[Federal Register: July 11, 2008 (Volume 73, Number 134)]
[Proposed Rules]
[Page 40087-40106]
[DOCID:fr11jy08-16]

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Part IV

Securities and Exchange Commission

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17 CFR Parts 229, 230, et al.

References to Ratings of Nationally Recognized Statistical Rating
Organizations; Security Ratings; Proposed Rules

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SECURITIES AND EXCHANGE COMMISSION

17 CFR Parts 240, 242, and 249

[Release No. 34-58070; File No. S7-17-08]
RIN 3235-AK17

References to Ratings of Nationally Recognized Statistical Rating
Organizations

AGENCY: Securities and Exchange Commission.

ACTION: Proposed rule.

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SUMMARY: This is one of three releases that the Securities and Exchange
Commission (``Commission'') is publishing simultaneously relating to
the use in its rules and forms of credit ratings issued by nationally
recognized statistical rating organizations (``NRSROs''). In this
release, the Commission proposes to amend various rules and forms under
the Securities Exchange Act of 1934 (``Exchange Act'') that rely on
NRSRO ratings. The proposed amendments are designed to address concerns
that the reference to NRSRO ratings in Commission rules and forms may
have contributed to an undue reliance on NRSRO ratings by market
participants.

DATES: Comments should be received on or before September 5, 2008.

ADDRESSES: Comments may be submitted by any of the following methods:

Electronic Comments

     Use the Commission's Internet comment form (http://
www.sec.gov/rules/proposed.shtml); or
     Send an e-mail to<EMAIL_ADDRESS>Please include
File Number S7-17-08 on the subject line; or
     Use the Federal eRulemaking Portal (http://
www.regulations.gov). Follow the instructions for submitting comments.

Paper Comments

     Send paper comments in triplicate to Secretary, Securities
and Exchange Commission, 100 F Street, NE., Washington, DC 20549-1090.

All submissions should refer to File Number S7-17-08. This file number
should be included on the subject line if e-mail is used. To help us
process and review your comments more efficiently, please use only one
method. The Commission will post all comments on the Commission's
Internet Web site (http://www.sec.gov/rules/proposed.shtml). Comments
are also available for public inspection and copying in the
Commission's Public Reference Room, 100 F Street, NE., Washington, DC
20549, on official business days between the hours of 10 a.m. and 3
p.m. All comments received will be posted without change; we do not
edit personal identifying information from submissions. You should
submit only information that you wish to make publicly available.

FOR FURTHER INFORMATION CONTACT: Michael A. Macchiaroli, Associate
Director, Thomas K. McGowan, Assistant Director, Randall W. Roy, Branch
Chief, and Joseph I. Levinson, Attorney (Net Capital Requirements and
Customer Protection) at<PHONE_NUMBER>; Michael Gaw, Assistant
Director, Brian Trackman, Special Counsel, and Sarah Albertson,
Attorney (Alternative Trading Systems) at<PHONE_NUMBER>; Paula Jenson,
Deputy Chief Counsel, Joshua Kans, Senior Special Counsel, Linda Stamp
Sundberg, Senior Special Counsel (Confirmation of Transactions) at
(202) 551-5550; Josephine J. Tao, Assistant Director, Elizabeth A.
Sandoe, Branch Chief, and Bradley Gude, Special Counsel (Regulation M)
at<PHONE_NUMBER>; or Catherine Moore, Counsel to the Director at (202)
551-5710, Division of Trading and Markets, Securities and Exchange
Commission, 100 F Street, NE., Washington, DC 20549-6628.

SUPPLEMENTARY INFORMATION:

I. Introduction

    On June 16, 2008, in furtherance of the Credit Rating Agency Reform
Act of 2006,\1\ the Commission published for notice and comment two
rulemaking initiatives.\2\ The first proposes additional requirements
for NRSROs \3\ that were directed at reducing conflicts of interests in
the credit rating process, fostering competition and comparability
among credit rating agencies, and increasing transparency of the credit
rating process.\4\ The second is designed to improve investor
understanding of the risk characteristics of structured finance
products. Those proposals address concerns about the integrity of the
credit rating procedures and methodologies of NRSROs in light of the
role they played in determining the credit ratings for securities that
were the subject of the recent turmoil in the credit markets.
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    \1\ Public Law 109-291, 120 Stat. 1327 (2006).
    \2\ Proposed Rules for Nationally Recognized Statistical Rating
Organizations, Securities Exchange Act Release No. 57967 (June 16,
2008), 73 FR 36212 (June 25, 2008).
    \3\ As described in more detail below, an NRSRO is an
organization that issues ratings that assess the creditworthiness of
an obligor itself or with regard to specific securities or money
market instruments, has been in existence as a credit rating agency
for at least three years, and meets certain other criteria. The term
is defined in section 3(a)(62) of the Securities Exchange Act. A
credit rating agency must apply with the Commission to register as
an NRSRO, and currently there are nine registered NRSROs.
    \4\ See Press Release No. 2008-110 (June 11, 2008).
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    Today's proposals comprise the third of these three rulemaking
initiatives relating to credit ratings by an NRSRO that the Commission
is proposing. This release, together with two companion releases, sets
forth the results of the Commission's review of the requirements in its
rules and forms that rely on credit ratings by an NRSRO. The proposals
also address recent recommendations issued by the President's Working
Group on Financial Markets (``PWG''), the Financial Stability Forum
(``FSF''), and the Technical Committee of the International
Organization of Securities Commissions (``IOSCO'').\5\ Consistent with
these recommendations, the Commission is considering whether the
inclusion of requirements related to ratings in its rules and forms
has, in effect, placed an ``official seal of approval'' on ratings that
could adversely affect the quality of due diligence and investment
analysis. The Commission believes that today's proposals could reduce
undue reliance on credit ratings and result in improvements in the
analysis that underlies investment decisions.
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    \5\ See President's Working Group on Financial Markets, Policy
Statement on Financial Market Developments (March 2008), available
at http://www.ustreas.gov (``PWG Statement''); The Report of the
Financial Stability Forum on Enhancing Market and Institutional
Resilience (April 2008), available at http://www.fsforum.org (``FSF
Report''); Technical Committee of the International Organization of
Securities Commissions, Consultation Report: The Role of Credit
Rating Agencies in Structured Finance Markets (March 2008), page 9,
available at http://www.iosco.org.
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II. Background

    The Commission first used the term NRSRO in our rules in 1975 in
the net capital rule for broker-dealers, Rule 15c3-1 under the Exchange
Act (``Net Capital Rule'') \6\ as an objective benchmark to prescribe
capital charges for different types of debt securities. Since then, we
have used the designation in a number of regulations under the federal
securities laws. Although we originated the use of the term NRSRO for a
narrow purpose in our own regulations, ratings by NRSROs today are used
widely as benchmarks in federal and state legislation, rules issued by
other financial regulators, in the United States and abroad, and
private financial contracts.
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    \6\ 17 CFR 240.15c3-1.

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    Referring to NRSRO ratings in regulations was intended to provide a
clear reference point to both regulators and market participants.
Increasingly, we have seen clear disadvantages of using the term in
many of our regulations. Foremost, there is a risk that investors
interpret the use of the term in laws and regulations as an endorsement
of the quality of the credit ratings issued by NRSROs, which may have
encouraged investors to place undue reliance on the credit ratings
issued by these entities. In addition, as demonstrated by recent
events,\7\ there has been increasing concern about ratings and the
ratings process. Further, by referencing ratings in the Commission's
rules, market participants operating pursuant to these rules may be
vulnerable to failures in the ratings process. In light of this, the
Commission proposes to amend the regulations.
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    \7\ See Proposed Rules for National Recognized Statistical
Rating Organizations, Securities Exchange Act Release No. 57967.
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    We have identified a small number of rules and forms, however,
where we believe it is appropriate to retain the reference to NRSRO
ratings. These rules and forms generally relate to non-public reporting
or recordkeeping requirements we use to evaluate the financial
stability of large brokers or dealers or their counterparties and are
unlikely to contribute to any undue reliance on NRSRO ratings by market
participants.\8\
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    \8\ These include Rules 15c3-1g(c)(1)(i), 15c3-1g(e)(2)(i), 17i-
5, and 17i-8, which impose certain recordkeeping and reporting
requirements for ultimate holding companies of broker-dealers and of
supervised investment bank holding companies, and Forms 17-H and X-
17A-5 Part IIB, which require reports regarding the risk exposures
of large broker-dealers and OTC derivatives dealers.
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III. Proposed Amendments

    We are proposing to remove references to NRSROs in the following
rules and forms: Rule 3a1-1, Rule 10b-10, Rule 15c3-1, Rule 15c3-3,
Rules 101 and 102 of Regulation M, Regulation ATS, Form ATS-R, Form
PILOT, and Form X-17A-5 Part IIB.

A. Proposed Amendments to Rule 3a1-1, Regulation ATS, Form ATS-R, and
Form PILOT

    In 1998, we established a new framework for the regulation of
exchanges and alternative trading systems (``ATSs'').\9\ That framework
allowed an ATS to choose whether to register as a national securities
exchange or to register as a broker-dealer and comply with the
requirements of Regulation ATS. As part of this framework, we adopted
Rule 3a1-1 under the Exchange Act,\10\ Regulation ATS,\11\ and Forms
ATS and ATS-R.
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    \9\ See Securities Exchange Act Release No. 40760 (December 8,
1998), 63 FR 70844 (December 22, 1998) (``Regulation ATS Adopting
Release'').
    \10\ 17 CFR 240.3a1-1.
    \11\ 17 CFR 242.300 to 242.303.
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    Rule 3a1-1(a) provides an exemption from the Exchange Act
definition of ``exchange''--and thus the requirement to register as an
exchange--for a trading system that, among other things, is in
compliance with Regulation ATS.\12\ Rule 3a1-1(b) contains an exception
to the exemption from the exchange definition. Under this exception,
the Commission may require a trading system that is a ``substantial
market'' to register as a national securities exchange if it finds that
such action is necessary or appropriate in the public interest or
consistent with the protection of investors.\13\ Specifically, the
Commission may--after notice to an ATS and an opportunity for it to
respond--require the ATS to register as an exchange if, during three of
the preceding four calendar quarters, the ATS had: (1) 50% or more of
the average daily dollar trading volume in any security and 5% or more
of the average daily dollar trading volume in any class of securities;
or (2) 40% or more of the average daily dollar volume in any class of
securities.\14\
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    \12\ See 17 CFR 240.3a1-1(a)(2).
    \13\ See 17 CFR 240.3a1-1(b); Regulation ATS Adopting Release,
63 FR at 70857.
    \14\ See 17 CFR 240.3a1-1(b)(1).
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    As the Commission explained in the Regulation ATS Adopting Release,
it was reserving the right to require a ``dominant'' ATS to register as
an exchange.\15\ The Commission noted, for example, that ``it may not
be consistent with the protection of investors or in the public
interest for a trading system that is the dominant market, in some
important segment of the securities market, to be exempt from
registration as an exchange if competition cannot be relied upon to
ensure fair and efficient trading structures.'' \16\ The Commission
also stated that it might be necessary to require an ATS to register as
an exchange if it ``would create systemic risk or lead to instability
in the securities markets' infrastructure.'' \17\ The Commission made
clear that its authority under Rule 3a1-1 was discretionary: ``Although
the standard for denying or withholding the exemption is based on
objective factors, the Commission has discretion to initiate any
process to consider whether to revoke a particular entity's exemption
under the rule.'' \18\ Thus, while observing that some ATSs likely were
above the volume thresholds of Rule 3a1-1, the Commission did not at
the time believe it was appropriate to revoke the exemption for any
such ATS.\19\
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    \15\ See 63 FR at 70857.
    \16\ Id. at 70858.
    \17\ Id.
    \18\ Id. at 70857-58.
    \19\ See id. at 70858.
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    The Commission set forth eight classes of securities in any one of
which an ATS might achieve ``dominant'' status: (1) Equity securities;
(2) listed options; (3) unlisted options; (4) municipal securities; (5)
investment grade corporate debt securities; (6) non-investment grade
corporate debt securities; (7) foreign corporate debt securities; and
(8) foreign sovereign debt securities.\20\ Under the definitions
provided in Rule 3a1-1, investment grade and non-investment grade
corporate debt securities have three elements in common. They are
securities that: (1) Evidence a liability of the issuer of such
security; (2) have a fixed maturity date that is at least one year
following the date of issuance; and (3) are not exempted securities, as
defined in Section 3(a)(12) of the Exchange Act.\21\ The distinguishing
characteristic of an investment grade corporate debt security under our
current rules is that it has been rated in one of the four highest
categories by at least one NRSRO. A non-investment grade corporate debt
security under our current rules is a corporate debt security that has
not received such a rating.
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    \20\ See 17 CFR 240.3a1-1(b)(3).
    \21\ Compare 17 CFR 240.3a1-1(b)(3)(v) with 17 CFR 240.3a1-
1(b)(3)(vi).
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    We preliminarily believe that distinguishing investment grade
corporate debt securities and non-investment grade corporate debt
securities as separate classes of securities under Rule 3a1-1 is not
necessary to fulfill the purposes of that rule. We preliminary believe
instead that combining all corporate debt securities into a single
class for purposes of assessing whether an alternative trading system
is ``dominant'' is appropriate. Accordingly, we propose to amend Rule
3a1-1 by replacing paragraphs (b)(3)(v) and (b)(3)(vi) which define
investment grade corporate debt securities and non-investment grade
debt securities, respectively, with a single category ``corporate debt
securities'' in paragraph (b)(3)(v).\22\ This new definition would
retain verbatim the three elements common to the existing definitions
of investment grade and non-investment grade debt securities. The 5%
and 40% thresholds also would remain

