[Federal Register Volume 76, Number 88 (Friday, May 6, 2011)]
[Proposed Rules]
[Pages 26550-26577]
[FR Doc No: 2011-10619]

Vol. 76

Friday,

No. 88

May 6, 2011

Part VI

Securities and Exchange Commission

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17 CFR Parts 240, 242, and 249

Removal of Certain References to Credit Ratings Under the Securities
Exchange Act of 1934 Regulation Z; Truth in Lending; Proposed Rule

Federal Register / Vol. 76 , No. 88 / Friday, May 6, 2011 / Proposed
Rules

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SECURITIES AND EXCHANGE COMMISSION

17 CFR Parts 240, 242, and 249

[Release No. 34-64352; File No. S7-15-11]
RIN 3235-AL14

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

AGENCY: Securities and Exchange Commission.

ACTION: Proposed rule.

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SUMMARY: This is one of several proposed rules that the Securities and
Exchange Commission (the ``Commission'') will be considering relating
to the use of credit ratings in Commission rules and forms. Section
939A of the Dodd-Frank Act Wall Street Reform and Consumer Protection
Act (the ``Dodd-Frank Act'') requires the Commission to remove any
references to credit ratings from its regulations and to substitute
such standard of creditworthiness as the Commission determines to be
appropriate. In this release, the Commission is proposing to amend
certain rules and one form under the Securities Exchange Act of 1934
(the ``Exchange Act'') applicable to broker-dealer financial
responsibility, distributions of securities, and confirmations of
transactions. The Commission also is requesting comment on potential
standards of creditworthiness for purposes of Exchange Act Sections
3(a)(41) and 3(a)(53), which define the terms ``mortgage related
security'' and ``small business related security,'' respectively, as
the Commission considers how to implement Section 939(e) of the Dodd-
Frank Act.

DATES: Comments should be received on or before July 5, 2011.

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 S7-15-11 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 Elizabeth M. Murphy,
Secretary, Securities and Exchange Commission, 100 F Street, NE.,
Washington, DC 20549-1090.

All submissions should refer to File Number S7-15-11. This file number
should be included on the subject line if e-mail is used. To help the
Commission 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/concept.shtml). Comments are also available for Web site viewing and
printing 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, at<PHONE_NUMBER>; Thomas K. McGowan, Deputy Associate
Director, at<PHONE_NUMBER>; Randall W. Roy, Assistant Director, at
(202) 551-5522; Mark M. Attar, Branch Chief, at<PHONE_NUMBER>; Carrie
A. O'Brien, Special Counsel, at<PHONE_NUMBER>; and Leigh E. Bothe,
Attorney, at<PHONE_NUMBER>, Office of Financial Responsibility (Net
Capital, Customer Protection, and Books and Records Requirements, and
Section 939(e) of the Dodd-Frank Act); Josephine J. Tao, Assistant
Director, Elizabeth A. Sandoe, Senior Special Counsel, David P. Bloom,
Branch Chief, or Bradley Gude, Special Counsel, Office of Trading
Practices and Processing at<PHONE_NUMBER> (Regulation M); and Joseph
M. Furey, Co-Acting Chief Counsel, and Ignacio Sandoval, Special
Counsel, Office of Chief Counsel at<PHONE_NUMBER> (Confirmation of
Transactions), Division of Trading and Markets, Securities and Exchange
Commission, 100 F Street, NE., Washington, DC 20549-7010.

SUPPLEMENTARY INFORMATION: On July 21, 2010, the President signed the
Dodd-Frank Act into law. The Commission is requesting public comment on
proposed amendments to Exchange Act Rules 15c3-1, 15c3-3, 17a-4, 101
and 102 of Regulation M, and 10b-10, and one Exchange Act form--Form X-
17A-5, Part IIB--to remove references to credit ratings and, in certain
cases, substitute alternative standards of creditworthiness as required
by Section 939A of the Dodd-Frank Act.\1\ The Commission is also
requesting public comment on potential standards of creditworthiness
for purposes of Exchange Act Sections 3(a)(41) and 3(a)(53), which
define the terms ``mortgage related security'' and ``small business
related security,'' respectively, as the Commission considers how to
implement Section 939(e) of the Dodd-Frank Act.
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    \1\ See Public Law 111-203 Sec.  939A.
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I. Background

A. Dodd-Frank Wall Street Reform and Consumer Protection Act

    The Dodd-Frank Act was enacted to, among other things, promote the
financial stability of the United States by improving accountability
and transparency in the financial system.\2\ Title IX, Subtitle C, of
the Dodd-Frank Act \3\ includes provisions regarding statutory and
regulatory references to credit ratings in Exchange Act rules, as well
as in the Exchange Act itself.\4\
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    \2\ See Public Law 111-203, 124 Stat. 1376 (2010); Public Law
111-203, Preamble.
    \3\ Public Law 111-203, 124 Stat. 1376 (2010).
    \4\ These provisions are designed ``[t]o reduce the reliance on
ratings.'' See Joint Explanatory Statement of the Committee of
Conference, Conference Committee Report No. 111-517, to accompany
H.R. 4173, 864-879, 870 (Jun. 29, 2010).
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    Specifically, in Section 939A of the Dodd-Frank Act, Congress
requires that the Commission ``review any regulation issued by [the
Commission] that requires the use of an assessment of the credit-
worthiness of a security or money market instrument and any references
to or requirements in such regulations regarding credit ratings.'' \5\
Once the Commission has completed that review, the statute provides
that the Commission ``remove any reference to or requirement of
reliance on credit ratings, and to substitute in such regulations such
standard of credit-worthiness'' as the Commission determines to be
appropriate.\6\
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    \5\ Public Law 111-203 Sec.  939A(a)(1)-(2).
    \6\ See Public Law 111-203 Sec.  939A(b). The Commission has
recently proposed amendments to its rules in other contexts under
the federal securities laws to remove references to credit ratings.
See References to Credit Ratings in Certain Investment Company Act
Rules and Forms, Securities Act of 1933 (``Securities Act'') Release
No. 9193 (Mar. 3, 2011), 76 FR 12896 (Mar. 9, 2011) and Security
Ratings, Exchange Act Release No. 63874 (Feb. 9, 2011), 76 FR 8946
(Feb. 16, 2011).
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    As is discussed in detail below, there are five Exchange Act
rules--Rule 15c3-1, Rule 15c3-3, Rules 101 and 102 of Regulation M, and
Rule 10b-10--administered by the Commission and one Exchange Act form--
Form X-17A-5, Part IIB--that the Commission is proposing to amend in
this release as directed by Section 939A of the Dodd-Frank Act. The
Commission is also proposing corresponding changes to Exchange Act Rule
17a-4, relating to broker-dealer recordkeeping.

    Further, in Section 939(e) of the Dodd-Frank Act,\7\ Congress
deleted Exchange Act references to credit ratings in two sections: (1)
In Exchange Act Section 3(a)(41),\8\ which defines the term ``mortgage
related security,'' and (2) in Exchange Act Section 3(a)(53),\9\ which
defines the term ``small business related security.'' In place of the
credit rating references, Congress added language stating that a
mortgage related security and a small business related security will
need to satisfy ``standards of credit-worthiness as established by the
Commission.'' \10\ This replacement language becomes effective on July
21, 2012 (i.e., two years after the date the Dodd-Frank Act was signed
into law).
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    \7\ Public Law 111-203 Sec.  939(e).
    \8\ 15 U.S.C. 78c(a)(41).
    \9\ 15 U.S.C. 78c(a)(53).
    \10\ Public Law 111-203 Sec.  939(e).
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    As is discussed in detail below, the Commission also is requesting
comment on potential standards of creditworthiness for purposes of
Exchange Act Sections 3(a)(41) and 3(a)(53), as the Commission
considers how to implement Section 939(e) of the Dodd-Frank Act.

