters would not further paragraph (a)(8)'s purpose of
flagging unrated securities for more careful investor scrutiny. The
paragraph was added to the rule to require disclosure of information
suggesting that investors may want to obtain more information about
certain unrated securities, not to ``require that confirmations alert
customers to the importance of understanding the credit quality of a
debt security and the impact of credit quality on the value, resale,
and price of such securities.'' \221\ The purpose of Rule 10b-10 is not
to educate investors about the characteristics of different kinds of