unchanged. Under the proposed amendment to Rule 3a1-1, the Commission
could, for example, determine that an ATS must register as an exchange
if the system had--during three of the preceding four calendar
quarters--50% or more of the average daily dollar trading volume in any
security and 5% or more of the average daily dollar trading volume in
corporate debt securities, or 40% of the average daily dollar trading
volume in corporate debt securities.\23\
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    \22\ Existing paragraphs (b)(3)(vii) and (b)(3)(viii) would be
unchanged but redesignated as paragraphs (b)(3)(vi) and (b)(3)(vii),
respectively.
    \23\ The other six classes of securities--equity securities,
listed options, unlisted options, municipal securities, foreign
corporate debt securities, and foreign sovereign debt securities--
would remain unchanged. Therefore, as under existing Rule 3a1-1, the
Commission also could determine that an ATS must register as an
exchange if the system exceeded either volume threshold in any of
these other classes of securities.
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    The Commission preliminarily believes that exceeding a volume
threshold for a combined class of all corporate debt securities would
be a sufficient indication that an ATS should be required to register
as an exchange, and that it is not necessary or appropriate to assess
trading volumes in the narrower segments of investment grade and non-
investment grade corporate debt securities. While the proposed
amendment could reduce the likelihood that an ATS could be required to
register as an exchange,\24\ we preliminarily believe that this change
would nevertheless be appropriate. At this time, there does not appear
to be a continuing need to analyze ``dominance'' in separate classes of
investment grade and non-investment grade corporate debt securities,
particularly in view of the fact that the Commission would continue to
analyze for dominance in six other classes of securities (in addition
to the new single class for corporate debt securities). The Commission
notes that, in over nine years since the adoption of Rule 3a1-1, the
Commission has never determined to require an ATS to register as an
exchange because it had become ``dominant.'' Moreover, the Commission
would continue to be able to exercise discretion about whether to
revoke the exemption for any ATS that exceeded either threshold in Rule
3a1-1. The Commission seeks comment on whether, in light of the
proposed combination of investment grade and non-investment grade
corporate debt securities into a single class, it should adopt lower
thresholds at which an ATS that trades corporate debt securities should
be required to register as an exchange. If so, what should those
thresholds be and why?
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    \24\ For example, under existing Rule 3a1-1, an ATS that has 40%
of the average daily dollar trading volume in non-investment grade
corporate debt securities and 0% of the average daily dollar trading
volume in investment grade corporate debt securities for three
consecutive months could be required by the Commission to register
as an exchange. Under the proposed amendment, the Commission could
not do so because the ATS's combined average daily dollar trading
volume in corporate debt securities would be less than 40%.
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    We are proposing similar changes to Regulation ATS, which
establishes certain requirements applicable to ATSs that choose to
register as broker-dealers and comply with Regulation ATS in lieu of
exchange registration. Rule 301(b)(5) of Regulation ATS imposes a
``fair access'' requirement, whereby an ATS that exceeds certain volume
thresholds in any class of securities must establish written standards
for granting access to trading on its system and not unreasonably
prohibit or limit any person in respect to access to the services it
offers.\25\ The fair access standard applies if an ATS has 5% or more
of the average daily volume during at least four of the preceding six
calendar months in any of the following: (1) Any individual NMS stock;
\26\ (2) any individual equity security that is not an NMS stock and
for which transactions are reported to a self-regulatory organization;
(3) municipal securities; (4) investment grade corporate debt
securities; and (5) non-investment grade corporate debt securities.\27\
The terms investment grade and non-investment grade debt security are
defined in Rule 300 of Regulation ATS.
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    \25\ See 17 CFR 242.301(b)(5).
    \26\ See 17 CFR 240.600(a)(47) (defining ``NMS stock'').
    \27\ In proposing Regulation ATS, the Commission requested
comment ``on whether categories of debt securities should be further
divided based on an instrument's maturity, credit rating, or other
criteria.'' Securities Exchange Act Release No. 39884 (April 21,
1998), 63 FR 23504, 23519 (April 29, 1998). However, in adopting
Regulation ATS, the Commission did not employ these narrower classes
of debt securities. See Regulation ATS Adopting Release, 63 FR at
70873.
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    We propose to amend Rules 300 and 301(b)(5) to establish a single
class of corporate debt securities and to eliminate the existing
separate classes of investment grade and non-investment grade corporate
debt securities. Accordingly, paragraphs (i) and (j) of Rule 300 would
be replaced with a new paragraph (i) defining ``corporate debt
security'' to mean any security that: (1) Evidences a liability of the
issuer of such security; (2) has a fixed maturity date that is at least
one year following the date of issuance; and (3) is not an exempted
security, as defined in Section 3(a)(12) of the Exchange Act. Existing
paragraphs (i)(D) and (i)(E) of Rule 301(b)(5) would be replaced with a
new paragraph (i)(D) providing that an ATS must comply with the access
requirements set out in Rule 301(b)(5) if, with respect to corporate
debt securities, such system accounts for 5% or more of the average
daily volume traded in the United States for the requisite number of
months. The 5% threshold at which an ATS would have to grant fair
access to its system also would remain unchanged.\28\ As with the
proposed changes to Rule 3a1-1, the other classes of securities would
remain unchanged.
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    \28\ When the Commission originally adopted Regulation ATS, it
set the fair access threshold at 20%. It later lowered the threshold
to 5% in connection with the adoption of Regulation NMS. See
Securities Exchange Act Release No. 51808 (June 9, 2005), 70 FR
37496, 37550 (June 29, 2005).
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    In addition, Rule 301(b)(6) of Regulation ATS \29\ requires an ATS
that exceeds certain volume thresholds in any class of securities to
comply with standards regarding the capacity, integrity, and security
of its automated systems. Five classes of securities are currently
identified in Rule 301(b)(6): (1) NMS stocks; (2) equity securities
that are not NMS stocks and for which transactions are reported to a
self-regulatory organization; (3) municipal securities; (4) investment
grade corporate debt securities; and (5) non-investment grade corporate
debt securities.\30\ Consistent with the other proposed changes to
Regulation ATS, the Commission also proposes to eliminate separate
classes for investment grade and non-investment grade debt securities
in Rule 301(b)(6) and replace them with a single category for
``corporate debt securities,'' which would be defined in Rule 300.
Existing paragraphs (i)(D) and (i)(E) of Rule 301(b)(6) would be
replaced with a new paragraph (i)(D) providing that an ATS must comply
with the capacity, integrity, and security requirements of Rule
301(b)(6) if, with respect to corporate debt securities, such system
accounts for 20% or more of the average daily volume traded in the
United States for the requisite number of months. The 20% threshold and
the other three classes of securities would remain unchanged.
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    \29\ 17 CFR 242.301(b)(6).
    \30\ 17 CFR 242.301(b)(6)(i).
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    For the same reasons we are proposing to amend Rule 3a1-1, we
preliminarily believe that these proposed amendments to Regulation ATS
would be appropriate, and that a volume threshold for a combined class
of all corporate debt securities would be sufficient for the fair
access requirement and the capacity, integrity, and security
requirements. The Commission preliminarily believes that the purposes
of Regulation ATS would still be

fulfilled if investment grade and non-investment grade corporate debt
securities were combined into a single class. ATSs would continue to be
subject to the fair access requirements and the capacity, integrity,
and security requirements with respect to the other existing classes of
securities and at the same volume thresholds (5% and 20%,
respectively). The Commission seeks comment on whether, in light of the
proposed combination of investment grade and non-investment grade
corporate debt securities into a single class, it should adopt lower
thresholds for fair access and the capacity, security, and integrity
requirements under Regulation ATS. If so, what should those thresholds
be and why?
    We are also proposing revisions to Form ATS-R, which is used by
ATSs to report certain information about their activities on a
quarterly basis.\31\ Currently, Form ATS-R requires each ATS to report
the total unit volume and total dollar volume in the previous quarter
for various categories of securities, including investment grade and
non-investment grade corporate debt securities. Consistent with the
proposed amendments to Regulation ATS described above, we also propose
to revise Form ATS-R to eliminate the separate categories for
investment grade and non-investment grade corporate debt securities,
and instead create a single category for ``corporate debt securities.''
As with the proposed changes to Regulation ATS, ``corporate debt
securities'' would be defined in the instructions to Form ATS-R to mean
any security that: (1) Evidences a liability of the issuer of such
security; (2) has a fixed maturity date that is at least one year
following the date of issuance; and (3) is not an exempted security, as
defined in Section 3(a)(12) of the Exchange Act. Because separate
classes for investment grade and non-investment grade corporate debt
securities are proposed to be eliminated for purposes of the thresholds
in Rule 3a1-1 and Rules 301(b)(5) and 301(b)(6) of Regulation NMS, no
purpose would be served by requiring ATSs to separately report their
trading volumes for investment grade and non-investment grade debt
securities on Form ATS-R. The figures for the separate classes would be
added together and reported as a single item on the amended form. The
Commission is not proposing any other changes to Form ATS-R.
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    \31\ Each ATS must file a Form ATS-R within 30 days of the end
of each calendar quarter, and within ten days of a cessation of
operations. See 17 CFR 242.301(b)(9).
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    We are also proposing to revise Form PILOT consistent with the
proposed changes to Form ATS-R. Ordinarily, Section 19 of the Exchange
Act \32\ and Rule 19-4 thereunder \33\ require a self-regulatory
organization (``SRO'') to file with the Commission proposed rule
changes on Form 19b-4 regarding any changes to any material aspect of
its operations, including any trading system. Rule 19b-5 under the
Exchange Act \34\ sets forth a limited exception to that requirement by
permitting an SRO to operate a pilot trading system without filing
proposed rule changes with respect to that system if certain criteria
are met. One of those criteria is that the SRO file a Form PILOT in
accordance with the instructions on that form. Like Form ATS-R, Form
PILOT currently requires quarterly reporting of trading activity by
classes of securities, including investment grade and non-investment
grade corporate debt securities. For the same reasons we propose to
amend Rule 3a1-1 and Regulation ATS, we also propose to revise Form
PILOT to eliminate these two categories, replacing them with a single
category of ``corporate debt securities.'' Corporate debt securities
would be defined identically in Form PILOT and Form ATS-R. The
Commission preliminarily believes that it is appropriate to obtain
trading volumes from pilot trading systems for the combined class of
corporate debt securities, and that separate reporting of the two
classes is not necessary to adequately monitor the development of pilot
trading systems. The Commission notes that, in over nine years since
Rule 19b-5 and Form PILOT were adopted, no SRO has ever established a
pilot trading system pursuant to Rule 19b-5 to trade corporate debt
securities.
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    \32\ 15 U.S.C. 78s.
    \33\ 17 CFR 240.19b-4.
    \34\ 17 CFR 240.19b-5.
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    We generally request comment on all aspects of the proposed
elimination of the reference to NRSRO ratings in Rule 3a1-1, Regulation
ATS, Form ATS-R, and Form PILOT. In addition, we request comment on the
following specific questions:
     Would the proposed amendments to Rule 3a1-1 have any
significant impact on investors, market participants, the national
market system, or the public interest?
     Would the proposed amendments to Regulation ATS have any
significant impact on investors, market participants, the national
market system, or the public interest?
     Would the proposed amendments affecting the fair access
standards have other consequences, whether on investors, market
participants, the national market system, or the public interest? Have
investors experienced difficulty obtaining access to ATSs trading
corporate debt securities? Would the proposed amendments impair or
limit current investor access to ATSs?
     Would the proposed changes to Regulation ATS as they
relate to the capacity, integrity, and security requirements have any
adverse impact on investors, market participants, or the national
market system as a whole?
     In view of the proposed combination of investment grade
and non-investment grade corporate debt securities into a single class
for purposes of Rule 3a1-1 and Regulation ATS, should the Commission
also lower the thresholds in those rules for the combined class of
corporate debt securities? If so, what should those thresholds be? Why
are those suggested thresholds appropriate?
     Should the Commission retain investment grade and non-
investment grade corporate debt securities as separate classes of
securities under Rule 3a1-1 and Regulation ATS and instead use
different definitions of those terms that do not rely on NRSRO ratings?
If so, how should investment grade and non-investment grade be defined?
     Would the proposed amendments to Form ATS-R or Form PILOT
have any significant impact on investors, market participants, the
national market system, or the public interest?