B. Previous Commission Action

    In 1975, the Commission adopted the term ``nationally recognized
statistical rating organization'' (``NRSRO'') as part of the
Commission's amendments to its broker-dealer net capital rule, Exchange
Act Rule 15c3-1 (the ``Net Capital Rule'').\11\ Although the Commission
originated the use of the term NRSRO for a narrow purpose in its own
regulations, ratings by NRSROs today are widely used as benchmarks in
federal and state legislation, rules by financial and other regulators,
foreign regulatory schemes, and private financial contracts. The
Commission's initial regulatory use of the term NRSRO was intended
solely to provide a method for determining capital charges on different
grades of debt securities under the Net Capital Rule. The Commission's
reference to NRSROs for purposes of certain rules increased over time.
    Subsequent to the adoption of many of the Commission's requirements
using the NRSRO concept, the Commission--in 2006--obtained registration
and oversight authority with respect to credit rating agencies that
register to be treated as NRSROs.\12\ In response, the Commission
adopted rules to implement a registration and oversight program for
NRSROs in June 2007.\13\
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    \11\ See Adoption of Uniform Net Capital Rule and an Alternative
Net Capital Requirement for Certain Brokers and Dealers, Exchange
Act Release No. 11497 (Jun. 26, 1975), 40 FR 29795 (Jul. 16, 1975)
and 17 CFR 240.15c3-1.
    \12\ See Credit Rating Agency Reform Act of 2006 (``Rating
Agency Act of 2006''); Public Law 109-291 (2006). Among other
things, the Rating Agency Act of 2006 defined the terms ``credit
rating agency'' and ``nationally recognized statistical rating
organization'' in Exchange Act Sections 3(a)(61) and 3(a)(62),
respectively. See Public Law 109-291 Sec.  3. Under Section
3(a)(61), the term ``credit rating agency'' means any person: (A)
engaged in the business of issuing credit ratings on the Internet or
through another readily accessible means, for free or for a
reasonable fee, but does not include a commercial credit reporting
company; (B) employing either a quantitative or qualitative model,
or both, to determine credit ratings; and (C) receiving fees from
either issuers, investors, or other market participants, or a
combination thereof. 15 U.S.C. 78c(a)(61). Under Section 3(a)(62),
the term ``nationally recognized statistical rating organization''
means a credit rating agency that: (A) issues credit ratings
certified by qualified institutional buyers, in accordance with
section 15E(a)(1)(B)(ix) of the Exchange Act, with respect to (i)
financial institutions, brokers, or dealers; (ii) insurance
companies; (iii) corporate issuers; (iv) issuers of asset-backed
securities (as that term is defined in section 1101(c) of part 229
of title 17, Code of Federal Regulations, as in effect on the date
of enactment of this paragraph); (v) issuers of government
securities, municipal securities, or securities issued by a foreign
government; or (vi) a combination of one or more categories of
obligors described in any clauses (i) through (v); and (B) is
registered under Exchange Act Section 15E.
    \13\ See Oversight of Credit Rating Agencies Registered as
Nationally Recognized Statistical Rating Organizations, Exchange Act
Release No. 55857 (Jun. 5, 2007), 72 FR 33564 (Jun. 18, 2007). The
implementing rules were Form NRSRO, Rule 17g-1, Rule 17g-2, Rule
17g-3, Rule 17g-4, Rule 17g-5, and Rule 17g-6. The Commission has
twice adopted amendments to some of these rules. See Amendments to
Rules for Nationally Recognized Statistical Rating Organizations,
Exchange Act Release No. 59342 (Feb. 2, 2009), 74 FR 6456 (Feb. 9,
2009); and Amendments to Rules for Nationally Recognized Statistical
Rating Organizations, Exchange Act Release No. 61050 (Nov. 23,
2009), 74 FR 63832 (Dec. 4, 2009). The Commission also recently
added a new NRSRO rule. See Disclosure for Asset-Backed Securities
Required by Section 943 of the Dodd-Frank Wall Street Reform and
Consumer Protection Act, Securities Act Release No. 9175 (Jan. 20,
2011), 76 FR 4489 (Jan. 26, 2011).
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    The Commission notes that this is not the first time that the
Commission has proposed to remove references to credit ratings in
Commission rules. The Commission issued a concept release in 1994 on
the general idea of removing references to NRSROs in its rules.\14\ In
2003, the Commission again sought comment on whether it should
eliminate the NRSRO designation from Commission rules, and, if so, what
alternatives could be adopted to meet the Commission's regulatory
objectives.\15\ Most recently, in July 2008, the Commission made
specific proposals to remove rule references to ratings by NRSROs.\16\
In response, the Commission received many comments that raised serious
concerns about removing the references.\17\ Commenters argued that
removing NRSRO references in the context of the Net Capital Rule would
decrease the transparency of broker-dealers' net capital computations
and negatively affect market confidence in the financial strength of
broker-dealers.\18\ In addition, commenters contended that the proposed
amendments would place an undue burden on broker-dealers to justify the
propriety of internal methods for determining haircuts and on
Commission examiners who might be required to review those methods.\19\
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    \14\ See Concept Release: Nationally Recognized Statistical
Rating Organizations, Exchange Act Release No. 34616 (Aug. 31,
1994), 59 FR 46314 (Sep. 7, 1994).
    \15\ See Concept Release: Rating Agencies and the Use of Credit
Ratings under the Federal Securities Laws, Exchange Act Release No.
47972 (Jun. 4, 2003), 68 FR 35258 (Jun. 12, 2003).
    \16\ See Proposed Rule: References to Ratings of Nationally
Recognized Statistical Rating Organizations, Exchange Act Release
No. 58070 (Jul. 1, 2008), 73 FR 40088 (Jul. 11, 2008).
    \17\ See Comments on References to Ratings of NRSROs, available
on the Commission's Internet Web site at http://www.sec.gov/comments/s7-17-08/s71708.shtml.
    \18\ See, e.g., Letter from Jeffrey T. Brown, Senior Vice
President, Charles Schwab & Co., Inc. to Florence E. Harmon, Acting
Secretary, Commission, dated Sep. 5, 2008, stating, ``we are
concerned that the Commission's proposed amendments to remove
references to NRSRO ratings from [R]ule 15c3-1 (the Net Capital
Rule) * * * may be destabilizing and inject risk and uncertainty
into the operations of broker-dealers, investment advisers and money
market mutual funds. We urge the Commission to retain the references
to NRSRO ratings as a minimum floor of credit quality.''
    \19\ See, e.g., Deborah A. Cunningham and Boyce I. Greer, SIFMA
Credit Rating Agency Task Force Co-Chair to Elizabeth M. Murphy,
Secretary, Commission, dated Dec. 9, 2009.
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    In October 2009, the Commission adopted several of the proposed
reference removals and re-opened for comment the remaining
proposals.\20\ As noted above, in each of these concept releases and
rule proposals, commenters generally did not support the removal of
references to NRSRO ratings from Commission rules and provided few
possible regulatory alternatives. The Commission recognizes the
concerns raised by commenters that replacing credit ratings--which
provide an objective benchmark--with more subjective approaches could
increase costs to broker-dealers and the

Commission. For example, broker-dealers would be required to allocate
resources toward developing and maintaining compliance processes, and
the Commission would likewise be required to allocate resources toward
examining for compliance. The Commission also recognizes that an
alternative approach, if too rigid, could narrow the types of financial
instruments that qualify for benefits under existing rules and, if too
flexible, could broaden the types of financial instruments that qualify
for benefits under existing rules. The Commission, in proposing
alternatives to credit ratings, is seeking generally to neither narrow
nor broaden the scope of financial instruments that would qualify for
the benefits conferred in the existing rules while, at the same time,
fulfilling the statutory mandate in Section 939A of the Dodd-Frank
Act.\21\ In this regard, the Commission seeks comment below on whether
the proposed alternatives achieve this goal and whether more effective
alternatives exist.
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    \20\ See References to Ratings of Nationally Recognized
Statistical Rating Organizations, Exchange Act Release No. 60789
(Oct. 5, 2009), 74 FR 52358 (Oct. 9, 2009) (adopting release). In
the adopting release, the Commission amended Exchange Act Rule 3a1-1
(17 CFR 240.3a1-1), Exchange Act Rules 300, 301(b)(5) and 301(b)(6)
of Regulation ATS (17 CFR 242.300, 242.301(b)(5) and 242.301(b)(6)),
Form ATS-R (17 CFR 249.638) and Form PILOT (17 CFR 249.821). The
Commission also adopted amendments to Rules 5b-3 and 10f-3 under the
Investment Company Act of 1940 (17 CFR 270.5b-3 and 17 CFR 270.10f-
3). See References to Ratings of Nationally Recognized Statistical
Rating Organizations, Exchange Act Release No. 60790 (Oct. 5, 2009),
74 FR 52374 (Oct. 9, 2009) (re-opening comment for Net Capital Rule
purposes and various Exchange Act rules).
    \21\ See Public Law 111-203 Sec.  939.
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II. Commission Proposals