B. Proposed Amendments to Rule 10b-10

    We propose to amend Rule 10b-10,\35\ the transaction confirmation
rule for broker-dealers, to delete paragraph (a)(8) of that rule.\36\
Rule 10b-10 generally requires broker-dealers that effect transactions
for customers in securities, other than U.S. savings bonds or municipal
securities, which are covered by Municipal Securities Rulemaking Board
rule G-15 (which applies to all municipal securities brokers and
dealers), to provide customers with written notification, at or before
the completion of each transaction, of certain basic transaction terms.
This transaction confirmation must disclose, among other information:
the date of the transaction; the identity, price, and

number of shares bought or sold; \37\ the capacity of the broker-
dealer; \38\ the dollar price or yield at which a transaction in a debt
security was effected; \39\ and, under specified circumstances, the
amount of compensation paid to the broker-dealer and whether the
broker-dealer receives payment for order flow.\40\
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    \35\ 17 CFR 240.10b-10.
    \36\ Consistent with that change, we also are proposing to
redesignate paragraph (a)(9) of the rule, related to broker-dealers
that are not members of the Securities Investor Protection
Corporation (``SIPC''), as paragraph (a)(8).
    \37\ See 17 CFR 240.10b-10(a)(1) (the confirmation must also
include either the time of the transaction or the fact that it will
be furnished upon written request).
    \38\ See 17 CFR 240.10b-10(a)(2).
    \39\ See 17 CFR 240.10b-10(a)(5) and (6).
    \40\ See, e.g., 17 CFR 240.10b-10(a)(2)(i)(B), (C) and (D).
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    The rule's requirements, portions of which have been in effect for
over 60 years, provide basic investor protections by conveying
information that allows investors to verify the terms of their
transactions, alerts investors to potential conflicts of interest with
their broker-dealers, acts as a safeguard against fraud, and provides
investors a means to evaluate the costs of their transactions and the
execution quality.\41\
---------------------------------------------------------------------------

    \41\ See Securities Exchange Act Release No. 34962 (November 10,
1994), 59 FR 59612, 59613 (November 17, 1994).
---------------------------------------------------------------------------

    Paragraph (a)(8) of Rule 10b-10 requires transaction confirmations
for debt securities, other than government securities, to inform the
customer if the security is unrated by an NRSRO. When we adopted
paragraph (a)(8) in 1994, it was intended to prompt a dialogue between
the customer and the broker-dealer if the customer had not previously
been informed of the unrated status of the debt security. We stated
that this disclosure was not intended to suggest that an unrated
security is inherently riskier than a rated security.\42\ Upon further
consideration and in light of present concerns regarding undue reliance
on NRSRO ratings and confusion about the significance of those ratings,
we believe it would be appropriate to delete this requirement. However,
in proposing to no longer require broker-dealers to include in
transaction confirmations the information that a debt security is
unrated, we do not mean to suggest that information about an issuer's
creditworthiness is not a relevant subject for discussion and
consideration prior to purchasing a debt security. We would encourage
investors to seek to understand all of the risks of securities,
including credit-related risks, before buying. In addition, we note
that deleting this requirement would not prevent broker-dealers from
voluntarily continuing to include this information in transaction
confirmations.
---------------------------------------------------------------------------

    \42\ See Securities Exchange Act Release No. 34962 (November 10,
1994), 59 FR 59612 (November 17, 1994) (File No. S7-6-94).
---------------------------------------------------------------------------

    We generally request comment on all aspects of the proposed
elimination of the NRSRO reference in Rule 10b-10. In addition, we
request comment on the following specific questions:
     Have investors found confirmation disclosure about the
fact that a debt security is not rated by an NRSRO to be useful?
     Are there any possible alternatives to deletion that would
address concerns about undue reliance on NRSRO ratings or avoid
confusion about the significance of those ratings? For example, should
the confirmation disclose that the security is rated or not rated by an
NRSRO, as the case may be, instead of just that the security is not
rated?

C. Proposed Amendments to Rule 15c3-1

    Under the Net Capital Rule, broker-dealers are required to
maintain, at all times, a minimum amount of net capital. The rule
generally defines ``net capital'' as a broker-dealer's net worth
(assets minus liabilities), plus certain subordinated liabilities, less
certain assets that are not readily convertible into cash (e.g., fixed
assets), and less a percentage (haircut) of certain other liquid assets
(e.g., securities).\43\ Broker-dealers are required to calculate net
worth using generally accepted accounting principles.
---------------------------------------------------------------------------

    \43\ See 17 CFR 240.15c3-1(c)(2).
---------------------------------------------------------------------------

    In computing their net capital under the provisions of the Net
Capital Rule, broker-dealers are required to deduct from their net
worth certain percentages of the market value of their proprietary
securities positions. A primary purpose of these ``haircuts'' is to
provide a margin of safety against losses that might be incurred by
broker-dealers as a result of market fluctuations in the prices of, or
lack of liquidity in, their proprietary positions. We apply a lower
haircut to certain types of securities held by a broker-dealer that
were rated investment grade by a credit rating agency of national
repute since those securities typically were more liquid and less
volatile in price than securities that were not so highly rated.\44\
---------------------------------------------------------------------------

    \44\ See 17 CFR 240.15c3-1(c)(2)(vi)(E) (haircuts applicable to
commercial paper), 17 CFR 240.15c3-1(c)(2)(vi)(F) (haircuts
applicable to nonconvertible debt securities), and 17 CFR 240.15c3-
1(c)(2)(vi)(H) (haircuts applicable to cumulative nonconvertible
preferred stock). The term NRSRO is also used in appendices to the
Net Capital Rule. See 17 CFR 240.15c3-1a(b)(1)(i)(C) (defining the
term ``major market foreign currency'') and 17 CFR 240.15c3-1f(d)
(determining the capital charge for credit risk arising from certain
OTC derivatives transactions).
---------------------------------------------------------------------------

    We are proposing to remove, with limited exceptions, all references
to NRSROs from the Net Capital Rule.\45\ The broker-dealers subject to
the Net Capital Rule are sophisticated market participants regulated by
at least one SRO.\46\ As regulated entities, broker-dealers must meet
certain financial responsibility requirements, including maintaining
minimum amounts of liquid assets as net capital, safeguarding customer
funds and securities, and making and preserving accurate books and
records. Accordingly, we preliminarily believe that broker-dealers
would be able to assess the creditworthiness of the securities they
hold without undue hardship and, therefore, that exclusive reliance on
NRSRO ratings for the purposes of the Net Capital Rule is no longer
necessary, although broker-dealers that wish to continue to rely on
such ratings may do so.
---------------------------------------------------------------------------

    \45\ In 2003, the Commission published a concept release in
which we sought comment on the use of NRSRO ratings in our rules,
and specifically sought comment on eliminating the minimum quality
standards established with the use of NRSRO ratings in Exchange Act
Rule 15c3-1. See Rating Agencies and the Use of Credit Ratings Under
the Federal Securities Laws, Securities Exchange Act Release No.
47972 (June 4, 2003), 68 FR 35258 (June 12, 2003). (Comments on the
concept release are available at: http://www.sec.gov/rules/concept/
s71203.shtml.) As discussed above, recent events have highlighted
the need to revisit our reliance on NRSRO ratings in the context of
these developments. See also the extensive discussion of market
developments in the Release No. 57967.
    \46\ The SROs regulating broker-dealers include the Financial
Industry Regulatory Authority, the Municipal Securities Rulemaking
Board, and the national securities exchanges.
---------------------------------------------------------------------------

    We are proposing the substitution of two new subjective standards
for the NRSRO ratings currently relied upon under the Net Capital Rule.
For the purposes of determining the haircut on commercial paper,\47\ we
propose to replace the current NRSRO ratings-based criterion--being
rated in one of the three highest rating categories by at least two
NRSROs--with a requirement that the instrument be subject to a minimal
amount of credit risk and have sufficient liquidity such that it can be
sold at or near its carrying value almost immediately. For the purposes
of determining haircuts on nonconvertible debt securities as well as on
preferred stock,\48\ we propose to replace the current NRSRO ratings-
based criterion--being rated in one of the four highest rating
categories by at least two NRSROs--with a requirement that the
instrument be subject to no greater than moderate credit risk and have
sufficient liquidity such that it can be sold at or

near its carrying value within a reasonably short period of time. This
latter formulation would apply as well to long or short positions that
are hedged with short or long positions in securities issued by the
United States or any agency thereof or nonconvertible debt securities
having a fixed interest rate and a fixed maturity date and which are
not traded flat or in default as to principal or interest.\49\
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    \47\ See 17 CFR 240.15c3-1(c)(2)(vi)(E).
    \48\ See 17 CFR 240.15c3-1(c)(2)(vi)(F)(1) and (c)(2)(vi)(H).
    \49\ See 17 CFR 240.15c3-1(c)(2)(vi)(F)(2).
---------------------------------------------------------------------------

    We preliminarily believe that these new standards would continue to
advance the purpose the NRSRO ratings-based standards were designed to
advance, which is to enable broker-dealers to make net capital
computations that reflect the market risk inherent in the positioning
of those particular types of securities. The prior standards--being
rated in one of the three or four highest rating categories by at least
two NRSROs--were designed based on the practice of many credit rating
agencies to have at least eight categories for their debt securities
with the top four commonly referred to as ``investment grade.'' \50\
While the proposed standards, like the prior standards, do not use the
term ``investment grade,'' they are meant to serve the same purpose as
the prior standards. As such, the category of securities that have ``no
greater than moderate credit risk'' and can be sold at or near their
carrying value within a reasonably short period of time should
encompass all investment grade securities. The proposed new criteria
for commercial paper to be used for net capital purposes are securities
that are ``subject to a minimal amount of credit risk'' and can be sold
at or near their carrying value almost immediately. In each case, the
proposed liquidity standard would reflect the fact that only liquid
assets are relevant for the purposes of the Net Capital Rule.
---------------------------------------------------------------------------

    \50\ See Oversight of Credit Rating Agencies Registered as
Nationally Recognized Statistical Rating Organizations, Securities
Exchange Act Release No. 55857 (June 5, 2007), 72 FR 33564 (June 18,
2007).
---------------------------------------------------------------------------

    We further believe that broker-dealers have the financial
sophistication and the resources necessary to make the basic
determinations of whether or not a security meets the requirements in
the proposed amendments and to distinguish between securities subject
to minimal credit risk and those subject to moderate credit risk. The
broker-dealer would have to be able to explain how the securities it
used for net capital purposes meet the standards set forth in the
proposed amendments.
    Notwithstanding our belief that broker-dealers have the financial
sophistication and the resources to make these determinations, we
believe it would be appropriate, as one means of complying with the
proposed amendments, for broker-dealers to refer to NRSRO ratings for
the purposes of determining haircuts under the Net Capital Rule. As
such, if we adopt the proposed amendments, after considering comments,
we expect to take the view in the adopting release that securities
rated in one of the three highest categories by at least two NRSROs
would satisfy the requirements of proposed new paragraph (c)(2)(vi)(E)
and securities rated in one of the four highest rating categories by at
least two NRSROs to satisfy the requirements of proposed new paragraphs
(c)(2)(vi)(F) and (c)(2)(vi)(H). We emphasize, however, that references
to such NRSRO ratings would be just one means of satisfying the
requirements of the proposed amendments but would not the only means of
doing so.
    We are also proposing to remove references to NRSRO ratings from
Appendices E and F to Rule 15c3-1 and make conforming changes to
Appendix G of Rule 15c3-1 and the General Instructions to Form X-17 A-
5, Part IIB.\51\ Appendix E of the Net Capital Rule sets forth a
program that allows a broker-dealer to use an alternative approach to
computing net capital deductions, subject to certain conditions, most
importantly the broker-dealer's ultimate holding company consenting to
group-wide Commission supervision as a consolidated supervised entity
(``CSE'').\52\ Appendix F to the Net Capital Rule sets forth a similar
program for OTC derivatives dealers. In each case, the program sets
forth an alternative means of establishing net capital requirements
under the Net Capital Rule by which the broker-dealer or OTC
derivatives dealer, as applicable, may elect to determine counterparty
risk. This may be done either based on NRSRO ratings by requesting
Commission approval to determine credit risk weights based on internal
calculations.
---------------------------------------------------------------------------