A. Proposed Amendments to Exchange Act Rule 15c3-1 and the Appendices
to the Rule

1. Amendments to Rule 15c3-1
    As noted above, the Commission first developed the NRSRO concept
for use in the Net Capital Rule. The Net Capital Rule prescribes
minimum regulatory capital requirements for broker-dealers.\22\ A ``net
liquid assets test'' is the fundamental requirement of the Net Capital
Rule. This test is designed to provide that a registered broker-dealer
maintain at all times more than one dollar of highly liquid assets for
each dollar of liabilities (e.g., money owed to customers and
counterparties), excluding liabilities that are subordinated to all
other creditors by contractual agreement. Consequently, if the broker-
dealer experiences financial difficulty, it should be in a position to
meet all obligations to customers and counterparties and generate
resources to wind-down its operations in an orderly manner without the
need of a formal proceeding. The Net Capital Rule operates by requiring
a broker-dealer to perform two calculations: (1) A computation of
required minimum net capital; and (2) a computation of actual net
capital. A broker-dealer must ensure that its actual net capital
exceeds its minimum net capital requirement at all times.
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    \22\ See 17 CFR 240.15c3-1(a).
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    To calculate its actual net capital, a broker-dealer first computes
its net worth in accordance with generally accepted accounting
principles and then adds to this amount certain subordinated
liabilities. From that figure, the broker-dealer subtracts assets not
readily convertible into cash, such as intangible assets, fixed assets,
and most unsecured receivables. The broker-dealer then subtracts
prescribed percentages of the market value of securities owned by the
broker-dealer (otherwise known as ``haircuts'') to discount for
potential market movements. A primary purpose of these haircuts is to
provide a margin of safety against losses that might be incurred by the
broker-dealer as a result of market fluctuations in the prices of, or
lack of liquidity in, its proprietary positions. The resulting figure
is the broker-dealer's net capital.
    The Net Capital Rule currently applies a lower haircut to certain
types of securities held by a broker-dealer if the securities are rated
in higher rating categories by at least two NRSROs, since those
securities typically are more liquid and less volatile in price than
securities that are rated in the lower categories or are unrated.
Currently, to receive the benefit of a reduced haircut on commercial
paper, the commercial paper must be rated in one of the three highest
rating categories by at least two NRSROs.\23\ To receive the benefit of
a reduced haircut on a nonconvertible debt security and preferred
stock, the security must be rated in one of the four highest rating
categories by at least two NRSROs.\24\
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    \23\ 17 CFR 240.15c3-1(c)(2)(vi)(E).
    \24\ 17 CFR 240.15c3-1(c)(2)(vi)(F)(1) and (c)(2)(vi)(H).
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    In conformance with the Dodd-Frank Act, the Commission is proposing
to remove from the Net Capital Rule all references to credit ratings
and substitute an alternative standard of creditworthiness.
Specifically, in place of the current Net Capital Rule references to
credit ratings, the Commission is proposing that a broker-dealer take a
15% haircut on its proprietary positions in commercial paper,
nonconvertible debt, and preferred stock unless the broker-dealer has a
process for determining creditworthiness that satisfies the criteria
described below. However, commercial paper, nonconvertible debt, and
preferred stock without a ready market would remain subject to a 100%
haircut.\25\ The 15% haircut is derived from the catchall haircut
amount that applies to a security not specifically identified in the
Net Capital Rule as having an asset-class specific haircut, provided
the security is otherwise deemed to have a ready market.\26\ It is also
the haircut applicable to most equity securities.\27\
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    \25\ The term ``ready market'' is defined in the Net Capital
Rule as ``a market in which there exists independent bona fide
offers to buy and sell so that a price reasonably related to the
last sales price or current bona fide competitive bid and offer
quotations can be determined for a particular security almost
instantaneously and where payment will be received in settlement of
a sale at such price within a relatively short time conforming to
trade custom.'' 17 CFR 240.15c3-1(c)(11).
    \26\ 17 CFR 240.15c3-1(c)(2)(vi)(J). Securities without a ready
market would remain subject to a 100% haircut. 17 CFR 240.15c3-
1(c)(2)(vii).
    \27\ 17 CFR 240.15c3-1(c)(2)(vi)(J).
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    If a broker-dealer establishes, maintains, and enforces written
policies and procedures for determining creditworthiness under the
proposed amendments, the broker-dealer would be permitted to apply the
lesser haircut requirement currently specified in the Net Capital Rule
for commercial paper (i.e., between zero and \1/2\ of 1%),
nonconvertible debt (i.e., between 2% and 9%), and preferred stock
(i.e., 10%) when the creditworthiness standard is satisfied. Under this
proposal, in order to use these lower haircut percentages for
commercial paper, nonconvertible debt, and preferred stock, a broker-
dealer would be required to establish, maintain, and enforce written
policies and procedures designed to assess the credit and liquidity
risks applicable to a security, and based on this process, would have
to determine that the investment has only a ``minimal amount of credit
risk.''
    Under the proposed amendments, a broker-dealer, when assessing
credit risk, could consider the following factors, to the extent
appropriate, with respect to each security: \28\
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    \28\ This list of factors is not meant to be exhaustive or
mutually exclusive.
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     Credit spreads (i.e., whether it is possible to
demonstrate that a position in commercial paper, nonconvertible debt,
and preferred stock is subject to a minimal amount of credit risk based
on the spread between the security's yield and the yield of Treasury or
other securities, or based on credit default swap spreads that
reference the security);
     Securities-related research (i.e., whether providers of
securities-related research believe the issuer of the security will be
able to meet its financial commitments, generally, or specifically,
with respect to securities held by the broker-dealer);
     Internal or external credit risk assessments (i.e.,
whether credit assessments developed internally by the broker-dealer or
externally by a credit