    \51\ 17 CFR 240.15c3-1e, 240.15c3-1f, and 240.15c3-1g; see 17
CFR 249.617.
    \52\ See 17 CFR 240.15c3-1e.
---------------------------------------------------------------------------

    We are proposing to delete the provisions of Appendices E and F
permitting reliance on NRSRO ratings for the purposes of determining
counterparty risk. As a result of these deletions, a broker-dealer that
is part of a CSE or a OTC derivatives dealer that wished to use the
approach set forth Appendix E or F, respectively, to determine
counterparty risks would be required, as part of its initial
application to use the alternative approach or in an amendment, to
request Commission approval to determine credit risk weights based on
internal calculations. Based on the strength of the broker-dealer/CSE
or OTC derivatives dealer's internal credit risk management system, we
may approve the application. A broker-dealer or OTC derivatives dealer
that obtained such approval would be required to make and keep current
a record of the basis for the credit risk weight of each counterparty.
To date, a total of seven entities have applied for and been granted
permission to use the methods set forth in Appendix E, while five have
applied for and been granted permission to use the methods set forth in
Appendix F. We do not currently anticipate that any additional firms
will apply for permission to use either Appendix E or Appendix F. All
of the approved firms have already developed models to calculate market
and credit risk under the alternative net capital calculation methods
set forth in the appendices as well as internal risk management control
systems.\53\ As such, each firm already employs the non-NRSRO ratings-
based method that would, under the proposed amendments, become the only
option for determining counterparty credit risk under Appendices E and
F. We are also proposing conforming amendments to Appendix G of Rule
15c3-1 and the General Instructions to Form X-17 A-5, Part IIB. The
proposed amendments would delete references to the provisions of
Appendices E and F, respectively, that are proposed to be deleted.
---------------------------------------------------------------------------

    \53\ See, e.g., Alternative Net Capital Requirements for Broker-
Dealers That Are Part of Consolidated Supervised Entities,
Securities Exchange Act Release No. 49830 (June 8, 2004), 69 FR
33428 at 33456 (June 21, 2004).
---------------------------------------------------------------------------

    We generally request comment on all aspects of the proposed
elimination of the use of NRSRO ratings in the Net Capital Rule. In
addition, we request comment on the following specific questions:
     Would internal evaluations of individual debt securities
by broker-dealers for purposes of determining the capital charges
(``internal processes'') instead of reliance on NRSRO ratings
accomplish the stated goals of the Commission's net capital
requirements?
     What are the benefits, other than those we have
identified, of the use of internal processes?
     Besides the use of internal processes by broker-dealers,
are there potential alternate means of establishing creditworthiness
for the purposes of the Net Capital Rule without reference to NRSRO
ratings? Commenters who

believe that this is the case should include detailed descriptions of
such alternate means.
     Are we correct in our preliminary belief that broker-
dealers have the financial sophistication and the resources necessary
to generate internal processes and make the basic determinations of
whether or not a security is meets the requirements in the proposed
amendments and to distinguish between securities subject to minimal
credit risk and those subject to moderate credit risk? If not, how
should the proposed rule be modified to address those concerns?
     What would be the potential consequences of using internal
processes for purposes of the net capital rule and how could these be
addressed? For example, one concern is that a broker-dealer would have
an incentive to downplay the credit risk associated with a particular
security in order to minimize capital charges. How could this concern
be addressed?
     If we provided for the use of internal processes, should
we require that the persons responsible for developing a broker-
dealer's internal processes and applying them to individual securities
for the purposes of the Net Capital Rule be separate from employees who
perform other functions for the broker-dealer, such as making
proprietary investment decisions for the broker-dealer?
     What would be the appropriate level of regulatory
oversight for broker-dealers employing internal processes?
     Should we require any policies and procedures with regard
to the basic determinations as to whether a security meets the
standards in the proposed amendments?
     Should we explicitly define the terms used in the proposed
new standards in Rules 15c3-1(c)(2)(vi)(E), (F), and (H)?
     If we adopt the proposed standards, would broker-dealers
find it useful to employ market-based models, including models using
credit spreads to satisfy the requirements of the proposed standards?
Should we provide guidance about the use of these models?
     What is the likelihood that small broker-dealers would
purchase credit ratings or the models used to develop those ratings
from large broker-dealers?
     If we adopt the proposed amendments after considering
comments, should we take the view in the adopting release that
securities rated in one of the three highest categories by at least two
NRSROs satisfy the requirements of proposed new paragraph (c)(2)(vi)(E)
and securities rated in one of the four highest rating categories by at
least two NRSROs to satisfy the requirements of proposed new paragraphs
(c)(2)(vi)(F) and (c)(2)(vi)(H)? Commenters should include detailed
descriptions of any subset of broker-dealers they believe should be
able to continue to rely on NRSRO ratings and the rationale therefor.
     What factors should we take into account when considering
the potential regulatory compliance costs of removing references to
NRSROs from the Net Capital Rule? Commenters should include detailed
descriptions of any potential costs.

D. Proposed Amendment to Rule 15c3-3

    Note G to Exhibit A of Rule 15c3-3 under the Exchange Act (the
``Customer Protection Rule''), which provides the formula for the
determination of broker-dealers' reserve requirements, allows a broker-
dealer to include as a debit in the formula the amount of customer
margin related to customers' positions in security futures products
posted to a registered clearing or derivatives organization that
maintains the highest investment grade rating from an NRSRO.\54\ This
standard, which is one of four different means by which a registered
clearing or derivatives organization can be judged to meet the
requirements of paragraph (b)(1) of Note G,\55\ is consistent with the
customer protection function of Rule 15c3-3 and is necessary because of
the unsecured nature of the customer positions in security futures
products margin debit. We propose to replace this standard with a
requirement that the registered clearing or derivatives organization to
which customers' positions in security futures products are posted has
the highest capacity to meet its financial obligations and is subject
to no greater than minimal credit risk.
---------------------------------------------------------------------------

    \54\ 17 CFR 240.15c3-3a(b)(1)(i).
    \55\ A broker-dealer may also include customer margin related to
customers' positions in security futures products posted to a
registered clearing or derivatives organization (1) that 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; (2)
that maintains at least $3 billion in margin deposits; or (3) which
does not meet the other requirements but which the Commission has
agreed, upon a written request from the broker-dealer, that the
broker-dealer may utilize. 17 CFR 240.15c3-3a(b)(1)(ii)-(iv).
---------------------------------------------------------------------------

    We preliminarily believe that these new standards would continue to
advance the purpose the NRSRO-ratings standard was designed to advance,
namely to ensure both of the long-term financial strength of a clearing
organization to which customers' positions in security futures products
are posted and its general creditworthiness.\56\ Although the rule was
originally designed to provide an indication of long-term financial
strength and general creditworthiness from an independent source,\57\
we preliminarily believe that broker-dealers, as sophisticated market
participants and regulated entities that are subject to financial
responsibility requirements, have the financial sophistication and the
resources necessary to make this determination. The broker-dealer would
have to be able to explain how the registered clearing or derivatives
organization to which customers' positions in security futures products
are posted meets the standard in the proposed amendment.
---------------------------------------------------------------------------

    \56\ See Rule 15c3-3 Reserve Requirements for Margin Related to
Security Futures Products, Securities Exchange Act Release No. 50295
(August 31, 2004), 69 FR 54182, 54185 (September 7, 2004).
    \57\ Id.
---------------------------------------------------------------------------

    We also believe, however, that it would be appropriate, as one
means of complying with the proposed amendment, for broker-dealers to
refer to NRSRO ratings for the purposes of paragraph (b) of Note G. As
such, if we adopt the proposed amendments after considering comments,
we expect to take the view in the adopting release that we would
continue to consider a registered clearing agency or derivatives
clearing organization that maintains the highest investment-grade
rating from an NRSRO to satisfy the requirements of that provision. We
emphasize, however, that the references to such NRSRO ratings would be
just one means of satisfying the requirements of the proposed
amendments and would not be the only means of doing so.
    We request comment on the following specific questions in
connection with Exhibit A to the Customer Protection Rule:
     As an alternative to relying on an NRSRO rating to
distinguish the creditworthiness of a registered clearing agency or
derivatives clearing organization, should we prescribe a minimum net
worth or asset test for the organizations? Alternatively, should we
prescribe a test based on a minimum level of members of the
organization or minimum level of clearing deposits held by the
organization? Commenters that support any of these proposals should
provide details (e.g., the minimum levels in dollar amounts) as to how
they should be implemented.
     Would it be more appropriate to delete current paragraph
(b)(1)(i) of Note G to Exhibit A to the Customer

Protection Rule in its entirety? Put differently, do the guidelines
offered by current paragraphs (b)(1)(ii)-(iv) of Note G in and of
themselves provide sufficient means by which a registered clearing or
derivatives organization could be judged to meet the requirements of
paragraph (b)(1) of Note G?
     If we adopted the proposed amendment to Note G to Exhibit
A of Rule 15c3-3, should we explicitly define the terms used in the
proposed new standard?
     Is it appropriate to allow broker-dealers to make the
determination of whether a clearing organization possesses the highest
capacity to meet its financial obligations and is subject to no greater
than minimal credit risk? If not, what are suggested ways that the
proposed rule could be amended to address that concern?
     Should we require any policies and procedures with regard
to the determination whether a registered clearing or derivatives
organization meets the standard in the proposed amendment?
     What would be the potential consequences of allowing
broker-dealers to determine whether a clearing organization possessed
the highest capacity to meet its financial obligations and was subject
to no greater than minimal credit risk and how could these be
addressed? For example, one concern is that a broker-dealer would have
an incentive to downplay the credit risk associated with a particular
clearing organization in order to be able to post customers' positions
in security futures products to it. How could this concern be
addressed?
     If we adopt the proposed amendments after considering
comments, should we take the view in the adopting release that we would
consider a registered clearing agency or derivatives clearing
organization that maintains the highest investment-grade rating from an
NRSRO to satisfy the requirements of that provision? Commenters should
include detailed descriptions of any subset of broker-dealers they
believe should be able to continue to rely on NRSRO ratings and the
rationale therefore.
     What factors should we take into account when considering
the potential regulatory compliance costs of removing references to
NRSROs from paragraph (b)(1) of Note G to Rule 15c-3a? Commenters
should include detailed descriptions of any potential costs.