rating agency, irrespective of its status as an NRSRO, express a view
as to the credit risk associated with a particular security);
     Default statistics (i.e., whether providers of credit
information relating to securities express a view that specific
securities have a probability of default consistent with other
securities with a minimal amount of credit risk);
     Inclusion on an index (i.e., whether a security, or issuer
of the security, is included as a component of a recognized index of
instruments that are subject to a minimal amount of credit risk);
     Priorities and enhancements (i.e., the extent to which a
security is covered by credit enhancements, such as
overcollateralization and reserve accounts, or has priority under
applicable bankruptcy or creditors' rights provisions);
     Price, yield and/or volume (i.e., whether the price and
yield of a security or a credit default swap that references the
security are consistent with other securities that the broker-dealer
has determined are subject to a minimal amount of credit risk and
whether the price resulted from active trading); and
     Asset class-specific factors (e.g., in the case of
structured finance products, the quality of the underlying assets).
    To establish a basis for a haircut of less than 15% for commercial
paper, nonconvertible debt, or preferred stock, a broker-dealer would
have to establish, maintain, and enforce written policies and
procedures for determining the creditworthiness of a security acquired
by the firm. The range and type of specific factors considered would
vary depending on the particular securities that are reviewed. A
broker-dealer that applies a haircut below 15%, as described above,
would have a greater burden to support its application of that haircut
when a creditworthiness finding under one factor is contradicted by a
finding under another factor. Further, any broker-dealer that
determines that application of the factors specified above do not
support a finding of a minimal amount of credit risk would apply the
15% haircut with respect to the subject security, or, if that security
does not have a ready market, a 100% haircut.\29\
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    \29\ A financial instrument that possesses the necessary credit
ratings under Rule 15c3-1 is nevertheless subject to the 100%
deduction required by the rule if the financial instrument does not
have a ready market. For example, commercial paper rated in the
third highest credit rating category may not have a ready market
and, therefore, would be subject to the 100% deduction. See, e.g.,
Nandkumar Nayar and Michael S. Rozeff, Ratings, Commercial Paper,
and Equity Returns, XLIX J. of Finance 1431, 1433, n.5 (1994)
(noting that ``issuers with the lowest ratings find that they cannot
issue commercial paper in quantity''). The Commission notes that
treatment of commercial paper rated in the third highest credit
rating as discussed in this release is limited to Rule 15c3-1 only.
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    Each broker-dealer would be required to preserve for a period of
not less than three years, the first two years in an easily accessible
place, the written policies and procedures that the broker-dealer
establishes, maintains, and enforces for assessing credit risk for
commercial paper, nonconvertible debt, and preferred stock. Broker-
dealers would be subject to this requirement in the Commission's
broker-dealer record retention rule, Exchange Act Rule 17a-4, which the
Commission is proposing to amend in conjunction with this
rulemaking.\30\
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    \30\ Specifically, the Commission is proposing to adopt a new
paragraph (b)(13) of Rule 17a-4, which would require broker-dealers
to preserve the written policies and procedures the broker-dealer
establishes, maintains, and enforces to assess creditworthiness of
nonconvertible debt, preferred stock, and commercial paper under the
Net Capital Rule.
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    A broker-dealer's process for establishing creditworthiness and its
written policies and procedures documenting that process would be
subject to review in regulatory examinations by the Commission and
self-regulatory organizations. A broker-dealer that applies a haircut
of less than 15% for commercial paper, nonconvertible debt, and
preferred stock without establishing, maintaining, and enforcing
written policies and procedures reasonably designed to assess
creditworthiness would be subject to disciplinary action for non-
compliance with the rule and could be required to recalculate its net
capital.
    The Commission preliminarily believes that these new standards
would enable broker-dealers to make the net capital computations
required under the Net Capital Rule reflect the market and credit risk
inherent in particular commercial paper, nonconvertible debt, and
preferred stock.\31\ The Commission also recognizes that credit ratings
may provide useful information to institutional and retail investors as
part of the process of making an investment decision. The requirements
of the current rule are based on the practice of many NRSROs to have at
least eight categories of ratings for debt securities, with the top
four ratings commonly referred to in the industry as ``investment
grade.'' Although the proposed amendments do not use the term
``investment grade,'' they are meant to capture securities that should
generally qualify for that designation, without placing undue reliance
on third-party credit ratings.
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    \31\ See Uniform Net Capital Rule, Exchange Act Release No.
13635 (Jun. 16, 1977), 42 FR 31778 (Jun. 23, 1977).
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    Currently, the Net Capital Rule distinguishes between those
securities that are rated in one of the three highest categories by an
NRSRO (i.e., for commercial paper) and those securities that are rated
in one of the four highest ratings by an NRSRO (i.e., for
nonconvertible debt and preferred stock). The proposed amendments would
eliminate the distinction among types of securities. Instead, each of
the three classes of securities would be subject to the same
requirements under the proposed amendments.
    According to data collected by the Commission, of the approximately
5,060 broker-dealers registered with the Commission as of year-end
2009, approximately 480 broker-dealers maintained proprietary positions
in debt securities at that time.\32\ Thus, it appears that only a small
percentage of active broker-dealers registered with the Commission
would be impacted by the proposed amendments. The Commission
preliminarily believes, based on its oversight activities, that many of
the broker-dealers with substantial proprietary positions in debt
securities already make independent assessments of creditworthiness
based on the types of factors identified in the proposed amendments.
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    \32\ This number was obtained by reviewing broker-dealer
Financial and Operational Combined Single (or ``FOCUS'') Reports for
2009 year-end and then calculating how many firms reported holding
proprietary debt positions. For FOCUS Part II filers, the balances
examined were ``Bankers Acceptances'' and ``Corporate Debt.'' For
FOCUS CSE filers, the balances examined were: ``Money Market
Instruments,'' ``Private Label Mortgage Backed Securities,'' ``Other
Asset Backed Securities,'' and ``Corporate Debt.'' For Part IIA
filers, the balance examined was ``Debt Securities.'' Broker-dealers
that hold preferred stock also may hold positions in debt
securities. However, because preferred stock is not a separate line
item on the FOCUS Report, broker-dealers that hold only preferred
stock and not other debt securities are not included in this
estimate.
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    As noted above, the Commission does not intend through the proposed
amendments to narrow or broaden the range of securities that generally
qualify for reduced haircuts under the Net Capital Rule as currently
written. The Commission recognizes that broker-dealers, when purchasing
for their proprietary accounts, provide a substantial source of capital
for issuers of commercial paper, nonconvertible debt, and preferred
stock. Accordingly, any significant change in practice by broker-
dealers, whether because of potential compliance costs, difficulties in
applying the proposed criteria or minimal credit risk standard, or
other factors, that results in a change in the

general allocation of such securities in proprietary accounts could
have unintended consequences. Accordingly, the Commission is interested
in receiving comment on the potential impact of the proposed amendments
on the capital markets generally, and on capital raising efforts by
issuers of the affected types of securities specifically, and on how
any potential effect could be mitigated or eliminated.
    The Commission requests comment on all aspects of these proposed
amendments. In addition, the Commission requests comment on the
following specific questions:
     Do broker-dealers that would be subject to the proposed
amendments either already have processes in place for determining
creditworthiness of commercial paper, nonconvertible debt, and
preferred stock or have the financial sophistication and the resources
necessary to adopt such processes without undue effort or expense? Are
there particular types of broker-dealers that would not be capable of
meeting this new standard without undue hardship? In what ways and to
what extent, if any, would establishing and implementing procedures for
determining creditworthiness in lieu of using a credit rating
disproportionately impact medium-sized and smaller broker-dealers?
Commenters who believe that medium-sized and smaller broker-dealers
would be disproportionately affected by these amendments, should
describe the firms that would be adversely impacted, as well as provide
suggestions as to how the proposal could be amended to accommodate
them.
     With respect to the factors a broker-dealer could
consider, would the use of these factors in lieu of credit ratings
reduce undue reliance on a third party's assessment of credit risk? To
what extent, if any, is there a risk that undue reliance will shift
from relying on a credit rating to relying on some other third party
assessment of creditworthiness?
     What is the potential impact of moving from an objective
standard to a more flexible standard? Is there the potential that a
broker-dealer's evaluations of creditworthiness may be second-guessed?
If so, how might the prospect of being second-guessed impact a broker-
dealer's evaluation of minimal credit risk and the appropriate haircuts
to take for purposes of the broker-dealer's net capital calculation?
     If broker-dealers establish and implement procedures for
determining creditworthiness, some broker-dealers may determine that a
security qualifies for a reduced haircut when it would not have
qualified for a reduced haircut under the current NRSRO standard.
Alternatively, some broker-dealers may determine that a security does
not qualify for a reduced haircut when the security would have
qualified for a reduced haircut under the current standard. Describe
the potential impact on capitalization and the efficient allocation of
capital under these two scenarios and the likelihood of each occurring.
In addition, with respect to the first scenario, describe the potential
impact on the objective of Rule 15c3-1, which, among other things, is
to protect investors by enabling a broker-dealer, if the firm
experiences financial difficulty, to be in a position to meet all
obligations to customers and counterparties and generate resources to
wind-down its operations in an orderly manner without the need of a
formal proceeding.
     What are the risks of using internal processes to make
credit determinations and how could these risks be addressed? For
example, would broker-dealers be likely to adopt procedures that
minimize the credit risk associated with a particular security in order
to minimize capital charges? How could this risk be addressed?
     Are there other factors a broker-dealer should use when
determining creditworthiness? Should the Commission mandate that
broker-dealers consider each factor in this release when assessing a
security's credit risk? Should the list of factors be included in the
text of Rule 15c3-1?
     Should the Commission place conditions on the ability of a
broker-dealer to outsource factors related to the determination of
creditworthiness to a third party? If the determination of factors
related to creditworthiness is outsourced, how can the Commission
determine that the outsourced determination meets the proposed
standard?
     How often should a broker-dealer be required to update its
assessment of a specific security to ensure the broker-dealer's
determination of creditworthiness remains current? Should the rule
contain a requirement that the assessment be updated after a specific
period of time? Should the Commission limit the ability of a broker-
dealer to outsource the monitoring of its determination of
creditworthiness?
     Should the Commission require that the persons responsible
for developing a broker-dealer's internal processes and applying them
to possible positions in individual securities for purposes of the Net
Capital Rule be separate from employees who make proprietary investment
decisions for the broker-dealer?
     What would be the appropriate level of regulatory
oversight of a broker-dealer's credit determination processes? Should
the Commission describe in more detail how examiners will examine these
processes? How should a broker-dealer be able to demonstrate to
regulators the adequacy of the processes that it adopts and that it is
following them?
     Should the Commission require the securities industry
self-regulatory organizations to set appropriate standards for broker-
dealers to use in evaluating creditworthiness and evaluating individual
positions in commercial paper, nonconvertible debt, and preferred stock
for net capital purposes?
     Should the Commission require broker-dealers to create and
maintain records of creditworthiness determinations? If so, what
records should be required to be maintained and how should they be
described in a rule? Are there standard records that are used when
making creditworthiness determinations that the Commission could
require broker-dealers to keep? Are there other measures the Commission
could consider to reduce the risk that broker-dealers will adopt
inadequate processes or fail to adhere to them?
     Rather than referencing a list of factors that broker-
dealers could consider, should the rule reference a single or limited
set of factors (e.g., credit spreads)? Could a simpler approach
adequately capture the risks of holding the full range of securities
covered by the rule?
     Are there alternate and more reliable means of
establishing creditworthiness for purposes of the Net Capital Rule?
Please include detailed descriptions.
     Should the Commission define ``minimal amount of credit
risk''? Commenters who believe the Commission should define this term
should include a detailed description of what should be included in the
definition.
2. Proposed Amendments to Appendix A to Rule 15c3-1
    Appendix A to Rule 15c3-1 allows broker-dealers to employ
theoretical option pricing models in determining net capital
requirements for listed options and related positions.\33\ Broker-
dealers may also elect a strategy-based methodology.\34\ The purpose of