E. Proposed Amendments to Rules 101 and 102 of Regulation M

1. Regulation M
    As a prophylactic, anti-manipulation set of rules, Regulation M is
designed to protect the integrity of the securities trading market as
an independent pricing mechanism by prohibiting activities that could
artificially influence the market for the offered security. Rules 101
and 102 of Regulation M specifically prohibit issuers, selling security
holders, underwriters, brokers, dealers, other distribution
participants, and any of their affiliated purchasers, from directly or
indirectly bidding for, purchasing, or attempting to induce another
person to bid for or purchase, a covered security until the applicable
restricted period has ended.\58\
---------------------------------------------------------------------------

    \58\ ``Covered security'' is defined as ``any security that is
the subject of a distribution or any reference security.'' 17 CFR
242.100.
---------------------------------------------------------------------------

2. Current Rule 101(c)(2) and Rule 102(d)(2) Exceptions
    Both rules currently except ``investment grade nonconvertible and
asset-backed securities.'' \59\ These exceptions apply to
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.\60\
The current exceptions for certain investment grade debt and preferred
securities rated by a NRSRO were originally based on the premise that
these securities are traded on the basis of their yields and credit
ratings, are largely fungible and, thus, are less likely to be subject
to manipulation.\61\ With respect to asset-backed securities, the
current exceptions were premised on the fact that asset-backed
securities also trade primarily on the basis of yield and credit rating
and that asset-backed securities investors are concerned with ``the
structure of the class of securities and the nature of the assets
pooled to serve as collateral for those securities.'' \62\
---------------------------------------------------------------------------

    \59\ 17 CFR 242.101(c)(2) and 242.102(d)(2).
    \60\ Id.
    \61\ Securities Exchange Act Release No. 19565 (March 4, 1983);
48 FR 10628 (March 14, 1983). See also Securities Exchange Act
Release No. 18528 (March 3, 1982); 47 FR 11482 (March 16, 1982).
    \62\ Securities Exchange Act Release No. 38067 (December 20,
1996); 62 FR 520 (January 3, 1997).
---------------------------------------------------------------------------

3. Proposed Amendments' Elimination of the NRSRO Reference
    In light of our effort to reduce undue reliance on NRSRO ratings,
we believe that it is appropriate to alter the current exceptions in
Rules 101 and 102 to eliminate the reference to NRSROs. We propose to
remove Rules 101 and 102's current exceptions for investment grade
nonconvertible debt securities, nonconvertible preferred securities,
and asset-backed securities based on NRSRO ratings. In place of those
exceptions, we propose new exceptions for nonconvertible debt
securities and nonconvertible preferred securities based on the ``well-
known seasoned issuer'' (``WKSI'') concept of Securities Act of 1933
(``Securities Act'') Rule 405.\63\ We are also proposing to except
asset-backed securities from Rules 101 and 102 if those securities are
registered on Form S-3.\64\
---------------------------------------------------------------------------

    \63\ 17 CFR 230.405.
    \64\ Asset-backed securities are defined out of the WKSI
standard at subparagraph (1)(iv) of the definition and, further,
could not meet the requirements of (1)(i)(A) or (B) of the
definition because they are generally one-time issuers. Id.
---------------------------------------------------------------------------

    The proposed exceptions continue to be based on the premise that
these securities are traded on factors such as their yields and are
largely fungible. In addition we believe that the marketplace is more
likely to have access to a significant amount of useful and high-
quality public information concerning these securities that may assist
investors in assessing the creditworthiness of the issuer on their own
without needing to unduly rely on a NRSRO.\65\ We understand that WKSI
and Form S-3 issuers are some of the largest and highest quality
issuers of nonconvertible debt, nonconvertible preferred securities and
asset-backed securities which makes default generally less likely. But
the availability of this information or quality of underlying assets is
not enough to justify the exceptions in and of itself, the security
must also trade in such a way that it is resistant to manipulation.
This is why we are proposing to continue to limit these exceptions to
nonconvertible debt, nonconvertible preferred, and asset-backed
securities as those securities trade largely on the basis of their
yield and are largely fungible.
---------------------------------------------------------------------------

    \65\ See Securities Exchange Act Release No. 52056 (July 19,
2005); 70 FR 44722 (August 3, 2005). See also Note 61, infra.
---------------------------------------------------------------------------

a. Proposed Rules 101(c)(2)(i) and 102(d)(2)(i)--Nonconvertible Debt
and Preferred Securities
    The proposed exceptions for nonconvertible debt and nonconvertible
preferred securities would require that the issuer of such securities
meet the requirements of the WKSI definition and meet the requirements
for nonconvertible securities other than common equity in paragraph
(1)(i)(B)(1)

of the definition of WKSI in Rule 405. As proposed, the exceptions
would be available for nonconvertible debt or nonconvertible preferred
securities issued by a WKSI issuer, regardless of the method the issuer
used to attain WKSI status. However, in order to rely on the proposed
exceptions, the security must be issued by an issuer who also meets the
requirements of paragraph (1)(i)(B)(1) of the definition of WKSI in
Rule 405.\66\ This would require that the issuer have issued at least
$1 billion aggregate principal amount of nonconvertible securities,
other than common equity, in primary offerings for cash, not exchange,
registered under the Securities Act.\67\ This would limit the
exceptions to securities whose issuers have an existing public market
in nonconvertible securities other than common equity that is publicly
known and followed and, thus, are less likely to be subject to
manipulation.
---------------------------------------------------------------------------

    \66\ A nonconvertible debt or nonconvertible preferred security
issued by an issuer who is a WKSI based on the common equity
calculation in paragraph (1)(i)(A) of the definition of WKSI in Rule
405 would still be able to rely on the proposed exception if the
issuer can also meet the requirements of paragraph (1)(i)(B)(1) of
the definition of WKSI in Rule 405.
    \67\ 17 CFR 230.405, paragraph (1)(i)(B)(1) of the definition of
WKSI.
---------------------------------------------------------------------------

    With respect to these proposed exceptions for nonconvertible debt
and non-convertible preferred securities utilizing a WKSI requirement,
we have noted that WKSI issuers:

    [A]re followed by sophisticated institutional and retail
investors, members of the financial press, and numerous sell-side
and buy-side analysts that actively seek new information on a
continual basis. Unlike smaller or less mature issuers, large
seasoned public issuers tend to have a more regular dialogue with
investors and market participants through the press and other media.
The communications of these well-known seasoned issuers are subject
to scrutiny by investors, the financial press, analysts, and others
who evaluate disclosure when it is made.\68\
---------------------------------------------------------------------------

    \68\ Securities Exchange Act Release No. 52056 (July 19, 2005);
70 FR 44722 (August 3, 2005).

Thus, we believe that the nonconvertible debt and nonconvertible
preferred securities that fall within the proposed exceptions should be
resistant to manipulation because of their fungibility, trading based
on yield, and this wide industry following.
b. Proposed Rules 101(c)(2)(ii) and 102(d)(2)(ii)--Asset-Backed
Securities
    The proposed changes to the asset-backed securities exceptions
would require that the offer and sale of the security is registered
using Form S-3.\69\ We believe that the proposed amendments should
provide exceptions to only those asset-backed securities that are
approximately the equivalent quality of securities that are currently
excepted from Rules 101 and 102. Additionally, the proposal is also
based on the premise that asset-backed securities trade primarily on
the basis of yield and that asset-backed securities investors are
primarily concerned with the structure of the class of securities and
the nature of the assets pooled to serve as collateral for those
securities and, thus, such securities are less likely to be subject to
manipulation.\70\
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    \69\ The Commission is also proposing to revise the General
Instruction I.B.5 to Form S-3 (which sets the eligibility
requirements for asset-backed securities to use that form) to remove
references to NRSROs. Securities Act Release No. 8940 (July 1, 2008)
(File No. 27-18-08).
    \70\ These were the reasons that we originally excepted such
securities. Securities Exchange Act Release No. 38067 (December 20,
1996); 62 FR 520 (January 3, 1997).
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4. Bright-Line Alternative/Existing Benchmarks
    We believe that the proposed amendments are appropriate
replacements for the NRSRO investment grade standard for the following
reasons. We believe that the proposals will capture securities that are
more likely to be resistant to manipulation similar to the current
exceptions because they are based on the same premises as the current
exceptions (such as high liquidity and fungibility).\71\ Second, the
proposals provide a bright line demarcation and objective criteria for
the exceptions. As both the WKSI and Form S-3 standards as utilized by
this proposal are established benchmarks, they should be familiar to
those persons subject to Rules 101 and 102 and easily applied by such
persons seeking to rely on the proposed exceptions. Thus, we believe
that the proposals are comparable in scope to the existing exceptions
but use alternate benchmarks that provide an equally bright line that
is not unduly reliant on NRSRO ratings.
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    \71\ See Securities Exchange Act Release Number 19565 (March 4,
1983); 48 FR 10628 (March 14, 1983); Securities Exchange Act Release
Number 18528 (March 3, 1982); 47 FR 11482 (March 16, 1982); and
Securities Exchange Act Release Number 38067 (December 20, 1996); 62
FR 520 (January 3, 1997).
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5. Comments
    We solicit comments on all aspects of this proposal. We ask that
commenters provide specific reasons and information to support
alternative recommendations. Please provide empirical data, when
possible, and cite to economic studies, if any, to support alternative
approaches.
     Are the WKSI requirements appropriate for use in a trading
(as opposed to disclosure) context? What effect(s) of the proposed
exceptions, if any, would you anticipate in the investment grade debt
market and the high-yield debt market?
     Should the Rule 101(c)(2) and 102(d)(2) exceptions be
based on criteria other than the WKSI requirements for nonconvertible
debt and nonconvertible preferred securities and Form S-3 registration
for asset-backed securities?
     Would the WKSI nonconvertible debt and nonconvertible
preferred securities excepted in the proposal be as resistant to
manipulation as those same securities that meet the existing investment
grade standard?
     Please provide comment as to whether the proposal would
capture the same type and quantity of securities that fall within the
current Rule 101(c)(2) and Rule 102(d)(2) exceptions.
     Do the proposed WKSI and Form S-3 benchmarks adequately
identify nonconvertible debt, nonconvertible preferred securities, and
asset-backed securities that are of high quality with low default risk?
Please distinguish the characteristics of nonconvertible debt,
nonconvertible preferred securities, and asset-backed securities that
meet these proposed benchmarks and those that do not.
     Is the proposed WKSI criterion easily applied by all
persons subject to Rules 101 and 102 with respect to nonconvertible
debt and nonconvertible preferred securities issued by issuers who are
WKSI by virtue of $700 million market value of common equity?
     Would persons other than issuers who are subject to Rules
101 and 102 have access to adequate information to determine if a
particular security fits into the exceptions?
     Should asset-backed securities registered on Form S-3 be
excepted from Rules 101 and 102 of Regulation M? Have there been
developments in the asset-backed securities market that might indicate
whether such securities should be eliminated from the proposed
exceptions or should continue to be excepted from Rules 101 and 102?
     How frequently is the current asset-backed exception from
Rules 101 and 102 relied upon?
     Is it appropriate to also except asset-backed securities
registered on Form F-3? If yes, please explain.
     We ask for specific comment as to any relevant changes to
the debt market since Regulation M was adopted in 1996 and the way debt
issues are brought to market and trade.
     Do nonconvertible debt securities continue to trade based
on their yield

and fungibility? Nonconvertible preferred securities? Asset-backed
securities? Are there other factors that influence the trading of such
securities?

IV. Request for Comment

    We generally request comment on all aspects of our proposal to end
our regulatory reliance on NRSRO credit ratings. In addition, we
request comment on the following specific questions:
     Should we eliminate the NRSRO designation from all our
rules or only from select rules? Commenters who believe that certain
rules should retain references to NRSROs or NRSRO ratings should
identify each rule they believe should retain the use of the NRSRO
concept and explain the rationale for doing so.
     Does the use of the NRSRO designation in our rules cause
investors to overly rely on NRSRO credit ratings? Would its elimination
mitigate this over reliance?
     Does the use of the NRSRO designation in our rules
adversely impact competition among credit rating agencies by favoring
those agencies that are registered as NRSROs? Would its elimination
mitigate this negative impact?

V. Paperwork Reduction Act

    Certain provisions of the proposed amendments to the rules and
forms contain ``collection of information requirements'' within the
meaning of the Paperwork Reduction Act of 1995.\72\ The hours and costs
associated with preparing and filing the disclosure, filing the forms
and schedules and retaining records required by these regulations
constitute reporting and cost burdens imposed by each collection of
information. An agency may not conduct or sponsor, and a person is not
required to respond to, a collection of information unless it displays
a currently valid control number. The titles of the affected
information forms are Rule 10b-10, ``Confirmation of Transactions,''
(OMB Control Number 3235-0444), Rule 15c3-1 (OMB Control Number 3235-
0200), Rule 15c3-3 (OMB Control Number 3235-0078), Form ATS-R (OMB
Control Number 3235-0509), Form PILOT (OMB Control Number 3235-0507),
and Form X-17A-5, Financial and Operational Combined Uniform Single
Report, Part IIB, OTC Derivatives Dealer (OMB Control Number 3235-
0498). For the reasons discussed below, we do not believe the proposed
amendments if adopted would result in a material or substantive
revision to these collections of information.\73\
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    \72\ 44 U.S.C. 3501 et seq.
    \73\ 5 CFR 1320.5(g).
---------------------------------------------------------------------------

    The proposed amendments to Form ATS-R and Form PILOT would revise
the forms to provide that information which is currently reported as
separate items, i.e., investment grade debt corporate debt securities
and non-investment grade corporate debt securities, would be combined
and reported as a single item, i.e., corporate debt securities. In all
other respects, the information collected on these forms would remain
unchanged. Accordingly, we do not believe the proposed amendment would
result in a substantive revision to those collections of information if
adopted.
    The proposed amendment to Rule 10b-10 would eliminate a requirement
for transaction confirmations for debt securities (other than
government securities) to inform customers if a security is unrated by
an NRSRO. This proposed amendment would alter neither the general
requirement that broker-dealers generate transaction confirmations and
send those confirmations to customers, nor the potential use of
information contained in confirmations by the Commission, self-
regulatory organizations, and other securities regulatory authorities
in the course of examinations, investigations and enforcement
proceedings. Moreover, the proposed amendment is not expected to change
the cost of generating and sending confirmations, and, we believe that
broker-dealers may not need to incur significant costs if they choose
not to input information that a debt security is unrated into their
existing confirmation systems. Accordingly, we do not believe the
proposed amendment would result in a material or substantive revision
to these collections of information if adopted.
    The proposed amendment to Rule 15c3-1 would potentially modify
broker-dealers' existing practices to impose additional recordkeeping
burdens. The proposed amendment would replace NRSRO ratings-based
criteria for evaluating creditworthiness with new subjective standards
based on the broker-dealer's own evaluation of creditworthiness,
although broker-dealers would still be able to refer to NRSRO ratings
for those purposes. The broker-dealer would have to be able to explain
how the securities it used for net capital purposes meet the standards
set forth in the proposed amendments. As such, we believe that firms
would be required to develop (if they have not already) criteria for
assessing the creditworthiness of securities to be included in net
capital calculations and apply those criteria to such securities. In
addition, the expectation that the broker-dealer be able to explain
that any securities used for net capital purposes meet the standards
set forth in the proposed amendments would result in the creation and
maintenance of records of those assessments.
    We believe that all broker-dealers already have policies and
procedures in place for evaluating the overall risk and liquidity
levels of the securities they use for the purposes of the Net Capital
Rule and that they keep records of the assessments of securities they
make for net capital purposes; however, the proposed requirements,
which specifically address credit risk, could result in additional
burdens. The proposed amendments would apply to the approximately 550
broker-dealers that take haircuts on securities pursuant to the Net
Capital Rule. We estimate that on average, broker dealers will spend
ten hours developing a system of standards for evaluating
creditworthiness for the purposes of the Net Capital Rule, resulting in
an aggregate initial burden of 5,500 hours. This estimate is based on
our belief that many of these broker-dealers already have their own
criteria in place for evaluating creditworthiness, while others would
continue to refer to NRSRO ratings as the basis of their
creditworthiness decisions.
    We further estimate that, on average, each broker-dealer will spend
an additional ten hours a year reviewing, adjusting, and applying its
own standards for evaluating creditworthiness, for a total of 5,500
annual hours across the industry. Once again, this estimate reflects
our belief that many of these broker-dealers already have their own
criteria in place, while others would continue to refer to NRSRO
ratings. We also estimate that firms would employ compliance attorneys,
in many cases relying on outside counsel, to review these standards,
both initially and on an annual basis. We estimate the per-firm costs
of outside counsel to be $2,700 initially and $1,350 on an annual
basis, for an aggregate industry cost of $1,485,000 initially and
$742,500 on an annual basis.\74\
---------------------------------------------------------------------------

    \74\ For the purposes of this analysis, we are using salary data
from the Securities Industry and Financial Markets Association
(``SIFMA'') Report on Management and Professional Earnings in the
Securities Industry 2007, which provides base salary and bonus
information for middle management and professional positions within
the securities industry, as modified by Commission staff to account
for an 1800-hour work-year and multiplied by 5.35 to account for
bonuses, firm size, employee benefits and overhead. We believe that
the legal reviews required by the proposed amendments would be
performed by compliance attorneys at an average rate of $270 per
hour. Furthermore, we believe that the review process will entail
ten hours of initial work and five hours on an annual basis of $270
x 10 = $2,700 x 550 = $1,485,000; $270 x 5 = $1,350 x 550 =
$742,500.

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    We generally request comment on all aspects of these proposed
estimates. In addition, we request specific comment on the following
items related to these estimates:
     Are we correct in our hours estimates and our belief that
many broker-dealers already have their own criteria in place for
evaluating creditworthiness?
     Are we correct in our belief that some broker-dealers
would continue to refer to NRSRO ratings as the basis of their
creditworthiness decisions?
     Are we correct in our estimation that broker-dealers would
engage outside counsel to review their internally generated standards
for creditworthiness? If not, how would firms review such standards and
what would be the effect of such differing approaches on our burden
estimates?
    The proposed amendments to the appendices of Rule 15c3-1 include
amendments to certain recordkeeping and disclosure requirements that
are subject to the PRA. Specifically, the proposed amendments to
Appendices E and F of Rule 15c3-1 and conforming amendments to Appendix
G would remove the provisions permitting reliance on NRSRO ratings for
the purposes of determining counterparty risk. As a result of these
deletions, an entity that wished to use the approach set forth in these
appendices to determine counterparty risks would be required, as part
of its initial application to use the alternative approach or in an
amendment, to request Commission approval to determine credit risk
weights based on internal calculations and make and keep current a
record of the basis for the credit risk weight of each counterparty.
    We do not believe that the removal of the option permitting
reliance on NRSRO ratings would affect the small number of entities
that currently elect to compute their net capital deductions pursuant
to the alternative methods set forth in Appendix E or F. Although the
collection of information obligations imposed by the proposed
amendments are mandatory, applying for approval to use the alternative
capital calculation is voluntary. To date, a total of seven entities
have applied for and been granted permission to use the methods set
forth in Appendix E, while five have applied for and been granted
permission to use the methods set forth in Appendix F. We do not
currently anticipate that any additional firms will apply for
permission to use either Appendix E or Appendix F. All of the approved
firms have already developed models to calculate market and credit risk
under the alternative net capital calculation methods set forth in the
appendices as well as internal risk management control systems.\75\ As
such, each firm already employs the non-NRSRO ratings-based method that
would, under the proposed amendments, become the only option for
determining counterparty credit risk under Appendices E and F. Since
each entity already employs its own models to calculate market and
credit risk and keeps current a record of the basis for the credit risk
weight of each counterparty, the proposed amendments would therefore
not alter the paperwork burden currently imposed by Appendices E and F.
---------------------------------------------------------------------------

    \75\ See, e.g., Alternative Net Capital Requirements for Broker-
Dealers That Are Part of Consolidated Supervised Entities,
Securities Exchange Act Release No. 49830 (June 8, 2004), 69 FR
33428 at 33456 (June 21, 2004).
---------------------------------------------------------------------------

    The proposed amendment to Note G of Exhibit A to Rule 15c3-3 would
potentially modify broker-dealers' existing practices to impose
additional recordkeeping burdens. Currently, Note G to Exhibit A of
Rule 15c3-3 allows a broker-dealer to include, as a debit in the
formula for determining its reserve requirements, the amount of
customer margin related to customers' positions in security futures
products posted to a registered clearing or derivatives organization
that meets one of four standards, including maintaining the highest
investment grade rating from an NRSRO.\76\ The proposed amendment would
replace the NRSRO ratings-based standard with a requirement that the
registered clearing or derivatives organization has the highest
capacity to meet its financial obligations and is subject to no greater
than minimal credit risk. As such, we believe that firms that
previously relied on NRSRO ratings for the purposes of Note G would be
required to develop criteria for assessing the creditworthiness of
registered clearing or derivatives organizations and apply those
criteria to such securities, although one means of complying with the
proposed amendment would be for broker-dealers to refer to NRSRO
ratings. In addition, the expectation that the broker-dealer be able to
explain that any such clearing or derivatives organizations meets the
standard set forth in the proposed amendment would result in the
creation and maintenance of records of those assessments.
---------------------------------------------------------------------------

    \76\ See 17 CFR 240.15c3-3a, Note G, (b)(1)(i). A broker-dealer
may also include customer margin related to customers' positions in
security futures products posted to a registered clearing or
derivatives organization (1) that 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; (2) that maintains
at least $3 billion in margin deposits; or (3) which does not meet
any of the other criteria but which the Commission has agreed, upon
a written request from the broker-dealer, that the broker-dealer may
utilize. 17 CFR 240.15c3-3a, Note G, (b)(1)(ii)--(iv).
---------------------------------------------------------------------------

    In the final release adding Note G to Exhibit A of Rule 15c3-3, we
estimated that approximately 102 firms would be required to comply with
the provisions of the Note.\77\ In addition, we estimated in that
release that under subparagraph (c) to Note G, each broker-dealer would
spend approximately 0.25 hours to verify that the clearing
organizations they used met the conditions of Note G, for an aggregate
one-time total of 25.5 hours; \78\ we believe that this estimate would
apply to the verification of that status under the proposed amendment
as well. We believe that the proposed amendment would impose an
additional one-time burden for broker-dealers that chose to rely on the
new standard of proposed Rule 15c3-3a(b)(1)(i). Given the additional
options set forth in Note G, we estimate that only half, or 51, of the
broker-dealers would choose this option, which we believe would result
in the broker-dealer spending, on average, ten hours developing a
system of standards for evaluating creditworthiness for the purposes of
Note G, resulting in an aggregate initial burden of 510 hours.\79\ We
also estimate that firms would employ compliance attorneys, in many
cases relying on outside counsel, to review these standards. We
estimate the one-time costs of outside counsel to be $1,350 per firm,
resulting in an aggregate industry cost of $68,850.\80\
---------------------------------------------------------------------------

    \77\ See Reserve Requirements for Margin Related to Security
Futures Products, Exchange Act Release No. 34-50295 (August 31,
2004), 69 FR 54182 at 54188 (September 7, 2004).
    \78\ 0.25 x 102 = 25.5.
    \79\ 10 x 51 = 510.
    \80\ For the purposes of this analysis, we are using salary data
from the SIFMA Report on Management and Professional Earnings in the
Securities Industry 2007. We believe that the legal reviews required
by the proposed amendments would be performed by compliance
attorneys at an average rate of $270 per hour. Furthermore, we
believe that the review process will entail five hours of initial
work. $270 x 5 = $1,350 x 51 = $68,850.
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    We generally request comment on all aspects of these proposed
estimates. In addition, we request specific comment on the following
items related to these estimates:

     Are we correct in our estimate of the number of broker-
dealers that would be affected by the proposed amendment to Note G?
     Are we correct in our estimate of the percentage of such
broker-dealers that choose to rely on proposed Rule 15c3-3a(b)(1)(i)?
     Are we correct in our belief that broker-dealers would
engage outside counsel to review their internally generated standards
for creditworthiness? If not, how would firms review such standards and
what would be the effect of such differing approaches on our burden
estimates?
    The instructions to Form X-17A-5 Part IIB currently include a
summary of the credit risk calculation in paragraph (d) of Rule 15c3-
1f. Paragraph (d) of Rule 15c3-1f is proposed to be amended to remove
that part of the credit risk calculation that is summarized in Form X-
17A-5 Part IIB. Accordingly, we have proposed a conforming amendment to
the form that would remove the summary of the credit risk calculation.
The summary in the instructions provides additional information for the
benefit of the filer and is not related to the information reported on
the forms. Accordingly, we do not believe the proposed amendment would
result in a substantive revision to these collections of information if
adopted.
    Pursuant to 44 U.S.C. 3506(c)(2)(B), we solicit comments to:
    (1) Evaluate whether the proposed collection of information is
necessary for the performance of the functions of the agency, including
whether the information shall have practical utility;
    (2) Evaluate and provide relevant data regarding the agency's
estimate of the burden of the proposed collection of information,
including the validity of the methodology and assumptions used;
    (3) Enhance the quality, utility and clarity of the information to
be collected; and
    (4) Minimize the burden of collection of information on those who
are to respond, including through the use of automated collection
techniques or other forms of information technology.
    Persons wishing to submit comments on the collection of information
requirements should direct them to the following persons: (1) Desk
Officer for the Securities and Exchange Commission, Office of
Information and Budget (``OMB''), Room 3208, New Executive Office
Building, Washington, DC 20503; and (2) Florence E. Harmon, Acting
Secretary, Securities and Exchange Commission, 100 F Street, NE.,
Washington, DC 20549-1090 with reference to File No. S7-17-08. OMB is
required to make a decision concerning the collection of information
between 30 and 60 days after publication, so a comment to OMB is best
assured of having its full effect if OMB receives it within 30 days of
publication. The Commission has submitted the proposed collection of
information to OMB for approval. Requests for the materials submitted
to OMB by the Commission with regard to this collection of information
should be in writing, refer to File No. S7-17-08, and be submitted to
the Securities and Exchange Commission, Records Management Office, 100
F Street, NE., Washington, DC 20549-1110.