Appendix A is to simplify the net capital treatment of options in order
to reflect the risk inherent in options and related positions.\35\
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    \33\ 17 CFR 240.15c3-1a.
    \34\ Id.
    \35\ See Net Capital Rule, Exchange Act Release No. 38248 (Feb.
6, 1997), 62 FR 6474 (Feb. 12, 1997).
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    Under Appendix A, broker-dealers' proprietary positions in ``major
market foreign currency'' options receive more favorable treatment than
options for all other currencies when using theoretical option pricing
models to compute net capital deductions. The term ``major market
foreign currency'' is currently defined to mean ``the currency of a
sovereign nation whose short-term debt is rated in one of the two
highest categories by at least two nationally recognized statistical
rating organizations and for which there is a substantial inter-bank
forward currency market.'' \36\
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    \36\ 17 CFR 240.15c3-1a(b)(1)(i)(C).
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    With respect to the definition of the term ``major market foreign
currency,'' the Commission proposes to remove from that definition the
phrase ``whose short-term debt is rated in one of the two highest
categories by at least two nationally recognized statistical rating
organizations.'' The change would modify the definition of that term to
include foreign currencies only ``for which there is a substantial
inter-bank forward currency market.'' The Commission also is proposing
to eliminate the specific reference in the rule to the European
Currency Unit (ECU), which is identified by the rule as the only major
market foreign currency under Appendix A.\37\ However, because of the
establishment of the euro as the official currency of the euro-zone, a
specific reference to the ECU is no longer needed. The Commission
preliminarily believes that specific reference to the euro also is not
necessary, as it is a foreign currency with a substantial inter-bank
forward currency market.
---------------------------------------------------------------------------

    \37\ Id.
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    The Commission requests comment on all aspects of the proposed
amendments to Appendix A to the Net Capital Rule. In addition, the
Commission requests comment on the following specific questions:
     Is the proposed definition of ``major market foreign
currency'' sufficiently clear to allow broker-dealers to determine
which currencies qualify as major market foreign currencies?
     It is not the intention of the Commission to change the
currencies that meet the definition of ``major market foreign
currency'' under this rule. Does the new definition of ``major market
foreign currency'' achieve this goal? Does the Commission need to keep
an example of a ``major market foreign currency'' in the definition?
     How should the Commission distinguish between major market
foreign currencies and all other currencies? Should the rule provide
that broker-dealers can apply for a Commission determination (e.g., in
the form of an Order or other Commission action) that a currency be
considered a major market foreign currency under Appendix A to Rule
15c3-1? Should a list be created and published on the Commission's Web
site? Should the Commission rely on other lists, such as the list of
member countries of the Organization for Economic Co-Operation and
Development? \38\ Should the determination be made by one of the self-
regulatory organizations?
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    \38\ See http://www.oecd.org/pages/0,3417,en_36734052_36761800_1_1_1_1_1,00.html.
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     Should the Commission replace the language in Appendix A
to Rule 15c3-1 with a new standard? If so, what should that standard
be? Should the Commission use the same standard of creditworthiness and
require the same type of process that it has proposed above for Rule
15c3-1?
3. Proposed Amendments to Appendix E to Rule 15c3-1
    Pursuant to Appendix E to Rule 15c3-1, a broker-dealer may apply to
the Commission for authorization to use an alternative method for
computing capital (i.e., the alternative net capital, or ``ANC,''
computation).\39\ Specifically, broker-dealers with internal risk
management practices that utilize certain mathematical modeling methods
to manage their own business risk, including value-at-risk (``VaR'')
models and scenario analysis, may apply to use these methods to compute
net capital requirements for market risk and derivatives-related credit
risk.
---------------------------------------------------------------------------

    \39\ As a condition of approval, applicants must maintain an
``early warning'' level of at least $5 billion in tentative net
capital, minimum levels of at least $1 billion in tentative net
capital, and $500 million in net capital. See 17 CFR 240.15c3-
1(a)(7) and (c)(15).
---------------------------------------------------------------------------

    Under Appendix E, broker-dealers subject to the ANC computation are
required to deduct from their net capital credit risk charges that take
counterparty risk into consideration. This counterparty risk
determination is currently based on either NRSRO ratings or a dealer's
internal counterparty credit rating. To comply with Section 939A of the
Dodd-Frank Act, the Commission is proposing to remove paragraphs
(c)(4)(vi)(A) through (c)(4)(vi)(D) of Appendix E, which base credit
risk charges for counterparty risk on NRSRO ratings, and in place of
these ratings, require a broker-dealer using the ANC computation to
apply a credit risk weight of either 20%, 50%, or 150% with respect to
an exposure to a given counterparty based on the internal credit rating
the broker-dealer determines for the counterparty.
    As a result, a broker-dealer that applies to use the approach set
forth in Appendix E to determine counterparty risk would be required,
as part of its initial application or in an amendment to the
application, to request Commission approval to determine credit risk
weights of either 20%, 50%, or 150% based on internal calculations and
credit ratings. The Commission notes that all of the firms approved to
use models to calculate market and credit risk charges under Appendix E
to Rule 15c3-1 have been approved to determine credit ratings using
internal ratings rather than ratings issued by NRSROs.\40\ Under the
proposal, firms that are already approved to use the ANC computation in
Appendix E would not need to seek new approval from the Commission.
Other broker-dealers applying for ANC computation in Appendix E would
be required to seek approval of their methodology for determining
internal ratings. A broker-dealer that is applying to use Appendix E
and intends to use internal ratings to determine the applicable credit
risk weights should so state in its application to the Commission.
---------------------------------------------------------------------------

    \40\ Currently six broker-dealers are approved to use the ANC
computation in Appendix E to Rule 15c3-1.
---------------------------------------------------------------------------

    As stated above, all of the broker-dealers approved to use Appendix
E to Rule 15c3-1 have already developed models approved for use in
performing the ANC computation, as well as internal risk management
control systems. As such, each firm already employs an internal credit
rating method (i.e., a non-NRSRO credit rating method) that would,
under the proposed amendments, become the only option for determining
the applicable credit risk weight.
    The Commission generally requests comment on all aspects of the
proposed amendments to Appendix E to Rule 15c3-1. In addition, the
Commission requests comment on the following specific questions:
     Should the Commission replace provisions in Appendix E to
Rule 15c3-1 with a new standard? If so, what should that standard be?
For example, should the Commission use the same standard of
creditworthiness that it has proposed above for commercial paper,

nonconvertible debt, and preferred stock?
     Should the Commission continue to use credit risk weights
of 20%, 50%, or 150%? If not, what risk weights should the Commission
require be applied?
     Should broker-dealers that are already approved to use
Appendix E be required to seek a new determination by the Commission of
the credit risk weights assigned to their internal ratings scale?
4. Proposed Amendments to Appendix F to Rule 15c3-1 and the General
Instructions to Form X-17A-5, Part IIB
    Appendix F to the Net Capital Rule sets forth a program for OTC
derivatives dealers that allow them to use an alternative approach to
computing net capital deductions, subject to certain conditions.\41\
Under Appendix F, OTC derivatives dealers with strong internal risk
management practices may utilize the mathematical modeling methods used
to manage their own business risk, including VaR models and scenario
analysis, to compute deductions from net capital for market and credit
risks arising from OTC derivatives transactions.\42\
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    \41\ OTC derivatives dealers are a special class of broker-
dealers that are exempt from certain broker-dealer requirements,
including membership in a self-regulatory organization (17 CFR
240.15b9-2), regular broker-dealer margin rules (17 CFR 240.36a1-1),
and application of the Securities Investor Protection Act of 1970
(17 CFR 240.36a1-2). OTC derivative dealers are subject to special
requirements, including limitations on the scope of their securities
activities (17 CFR 240.15a-1), specified internal risk management
control systems (17 CFR 240.15c3-4), recordkeeping obligations (17
CFR 240.17a-3(a)(10)), and reporting responsibilities (17 CFR
240.17a-12). They are also subject to alternative net capital
treatment (17 CFR 240.15c3-1(a)(5)). See 17 CFR 240.15a-1,
Preliminary Note.
    \42\ The minimum net capital requirements for an OTC derivatives
dealer are tentative net capital of at least $100 million and net
capital of at least $20 million. See 17 CFR 240.15c3-1(a)(5) and
(c)(15).
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    Under Appendix F to the Net Capital Rule, OTC derivatives dealers
are required to deduct from their net capital credit risk charges that
take counterparty risk into consideration. As part of this deduction,
the OTC derivatives dealer must apply a counterparty factor of either
20%, 50%, or 100%.\43\ In addition, the OTC derivatives dealer must
take a concentration charge where the net replacement value in the
account of any one counterparty exceeds 25% of the OTC derivatives
dealer's tentative net capital.\44\ The counterparty factor (i.e., 20%,
50%, or 100%) to apply currently is based on either NRSRO ratings or
the firm's internal credit ratings.\45\ The concentration charges also
are based on either NRSRO ratings or the firm's internal credit
ratings. All of the firms approved to use models to calculate market
and credit risk charges under Appendix F to Rule 15c3-1 have been
approved to determine credit risk charges using internal credit
ratings.\46\ To comply with Section 939A of the Dodd-Frank Act, the
Commission is proposing to amend Appendix F to Rule 15c3-1 and to make
conforming changes to Form X-17A-5, Part IIB.
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    \43\ 17 CFR 240.15c3-1f(d)(2).
    \44\ 17 CFR 240.15c3-1f(d)(3).
    \45\ See 17 CFR 240.15c3-1f(d)(2) and (4).
    \46\ Currently four firms are using Appendix F to the Net
Capital Rule.
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    Specifically, the Commission is proposing to revise paragraphs
(d)(2), (d)(3)(i), (d)(3)(ii), (d)(3)(iii), and (d)(4) of Appendix F to
the Net Capital Rule, which permit the use of NRSRO ratings when
determining counterparty risk. As a result of these revisions, an OTC
derivatives dealer that applies to use the approach set forth in
Appendix F to determine counterparty credit risk charges would be
required, as part of its initial application or in an amendment to the
application, to request Commission approval to determine credit ratings
using internal ratings rather than ratings issued by NRSROs. Under the
proposal, firms that are already approved to use internal ratings
pursuant to Appendix F would not need to seek new approval from the
Commission. An OTC derivatives dealer that is applying to use Appendix
F and intends to use internal ratings to determine the applicable
credit risk weights should so state in its application to the
Commission.
    As stated above, 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 Appendix F. As such, each firm
already employs a non-NRSRO ratings-based method that would, under the
proposed amendments, become the only option for calculating credit risk
charges.
    Based on these proposed amendments to Appendix F to Rule 15c3-1,
the Commission is proposing conforming changes to the General
Instructions to Form X-17A-5, Part IIB. This form constitutes the basic
financial and operational report required of OTC derivatives dealers to
be filed with the Commission. Under the heading ``Computation of Net
Capital and Required Net Capital'' and before the section ``Aggregate
Securities and OTC Derivatives Positions,'' the Commission is proposing
conforming changes to the section ``Credit risk exposure.'' This
section explains the counterparty charges for OTC derivatives dealers
based on the language in Appendix F to Rule 15c3-1. Therefore, the
Commission is proposing that all changes made to Appendix F to Rule
15c3-1 also be made to the section ``Credit risk exposure'' under the
heading ``Computation of Net Capital and Required Net Capital'' in the
General Instructions to Form X-17A-5, Part IIB.
    The Commission generally requests comment on all aspects of the
proposed amendments to Appendix F to Rule 15c3-1 and the conforming
changes to the General Instructions to Form X-17A-5, Part IIB. In
addition, the Commission requests comment on the following specific
questions:
     Should the Commission replace the provisions in Appendix F
to Rule 15c3-1 with a new standard? If so, what should that standard
be? Should the Commission use the same standard of creditworthiness
that it has proposed above for commercial paper, nonconvertible debt,
and preferred stock?
     Should the Commission continue to use counterparty factors
of 20%, 50%, or 100%? If not, what counterparty factors should the
Commission require be applied?
     Should the OTC derivatives dealers that have been approved
to use Appendix F be required to submit an amendment to their
applications to use internal credit ratings?
5. Proposed Amendment to Appendix G to Rule 15c3-1
    The Commission is also proposing a conforming amendment to Appendix
G to Rule 15c3-1. Under Appendix G, a broker-dealer that uses the ANC
computation can only do so if its ultimate holding company agrees to
provide the Commission with additional information about the financial
condition of the ultimate holding company and its affiliates. Appendix
G applies to an ultimate holding company that has a principal regulator
and is intended to ensure that the Commission can obtain certain
information designed to help the Commission assess the financial and
operational health of the ultimate holding company and its potential
impact on the risk exposure of the broker-dealer.\47\
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    \47\ Currently, each broker-dealer that uses the ANC computation
has an ultimate holding company that has a principal regulator. As a
result of both changes to the Commission's regulatory programs and
the Dodd-Frank Act, the Commission is no longer regulating ultimate
holding companies.
---------------------------------------------------------------------------

    The proposed amendment to Appendix G would delete references in
that appendix to the provisions of

Appendix E that the Commission is proposing to delete as described
above. These references are found in paragraph (a)(3)(i)(F) to Appendix
G. Because of the proposed amendments to Appendix E described above,
the references to Appendix E in Appendix G would no longer be accurate.
    The Commission generally requests comment on all aspects of the
proposed amendment to Appendix G to Rule 15c3-1.

B. Proposed Amendment to Exhibit A to Rule 15c3-3

    Exchange Act Rule 15c3-3 (the ``Customer Protection Rule'')
protects customer funds and securities held by broker-dealers. In
general, the Customer Protection Rule has two parts. The first part
requires a broker-dealer to have possession or control of all fully
paid and excess margin securities of its customers. In this regard, a
broker-dealer must make a daily determination in order to comply with
this aspect of the rule.
    The second part covers customer funds and requires broker-dealers
subject to the rule to make a periodic computation to determine how
much money it is holding that is either customer money or money
obtained from the use of customer securities (``credits''). From that
figure, the broker-dealer subtracts the amount of money which it is
owed by customers or by other broker-dealers relating to customer
transactions (``debits''). If the credits exceed debits after this
``reserve formula'' computation, the broker-dealer must deposit the
excess in a ``Special Reserve Bank Account for the Exclusive Benefit of
Customers'' (a ``Reserve Account''). If the debits exceed credits, no
deposit is necessary. Funds deposited in a Reserve Account cannot be
withdrawn until the broker-dealer completes another computation that
shows that the broker-dealer has on deposit more funds than the reserve
formula requires.
    The Customer Protection Rule is designed to prevent broker-dealers
from using customer money to finance their business, except as related
to customer transactions, since customer funds (the credits) can be
offset only by customer-related transactions (the debits). As a result,
broker-dealers must provide the capital to finance their trades and
firm activities and may not use customers' funds for such purposes.
    Exhibit A to Rule 15c3-3 contains the formula that a broker-dealer
must use to determine its reserve requirement. Under Note G to Exhibit
A, a broker-dealer may include required customer margin for
transactions in security futures products as a debit in its reserve
formula computation if that margin is required and on deposit at a
clearing agency or derivatives clearing organization that:
    1. Maintains the highest investment-grade rating from an NRSRO;
    2. Maintains security deposits from clearing members in connection
with regulated options or futures transactions and assessment power
over member firms that equal a combined total of at least $2 billion,
at least $500 million of which must be in the form of security
deposits;
    3. Maintains at least $3 billion in margin deposits; or
    4. Obtains an exemption from the Commission.\48\
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    \48\ 17 CFR 240.15c3-3a, Note G.
---------------------------------------------------------------------------

    Requiring a clearing agency or a derivatives clearing organization
to meet certain minimum criteria before margin deposits with that
entity may be included as a debit in a broker-dealer's customer reserve
formula is consistent with the customer protection function of Rule
15c3-3, because margin that is posted for customer positions in
security futures products constitutes an unsecured receivable from the
clearing agency or organization. Accordingly, this requirement is
intended to provide reasonable assurance that customer margin deposits
related to security futures products are adequately protected.
    The Commission is proposing to remove the first criterion described
above (i.e., the highest investment-grade rating from an NRSRO). The
Commission notes that the criteria are disjunctive and, therefore, a
clearing agency or derivatives clearing organization needs to satisfy
only one criterion to permit a broker-dealer to treat customer margin
as a reserve formula debit. Consequently, the Commission preliminarily
believes that the proposed amendment would not lessen the protections
for customer funds and securities. Furthermore, while one potential
criterion would be removed, there is only one clearing agency for
security futures products (namely, the Options Clearing Corporation)
and that clearing agency would continue to qualify under each of the
other applicable criteria. Moreover, if a new registered clearing
agency or derivatives clearing organization could not meet one of the
remaining criteria, a broker-dealer may request an exemption for the
clearing agency or organization under the rule.\49\
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    \49\ The Commission may, in its sole discretion, grant such an
exemption subject to such conditions as are appropriate under the
circumstances if the Commission determines that such conditional or
unconditional exemption is necessary or appropriate in the public
interest and is consistent with the protection of investors. See
paragraph (b)(iv) of Rule 15c3-3a, Note G.
---------------------------------------------------------------------------