VI. Costs and Benefits of the Proposed Rulemaking

    The Commission is sensitive to the costs and benefits imposed by
its rules. We have identified certain costs and benefits of the
proposed amendments and request comment on all aspects of this cost-
benefit analysis, including identification and assessment of any costs
and benefits not discussed in this analysis. We seek comment and data
on the value of the benefits identified. We also welcome comments on
the accuracy of the cost estimates in each section of this analysis,
and request that commenters provide data that may be relevant to these
cost estimates. In addition, we seek estimates and views regarding
these costs and benefits for particular covered institutions, including
small institutions, as well as any other costs or benefits that may
result from the adoption of these proposed amendments.
    As discussed above, the proposed rule amendments are designed to
address the risk that the reference to and use of NRSRO ratings in our
rules is interpreted by investors as an endorsement of the quality of
the credit ratings issued by NRSROs, and may encourage investors to
place undue reliance on the NRSRO ratings. The proposed amendments to
Rule 3a1-1, Rule 10b-10, Rule 15c3-1, Rule 15c3-3, Rules 101 and 102 of
Regulation M, Rules 300 and 301 of Regulation ATS, and Form ATS-R, Form
PILOT, and Form X-17A-5 Part IIB would eliminate the reference to and
requirement for the use of NRSRO ratings in these rules.

A. Benefits

    The Commission anticipates that one of the primary benefits of the
proposed amendments, if adopted, would be the benefit to investors of
reducing their possible undue reliance on NRSRO ratings that could be
caused by references to NRSROs in our rules. An over-reliance on
ratings can inhibit independent analysis and could possibly lead to
investment decisions that are based on incomplete information. The
purpose of the proposed rule amendments is to encourage investors to
examine more than a single source of information in making an
investment decision. Eliminating reliance on ratings in the
Commission's rules could also result in greater investor due diligence
and investment analysis. In addition, the Commission believes that
eliminating the reliance on ratings in its rules would remove any
appearance that the Commission has placed its imprimatur on certain
ratings.
    We expect that there would be little effect on broker-dealers or
other market participants that are subject to the rules that are
proposed to be amended. This is because the references to NRSROs in
these rules would be no longer necessary, can be replaced with an
alternative bright-line standard, or can be used as one possible
interpretation of a subjective standard set forth in a proposed
amendment to the rule.
    The proposed amendments to Rule 3a1-1, Rules 300 and 301 of
Regulation ATS, Form ATS-R, and Form PILOT would eliminate the separate
definitions of and references to investment grade corporate debt
securities and non-investment grade corporate debt securities and would
replace them with a single category ``corporate debt securities.'' For
reasons discussed above, the Commission preliminarily believes that it
is not necessary or appropriate to assess trading volumes in the
narrower segments of investment grade and non-investment grade
corporate debt securities to fulfill the purposes of those rules. The
other classes of securities and the threshold levels themselves would
remain unchanged. Therefore, the proposed amendments to Rule 3a1-1 and
Regulation ATS are not expected to significantly affect the regulatory
treatment of ATSs. With respect to the proposed changes to Form ATS-R
and Form PILOT, we expect that combining investment grade and non-
investment grade corporate debt securities into a single class for
purposes of those two forms would have only minimal impact, because the
total units and total dollar volume of corporate debt securities
transacted would still have to be reported.
    The proposed amendments to Rule 10b-10 to eliminate a requirement
for transaction confirmations for debt securities (other than
government securities) to inform customers if a security is unrated by
an NRSRO. The other requirements of Rule 10b-10 would remain unchanged.
Eliminating

this requirement would avoid giving credit ratings an imprimatur that
may inadvertently suggest to investors that an unrated security is
inherently riskier than a rated security. Accordingly, we anticipate
that investors and the marketplace would benefit from the elimination
of this requirement, in light of concerns about promoting over-reliance
on securities ratings or creating confusion about the significance of
those ratings. More generally, eliminating this requirement is
consistent with the goal of promoting a dialogue between broker-dealers
and their customers--prior to purchase--regarding the creditworthiness
of issuers, and should help avoid promoting the use of credit ratings
as an oversimplified shorthand that replaces a more complete discussion
of credit quality issues.
    We preliminarily believe that the proposed amendments to the Net
Capital Rule, its appendices, and Exhibit A to the Customer Protection
Rule would result in a better overall assessment of the risks
associated with securities held by broker-dealers for the purposes of
net capital calculations as well as of the long-term financial strength
and general creditworthiness of clearing organizations to which
customers' positions in security futures products are posted. As the
NRSROs themselves have stressed, the ratings they generate focus solely
on credit risk, that is, the likelihood that an obligor or financial
obligation will repay investors in accordance with the terms on which
they made their investment.\81\ Many broker-dealers already conduct
their own risk evaluation. However, for those broker-dealers that do
not, developing their own means of evaluating risk--including, as would
be required by the proposed amendments to the Net Capital Rule, an
evaluation of the degree of liquidity--would allow them to better
incorporate the overall levels of various categories of risk associated
with the securities they hold into their net capital calculations.
---------------------------------------------------------------------------

    \81\ See, e.g., Inside the Ratings: What Credit Ratings Mean,
Fitch, August 2007 (``Inside the Ratings''), p. 1; Testimony of
Michael Kanef, Group Managing Director, Moody's Investors Service,
Before the United States Senate Committee on Banking, Housing, and
Urban Affairs (September 26, 2007), p. 2; Testimony of Vickie A.
Tillman, Executive Vice President, Standard & Poor's Credit Market
Services, Before the United States Senate Committee on Banking,
Housing, and Urban Affairs (September 26, 2007), p. 3.
---------------------------------------------------------------------------

    A separate evaluation of risk by the broker-dealer should lead to a
better understanding of the risks associated with those securities
which would, we believe, lead to increased operational efficiency and
potentially lowered net capital charges for those broker-dealers that
currently do not conduct their own risk evaluation. We believe that
allowing broker-dealers to employ their own criteria in determining
credit risk for net capital purposes would, by reducing the reliance on
NRSRO ratings and therefore more closely aligning a broker-dealer's net
capital-related risk assessments with its general internal risk
assessments, increase operational efficiency. Furthermore, we believe
that the proposed amendments could result in more closely tailored
capital charges, and thus lowered costs, for broker-dealers while still
being designed to ensure net capital requirements sufficient to require
maintenance of capital to achieve the goals of the Net Capital Rule.
    We believe that the same reasoning applies to the proposed
amendment to Exhibit A of the Customer Protection Rule. Broker-dealers
that utilize their own means of evaluating the long-term financial
strength and general creditworthiness of clearing organizations to
which customers' positions in security futures products are posted
would better be positioned to incorporate the overall levels of various
categories of risk associated with those organizations into their
assessments.
    In the case of the amendments to Rules 101 and 102 of Regulation M,
we believe the proposed rule amendments would have benefits that
justify any costs, if adopted. Because the exceptions in Rules 101 and
102 are narrowly-tailored, the proposed amendments should continue to
promote investor confidence in the offering process and the market as a
whole by only excepting those securities that are resistant to
manipulation. Market integrity would also continue to be promoted,
which benefits the market and all participants. Also, since the
proposals would be a bright-line, compliance with the proposed
amendments would be easy for issuers and other persons subject to the
rules. In fact, this proposal may lower costs for these people by
eliminating the need to obtain an investment grade rating from a
nationally recognized statistical rating organization. We believe that
replacing the NRSRO investment grade requirement with the proposed
exceptions should not result in broker-dealers hiring new compliance
staff or making extensive systems changes because the proposals utilize
existing bright-line benchmarks.

B. Costs

    We anticipate that broker-dealers and other market participants
could incur certain costs if the proposed amendments are adopted.
Investors could incur additional costs if they perform a more detailed
and comprehensive analysis before making an investment decision.
Broker-dealers could incur additional costs if they perform their own
risk evaluation, if they do not currently do so. Furthermore, the
purpose of the proposal is to encourage investors not to place undue
reliance on NRSRO ratings in making investment decisions. Investors
could still choose to rely solely on NRSRO ratings without incurring
additional costs.
    The proposed amendments to Rule 3a1-1, Rules 300 and 301 of
Regulation ATS, Form ATS-R, and Form PILOT would eliminate the separate
definitions of and references to investment grade corporate debt
securities and non-investment grade debt securities and would replace
them with a single category ``corporate debt securities.'' We
preliminarily believe that these changes would not impose any
significant costs on market participants.
    The proposed amendments to Rule 3a1-1 and Regulation ATS would
marginally reduce the likelihood of an ATS meeting the thresholds in
those rules. For example, under existing Rule 3a1-1, an ATS that
currently has 40% of the average daily dollar trading volume in non-
investment grade corporate debt securities and 0% of the average daily
dollar trading volume in investment grade corporate debt securities for
at least four of the preceding six calendar months could be required to
register as an exchange. Under the proposed amendment to Rule 3a1-1,
the Commission would no longer be able to require the ATS to register
as an exchange, because its average daily dollar trading volume in
corporate debt securities combined would be less than 40%. A potential
cost of the proposed amendments to Rule 3a1-1 and Regulation ATS is
that an ATS that exceeds one of the existing thresholds and thus
becomes subject to additional regulatory requirements (in the case of
Regulation ATS) or must register as an exchange (in the case of Rule
3a1-1) would no longer exceed the threshold and would not have to meet
the attendant requirements. However, the Commission preliminarily
believes that this possibility is remote, and that the proposed
amendments are unlikely to impose any costs on investors, market
participants, or the national market system generally.
    We believe that any costs associated with the proposed changes to
Form ATS-R and Form PILOT would be minimal. Respondents already
determine and report the total units and

total trading volume for investment grade and non-investment grade
corporate debt securities separately. On the revised forms, respondents
would report them together as a single item for ``corporate debt
securities.'' The cost of the proposed changes to these forms would be
the cost of adding these previously separate items together.
    We do not expect the proposed amendment to result in any
significant changes in the costs associated with Rule 10b-10. Broker-
dealers will continue to generate transaction confirmations and send
those confirmations to customers, and the proposed amendment if adopted
would not be expected to change the cost of generating and sending
confirmations. Moreover, we believe that broker-dealers may not need to
incur significant costs if they choose not to input information that a
debt security is unrated into their existing confirmation systems.
    We believe that the costs of compliance with the proposed
amendments to the Net Capital Rule and its appendices as well as to
Note G of Exhibit A of the Rule 15c3-3 would be minimal for entities
that already employ their own criteria in determining credit risk for
net capital purposes. In the event the broker-dealer inaccurately
evaluates the creditworthiness and liquidity of its positions, a
potential cost could be that the broker-dealer is required to take a
larger haircut on its proprietary positions, and therefore reserve
additional capital. This could affect its ability to hold its positions
or to add to its positions. As for broker-dealers that do not currently
employ such criteria, if the proposed amendments are adopted, after
considering comment, we could take the view that securities rated by
NRSROs would meet the standards in the rules as amended and this would
provide a way for broker-dealers that do not determine credit risk on
their own to avoid incurring any additional costs. If we were to adopt
the view that NRSRO rated securities meet the standard in the proposed
amendments, it would mean that any potential costs would be wholly
voluntary. While we encourage broker-dealers that have not yet
developed their own credit risk evaluation procedures to do so, such
actions would proceed at the time and pace desired by the broker-
dealers.
    We expect the costs of the proposal to modify Rules 101 and 102 of
Regulation M to be minimal to most persons subject to those rules who
could rely on the proposed amendments as they relate to nonconvertible
debt and preferred securities. The proposed exceptions are only
triggered when the conditions in the exceptions are met which would
only occur in a limited number of situations. It is only when there is
an offering of nonconvertible debt or nonconvertible preferred
securities which qualifies as a distribution under Regulation M where a
covered person bids for, purchases or attempts to induce another person
to bid for or purchase the covered security during the applicable
restricted period. Thus, there may be offerings of nonconvertible debt
or preferred securities that do not constitute a distribution for
purposes of Regulation M. In such case, the prohibitions of Regulation
M are not triggered and neither the current nor the proposed exceptions
would be necessary. Additionally, even if a distribution of the
nonconvertible debt or nonconvertible preferred securities exists, a
person subject to Regulation M's prohibitions could structure buying
activity before or after the applicable restricted period so as not to
incur any costs, even if minimal, associated with relying on the
proposed exceptions. This holds true for asset-backed securities as
well.
    We believe that many of the issuers of these securities would
already know if they are WKSI issuers based on the non-common equity
standard because this analysis would have been already done as part of
the offering process. Persons other than issuers who would be subject
to Rules 101 and 102 should have access to the issuer's WKSI status as
well via the issuer's 10K filings. Such persons should also be in a
position with the issuer to obtain any other information needed to make
a determination as to whether the proposed exception would apply to the
security at issue. Thus, we believe that these persons should incur no
significant costs under the proposal. There may be, however, costs to
any person subject to Rules 101 or 102 to make minor system changes
should the Commission adopt this proposal because of the proposed new
standard.
    We do believe, however, that there may be increased costs for
issuers and other persons subject to Rules 101 and 102 as they relate
to nonconvertible debt and preferred securities if that issuer is WKSI
based on the common equity standard.\82\ Since the issuer in that case
would not need to determine the aggregate principal amount of their
nonconvertible securities other than common equity for purposes of
Securities Act disclosure, new analysis would need to be conducted and
communicated to other persons subject to Rules 101 and 102 to rely on
the exception. This could likely result in increased costs not
completely offset by not needing to obtain an investment grade rating.
---------------------------------------------------------------------------

    \82\ 17 CFR 230.405. The common equity standard is at
subparagraph (1)(i)(A) of the definition of ``well-known seasoned
issuer.''
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    With respect to asset-backed securities, we believe that there
should not be any significant increased costs to persons subject to
Rules 101 and 102. All persons who are subject to those rules should
know what form the issuer is using to register the offering, including
whether Form S-3 is being used. Thus, no new analysis would need to be
conducted. We also expect that there could be a small number of
securities taken out of this exception as a result of the proposed
change. Costs for such issuers, selling shareholders, underwriters,
brokers, dealers, any other distribution participants, or affiliated
purchasers of any of these persons affected by this change would be
more significant, but we do not expect there to be a significant number
of these persons. There could also be minimal costs to train broker-
dealer and self-regulatory organization staff and to update broker-
dealer policies and procedures and make system changes regarding the
new exceptions.