    The Commission preliminarily believes that eliminating the
reference to NRSRO ratings in Note G to Exhibit A to Rule 15c3-3 will
continue to advance the goals of the Customer Protection Rule by
ensuring the long-term financial strength of clearing agencies and
derivatives clearing organizations holding customer margin for
positions in security futures products.\50\ The Commission
preliminarily believes that requiring a registered clearing agency or
derivatives clearing organization to comply with one of the three
remaining criteria will adequately serve the customer protection
purpose of Rule 15c3-3.
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    \50\ See Rule 15c3-3 Reserve Requirements for Margin Related to
Security Futures Products, Exchange Act Release No. 50295 (Aug. 31,
2004), 69 FR 54182 (Sep. 7, 2004).
---------------------------------------------------------------------------

    The Commission generally requests comment on all aspects of the
removal of paragraph (b)(1)(i) of Note G to Rule 15c3-3a. In addition,
the Commission requests specific comment on the following questions:
     Should the Commission replace the language in paragraph
(b)(1)(i) of Note G with a new standard? If so, what should that
standard be? Should the Commission use the same standard of
creditworthiness that it has proposed above for commercial paper,
nonconvertible debt, and preferred stock?
     What factors should the Commission take into account when
considering the potential regulatory compliance costs of removing
references to NRSROs from paragraph (b)(1) of Note G? Commenters should
include detailed descriptions of any potential costs.
     Do the guidelines offered by current paragraphs
(b)(1)(ii)-(iv) of Note G provide sufficient means by which a
registered clearing agency or derivatives clearing organization could
be judged to meet the requirements of paragraph (b)(1) of Note G? If
not, what additional information should be added to meet the
requirements of paragraph (b)(1) of Note G?
     Are there clearing agencies or derivatives clearing
organizations that would not meet the remaining standards contained in
paragraph (b)(1) of Note G?

C. Exceptions for Investment Grade Nonconvertible and Asset-Backed
Securities in Rules 101 and 102 of Regulation M

    As a prophylactic anti-manipulation set of rules, Regulation M is
designed to

preserve the integrity of the securities trading market as an
independent pricing mechanism by prohibiting activities that could
artificially influence the market for an offered security. Rules 101
and 102 of Regulation M specifically prohibit issuers, selling security
holders, 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.\51\
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    \51\ ``Covered security'' is defined as ``any security that is
the subject of a distribution or any reference security,'' and
``reference security'' is defined as ``a security into which a
security that is the subject of a distribution (`subject security')
may be converted, exchanged, or exercised or which, under the terms
of the subject security, may in whole or in significant part
determine the value of the subject security.'' 17 CFR 242.100.
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    Rules 101(c)(2) and 102(d)(2) currently except ``investment grade
nonconvertible and asset-backed securities.'' \52\ 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. In accordance with Section 939A(b) of the Dodd-Frank Act, the
Commission is proposing to remove the references to credit ratings in
Rules 101(c)(2) and 102(d)(2) and replace them with new standards
relating to the trading characteristics of covered securities.
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    \52\ 17 CFR 242.101(c)(2) and 242.102(d)(2).
---------------------------------------------------------------------------

1. Background
    Historically, the Rule 101(c)(2) and 102(d)(2) exceptions trace
back to a no-action position taken by the staff in 1975 regarding
Exchange Act Rule 10b-6, the predecessor to Rules 101 and 102.\53\ The
lead underwriter of an offering of debentures had written the staff
seeking interpretive guidance because Rule 10b-6 prohibited it from
making markets in the debt securities of the same issuer other than the
security being distributed, as these other securities could be
considered ``of the same class and series'' under Rule 10b-6(a) as the
security being distributed.\54\ The staff, with the Commission's
concurrence, provided no-action relief permitting dealers participating
in a distribution of debt securities of an issuer to bid for or
purchase other outstanding debt securities of such issuer, but required
that the new issue and outstanding issues be subject to certain
investment grade ratings.\55\ In granting relief, the staff emphasized
representations from the underwriter that (1) ``because the non-
convertible bonds of particular issuers are not considered unique and
because of the concept of relative value, it is simply not possible to
manipulate the price of a corporate bond that has broad investor
interest'' and (2) purchasing activities in such securities generally
are ``unlikely to materially affect the price of [a nonconvertible debt
security being offered] because of the availability of large amounts of
securities of other issuers which have comparable quality yield
[spreads].'' \56\
---------------------------------------------------------------------------

    \53\ Letter from Robert C. Lewis, Associate Director, the
Division of Market Regulation, the Commission to Donald M.
Feuerstein, General Partner and Counsel, Salomon Brothers (Mar. 4,
1975).
    \54\ As explained below, the activity for which relief was
sought in this letter would be permissible under Rules 101 and 102
today even without the investment grade securities exceptions or no
action relief because of a change in the securities covered under
Rules 101 and 102 as compared to the securities covered under Rule
10b-6.
    \55\ Letter from Robert C. Lewis, Associate Director, the
Division of Market Regulation, the Commission, to Donald M.
Feuerstein, General Partner and Counsel, Salomon Brothers (Mar. 4,
1975).
    \56\ Id.
---------------------------------------------------------------------------

    In 1983, the Commission amended the rule to fully except all
investment grade nonconvertible debt securities from Rule 10b-6.\57\ At
that time, the Commission also added an exception for investment grade
nonconvertible preferred securities. In proposing the rule changes, the
Commission stated that ``it is very difficult, if not impossible, to
manipulate the price of investment grade debt. Investment grade debt
securities are generally thought to trade in accordance with the
concept of relative value, i.e., such securities are to a large degree
fungible,\58\ so that investors generally evaluate new offerings by
looking at comparably rated securities of other issuers.'' \59\
---------------------------------------------------------------------------

    \57\ Prohibitions Against Trading by Persons Interested in a
Distribution, Exchange Act Release No. 19565 (Mar. 4, 1983), 48 FR
10628 (Mar. 14, 1983). See also Prohibitions Against Trading by
Persons Interested in a Distribution, Exchange Act Release No. 18528
(Mar. 3, 1982), 47 FR 11482 (Mar. 16, 1982). The 1975 letter
included a number of other requirements that were not codified.
Letter from Robert C. Lewis, Associate Director, the Division of
Market Regulation, the Commission, to Donald M. Feuerstein, General
Partner and Counsel, Salomon Brothers (Mar. 4, 1975).
    \58\ With regard to whether investment grade nonconvertible
preferred securities are largely fungible with investment grade
nonconvertible preferred securities of other issuers, the Commission
noted that ``[n]onconvertible preferred securities possess some of
the attributes of debt securities and, when rated investment grade,
generally trade on the basis of their value in relation to
comparably-rated offerings of other issuers.'' Prohibitions Against
Trading by Persons Interested in a Distribution, Exchange Act
Release No. 19565 (Mar. 4, 1983), 48 FR 10628 (Mar. 14, 1983). The
Commission further noted that the exceptions are based on the
concept ``that investment grade debt and preferred securities are
traded on the basis of their yields and financial ratings and
therefore are largely fungible.'' Id. The Commission solicits
comment below as to whether this understanding with respect to the
fungibility of nonconvertible preferred securities remains accurate.
    \59\ Prohibitions Against Trading by Persons Interested in a
Distribution, Exchange Act Release No. 18528 (Mar. 3, 1982), 47 FR
11482 (Mar. 16, 1982).
---------------------------------------------------------------------------

    When Rules 101 and 102 of Regulation M were adopted, the Commission
substituted the concept of ``same class and series'' in Rule 10b-6 with
the concept of ``covered securities.'' The Commission clarified that as
a result of this change, ``bids for and purchases of outstanding
nonconvertible debt securities are not restricted unless the security
being purchased is identical in all of its terms to the security being
distributed.'' \60\ The effect of this change in application was that
``as a practical matter, Rule 101 and Rule 102 will have very limited
impact on debt securities, except for the rare situations where selling
efforts continue over a period of time.'' \61\ In contrast, under Rule
10b-6, bids for or purchases of debt securities of the issuer other
than those being distributed could be prohibited if they were similar
to the distributed securities in coupon interest rate and maturity
date.
---------------------------------------------------------------------------