C. Request for Comment

    We request data to quantify the costs and the benefits above. We
seek estimates of these costs and benefits, as well as any costs and
benefits not already described, which could result from the adoption of
the proposed amendments. Specifically, would the proposal result in
lower costs associated with debt and preferred securities covered by
the new exception? What new costs, if any, would be associated with the
proposal for persons subject to Rules 101 and 102 where the
nonconvertible debt and nonconvertible preferred securities are issued
by issuers who are WKSI based on the common equity standard? What
costs, if any, would be related to the change for asset-backed
securities? For these issues, what is the cost of determining the
aggregate principal amount of nonconvertible debt securities other than
common equity and then communicating the exception to other persons
subject to Rules 101 and 102? Would any securities that currently fall
within the existing exceptions not meet the exceptions as proposed?
Would the proposal affect the cost to broker dealers of generating
transaction confirmations? Do investors benefit from the notification
on the transaction confirmation? Does the confirmation help promote
conversations about broker-dealers and their customers

regarding unrated securities? Are there alternative means to promote
such conversations that would not create over-reliance on NRSRO
ratings?

VII. Consideration of the Burden on Competition, Promotion of
Efficiency, and Capital Formation

    Section 3(f) of the Exchange Act \83\ requires the Commission,
whenever it engages in rulemaking and is required to consider or to
determine whether an action is necessary or appropriate in the public
interest, to consider whether the action will promote efficiency,
competition, and capital formation. In addition, Section 23(a)(2) of
the Exchange Act \84\ requires the Commission, when promulgating rules
under the Exchange Act, to consider the impact any such rules would
have on competition. Section 23(a)(2) further provides that the
Commission may not adopt a rule that would impose a burden on
competition not necessary or appropriate in furtherance of the purposes
of the Exchange Act.
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    \83\ 15 U.S.C. 78c(f).
    \84\ 15 U.S.C. 78w(a)(2).
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    The proposed amendments would remove the reference to NRSRO ratings
in several of our rules and forms. These include Rules 3a1-1, 10b-10,
15c3-1, 15c3-3, Rules 101 and 102 of Regulation M, Rules 300 and 301 of
Regulation ATS, and Forms ATS-R and PILOT. The purpose of the proposed
amendments is to address concerns that the references to NRSRO ratings
in our rules and forms contributed to any over-reliance on credit
ratings by investors.
    We preliminarily believe that the proposed amendments to Rule 3a1-1
and Rules 300 and 301 of Regulation ATS would be unlikely to create any
adverse impact on efficiency, competition, or capital formation. The
Commission preliminarily believes that combining investment grade and
non-investment grade corporate debt securities into a single class of
securities for purposes of the thresholds in those rules is unlikely to
affect whether an ATS crosses one of those thresholds. Moreover, the
other classes of securities for which the thresholds are applied--and
the levels of the thresholds themselves--would remain unchanged.
    The proposed changes to Form ATS-R and Form PILOT would simplify
reporting for ATSs and self-regulatory systems that operate pilot
trading systems. Form ATS-R and Form PILOT respondents are already
required to determine and report the volumes of corporate debt
securities. A single reporting item for ``corporate debt securities''
would replace the existing separate entries for ``investment grade
corporate debt securities'' and ``non-investment grade corporate debt
securities.'' Therefore, we preliminarily believe that the changes to
Form ATS-R and Form PILOT would be unlikely to have any significant
impact on efficiency, competition, or capital formation.
    We do not believe that the proposed amendment to Rule 10b-10 would
result in any burden on competition that is not necessary or
appropriate in furtherance of the purposes of the Exchange Act. The
proposed deletion of paragraph (a)(8) of that rule would not be
expected to impose any significant additional costs upon broker-dealers
(which in any event would not be prohibited from voluntarily including
information that a particular debt security is unrated by an NRSRO).
For similar reasons, we do not believe that this proposed amendment
would impose any significant adverse effects on efficiency, competition
or capital formation.
    We preliminarily believe that the proposed amendments to the Net
Capital Rule and its appendices or to Note G of Exhibit A of the Rule
15c3-3 would serve to promote efficiency and capital formation. As
noted above, we believe that by relying on their own means of
evaluating risk, broker-dealers would better incorporate the overall
levels of risk associated with the securities they hold into their Net
Capital Rule. In turn, we believe, this better understanding would more
closely align a broker-dealer's net capital-related risk assessments
with its general internal risk assessments and lead to increased
operational efficiency, potentially lowered net capital charges, and a
more efficient allocation of capital. In addition, broker-dealers that
developed their own means of evaluating the long-term financial
strength and general creditworthiness of clearing organizations to
which customers' positions in security futures products are posted for
purposes of Note G to Exhibit A of Rule 15c3-3 would better be
positioned to incorporate the overall levels of various categories of
risk associated with those organizations into their assessments,
creating a more efficient means of evaluating those organizations for
the sake of the Rule 15c3-3 than simply relying on NRSRO credit ratings
alone. We do not anticipate that the proposed amendments to the Net
Capital Rule and its appendices or to Note G of Exhibit A of Rule 15c3-
3 would have any impact on competition.
    We preliminarily believe that the proposed amendments to Rules 101
and 102 of Regulation M are intended to promote capital formation. The
proposed amendments should promote continued investor confidence in the
offering process by proposing an exception from Regulation M's Rule 101
and 102 prohibitions limited to those securities which are resistant to
manipulation. Such investor confidence in our markets should promote
continued capital formation. We believe that the proposals should
foster continued market integrity which should also translate into
capital formation by only allowing for non-manipulative buying activity
during distributions. Issuers of nonconvertible debt, nonconvertible
preferred securities and asset-backed securities who fall within the
proposed exceptions may be encouraged to engage in capital formation
knowing that the proposed exceptions are available for their buying
activity as well as the buying activity of distribution participants.
Because the proposal eliminates the need to obtain an investment grade
rating by an NRSRO, a hurdle to both relying on the exception and
capital formation would be eliminated, which would also promote capital
formation.
    The proposal would provide an alternative to obtaining an
investment grade rating but still would provide clear guidance to all
persons subject to those rules. We preliminarily believe that the
proposed Regulation M amendments would promote market efficiency by
providing continued clarity to issuers, distribution participants, and
their affiliated purchasers as to the scope of permissible activity by
providing a bright line test for compliance with the proposed
exceptions comparable to the existing exception. In addition, the
proposals continue to utilize existing benchmarks so as not to trigger
inefficiencies that might result from use of a new standard. The
proposal would also eliminate the need to obtain an investment grade
rating from an NRSRO to rely on the exception, which will eliminate a
potential inefficiency in the capital raising process. For these
reasons, the Commission preliminarily believes that the proposed
exceptions will promote efficient capital formation and competition.
    We have considered the proposed amendments to Rules 101 and 102 of
Regulation M in light of the standards cited in Section 23(a)(2) and
believe preliminarily that, if adopted, they would not likely impose
any significant burden on competition not necessary or appropriate in
furtherance of the Exchange Act. We preliminary believe that the use of
the existing WSKI and

Form S-3 standards would mean that any additional burdens the proposal
may place on market participants should be minimal as market
participants are already familiar with and utilize these benchmarks in
other contexts. Additionally, the proposals would apply equally to all
issuers, distribution participants, and their affiliated issuers. Thus,
no person covered by Regulation M should be put at a competitive
disadvantage, and the proposal would not impose a significant burden on
competition not necessary or appropriate in furtherance of the Act.
    We generally request comment on the effects of the proposed
amendments to Rules 3a1-1, 10b-10, 15c3-1, 15c3-3, Rules 101 and 102 of
Regulation M, Rules 300 and 301 of Regulation ATS, and Forms ATS-R and
PILOT on efficiency, competition, and capital formation. Commenters
should provide analysis and empirical data to support their views.

VIII. Regulatory Flexibility Act Certification

    Section 3(a) of the Regulatory Flexibility Act of 1980 \85\
requires the Commission to undertake an initial regulatory flexibility
analysis of the proposed rule on small entities unless the Commission
certifies that the rule, if adopted, would not have a significant
economic impact on a substantial number of small entities.\86\ Pursuant
to Section 605(b) of the Regulatory Flexibility Act (``RFA''), the
Commission hereby certifies that the proposed amendments to the rule,
would not, if adopted, have a significant economic impact on a
substantial number of small entities.
---------------------------------------------------------------------------

    \85\ 5 U.S.C. 603(a).
    \86\ 5 U.S.C. 605(b).
---------------------------------------------------------------------------

    For purposes of Commission rulemaking in connection with the RFA,
small entities include broker-dealers with total capital (net worth
plus subordinated liabilities) of less than $500,000 on the date in the
prior fiscal year as of which its audited financial statements were
prepared pursuant to Rule 17a-5(d) under the Exchange Act,\87\ or, if
not required to file such statements, a broker or dealer that had total
capital (net worth plus subordinated liabilities) of less than $500,000
on the last day of the preceding fiscal year (or in the time that it
has been in business, if shorter); and is not affiliated with any
person (other than a natural person) that is not a small business or
small organization.\88\
---------------------------------------------------------------------------

    \87\ See 17 CFR 240.17a-5(d).
    \88\ See 17 CFR 240.0-10(c).
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    An alternative trading system that complies with Regulation ATS
must, among other things, register as a broker-dealer.\89\ Thus, the
Commission's definition of small entity as it relates to broker-dealers
also would apply to ATSs. An ATS that approaches the volume thresholds
for investment grade or non-investment grade corporate debt securities
in Rule 3a1-1 or Regulation ATS would be very large and thus unlikely
to be a small entity or small organization. With respect to the
proposed changes to Form ATS-R, even if an ATS is a ``small entity'' or
``small organization'' for purposes of the RFA, the only change being
proposed to the form is to eliminate the distinction between investment
grade and non-investment grade corporate debt securities and to require
reporting for the combined class of corporate debt securities. We
believe this would impose only negligible costs on ATSs, even if they
were small entities or small organizations.
---------------------------------------------------------------------------

    \89\ See 17 CFR 242.301(b)(1).
---------------------------------------------------------------------------

    Similarly, SROs are the only respondents to Form PILOT and are not
``small entities'' for purposes of the RFA. Accordingly, no small
entities would be affected by the proposed amendments to Form PILOT.
    We believe that the proposed amendment to Rule 10b-10 will not have
a significant economic impact on a substantial number of small
entities. While some broker-dealers that effect transactions in the
debt securities currently subject to paragraph (a)(8) of that rule may
be small entities, the proposed amendment should not result in any
significant change to the cost of providing confirmations to customers
in connection with those transactions.
    The proposed amendments to the securities haircut provisions in
paragraphs (E), (F), and (H) of Rules 15c3-1(c)(2)(vi), if adopted,