    \60\ Anti-manipulation Rules Concerning Securities Offerings,
Exchange Act Release No. 38067 (Dec. 20, 1996), 62 FR 520 (Jan. 3,
1997). The Commission noted that ``Rule 101 does not apply to a
security if there is a single basis point difference in coupon rates
or a single day's difference in maturity dates, as compared to the
security in distribution.'' Id.
    \61\ Id.
---------------------------------------------------------------------------

    Investment grade asset-backed securities were also added to the
exception with the adoption of Regulation M.\62\ The application of the
exception to these securities was based on the premise that asset-
backed securities also trade primarily on the basis of yield spread 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.'' \63\
2. 2008 Proposal
---------------------------------------------------------------------------

    \62\ Id.
    \63\ Anti-manipulation Rules Concerning Securities Offerings,
Exchange Act Release No. 38067 (Dec. 20, 1996), 62 FR 520 (Jan. 3,
1997).
---------------------------------------------------------------------------

    In 2008, the Commission proposed to eliminate NRSRO references to
address concerns that such references contributed to undue reliance on
NRSRO ratings by market participants. Specifically, the Commission
proposed to remove references to NRSRO ratings from the determination
of whether investment grade nonconvertible debt, investment grade
nonconvertible preferred, and investment grade asset-backed securities
would be eligible for

the Rule 101(c)(2) and 102(d)(2) exceptions, and instead except
nonconvertible debt securities and nonconvertible preferred securities
based on the ``well-known seasoned issuer'' (``WKSI'') concept of
Securities Act Rule 405 and except asset-backed securities that are
registered on Form S-3 (``2008 Regulation M Proposals'').\64\
---------------------------------------------------------------------------

    \64\ Proposed Rule: References to Ratings of Nationally
Recognized Statistical Rating Organizations, Exchange Act Release
No. 58070 (Jul. 1, 2008), 73 FR 40088 (Jul. 11, 2008).
---------------------------------------------------------------------------

    Those commenters that addressed the proposed Regulation M changes
expressed uniform opposition to the proposed amendments.\65\ Many of
these commenters stated their view that the proposal is not necessary
to address concerns about investors' undue reliance on NRSRO
ratings.\66\ Commenters also stated that, because the 2008 Regulation M
Proposals would have altered the scope of the exceptions for investment
grade nonconvertible debt securities, investment grade nonconvertible
preferred securities, and asset-backed securities, they would have
placed new burdens on issuers and underwriters by imposing the
restrictions of Regulation M on currently excepted investment grade
securities.\67\ Additionally, commenters expressed the view that
certain high yield securities that are currently subject to Regulation
M, but are arguably more vulnerable to manipulation than securities
currently excepted from Regulation M, would have been excepted from
Rules 101 and 102 of Regulation M under the 2008 Regulation M
Proposals.\68\ These commenters did not suggest any substitute to the
proposed rule changes.\69\
---------------------------------------------------------------------------

    \65\ We received five comment letters that specifically
addressed the Regulation M proposals and each opposed the proposals.
See Letters from Keith F. Higgins, Chair, Committee on Federal
Regulation of Securities, American Bar Association (``ABA''), to
Florence E. Harmon, Acting Secretary, dated Oct. 10, 2008 (``ABA
Letter''); Robert Dobilas, CEO and President, Realpoint LLC, to
Secretary, dated Sep. 8, 2008; Letter from Jeremy Reifsnyder and
Richard Johns, Co-chairs, American Securitization Forum (``ASF'')
Credit Rating Agency Task Force, to Florence E. Harmon, Acting
Secretary, dated Sep. 5, 2008 (``ASF Letter''); Deborah A.
Cunningham and Boyce I. Greer, Co-chairs, Securities Industry and
Financial Markets Association (``SIFMA'') Credit Rating Agency Task
Force, to Florence E. Harmon, Acting Secretary, dated Sep. 4, 2008
(``SIFMA Letter 1''); and Mayer Brown LLP to Florence E. Harmon,
Acting Secretary, dated Sep. 4, 2008 (``Mayer Brown Letter''). There
were comment letters supportive of the Commission's effort to
minimize undue reliance on NRSRO ratings by market participants,
however, these commenters did not discuss Regulation M. See, e.g.,
Letter from Suzanne C. Hutchinson, Executive Vice President,
Mortgage Insurance Companies of America, to Florence E. Harmon,
Acting Secretary, dated Sep. 5, 2008.
    \66\ See, e.g., SIFMA Letter 1 (``Regulation M is primarily
directed at the actions of the issuers of securities and the
investment banks who underwrite them; in contrast, the investors
that the Commission is concerned with are not users of Regulation
M'').
    \67\ ABA Letter, SIFMA Letter 1.
    \68\ Id.
    \69\ The ABA did, however, suggest that should the Commission
insist on using the WKSI standard for investment grade
nonconvertible debt and investment grade nonconvertible preferred
securities, it do so only as an alternative to the current
exceptions at Rules 101(c)(2) and 102(d)(2). ABA Letter. However,
the ABA expressed its ``strong[] belie[f] that the Commission should
retain the current exceptions.'' Id.
---------------------------------------------------------------------------

3. 2009 Comment Period Re-Opening
    In 2009, the Commission deferred consideration of the 2008
Regulation M Proposals and, in light of the uniform opposition by
commenters and continuing concern regarding the undue influence of
NRSRO ratings, the Commission reopened the comment period for the 2008
Regulation M Proposals.\70\ The Commission received three additional
comment letters.\71\ Of these, two reiterated earlier objections,\72\
and the third argued that the 2008 Regulation M Proposals would have
adverse effects on foreign sovereign issuers of debt securities.\73\
Although the Commission invited commenters to suggest alternative
proposals, no new alternatives were suggested.
---------------------------------------------------------------------------

    \70\ References to Ratings of Nationally Recognized Statistical
Rating Organizations, Exchange Act Release No. 60790 (Oct. 5, 2009);
74 FR 52374 (Oct. 9, 2009).
    \71\ Letter from Mary Keogh, Managing Director, Regulatory
Affairs and Daniel Curry, President, DBRS, Inc., to Elizabeth M.
Murphy, Secretary, dated Nov. 13, 2009 (``DBRS Letter''); Letter
from Steven G. Tepper, Arnold & Porter LLP, to the Honorable Mary L.
Schapiro, Chairman, dated Dec. 8, 2009 (``Arnold & Porter Letter'');
and Letter from Sean C. Davy, Managing Director, Corporate Credit
Markets Division, SIFMA, to Elizabeth M. Murphy, Secretary, dated
Dec. 8, 2009 (``SIFMA Letter 2'').
    \72\ DBRS Letter and SIFMA Letter 2.
    \73\ Arnold & Porter Letter.
---------------------------------------------------------------------------

4. Current Proposal
    In accordance with Section 939A(b) of the Dodd-Frank Act, and in
light of the opposition to the 2008 Regulation M Proposals, the
Commission is proposing new standards to replace the reference to NRSRO
credit ratings in the Regulation M exceptions. Specifically, the
Commission proposes to except nonconvertible debt securities,
nonconvertible preferred securities, and asset-backed securities from
Rules 101 and 102 if they: (1) Are liquid relative to the market for
that asset class; (2) trade in relation to general market interest
rates and yield spreads; and (3) are relatively fungible with
securities of similar characteristics and interest rate yield spreads.
    The proposed standards are an attempt to codify the subset of
trading characteristics of investment grade nonconvertible debt
securities, nonconvertible preferred securities, and asset-backed
securities, that make them less prone to the type of manipulation that
Regulation M seeks to prevent. The standards are not intended as
measures of or proxies for assessments of credit risk, or to provide
substitute criteria for whether or not a security would be considered
investment grade.
    The application of Rules 101 and 102 of Regulation M to debt
securities is very limited, as compared to Rule 10b-6. The Commission
is interested in comment as to whether and in what circumstances
issuers, selling shareholders, distribution participants, and their
affiliated purchasers rely on the current exception for investment
grade securities (including with respect to specific activities) and,
in particular, whether this exception serves a continuing purpose with
regard to nonconvertible debt and asset-backed securities. The
Commission further solicits comment as to whether, if the application
of Rules 101 and 102 of Regulation M to debt securities is in fact
quite limited as a practical matter, the current investment grade
exception should be eliminated or, alternatively, whether it should be
expanded to except from Rules 101 and 102 all nonconvertible debt
securities, nonconvertible preferred securities, and asset-backed
securities (or some subset thereof).
a. Standards
i. Liquid Relative to the Market for the Asset Class
    In order to qualify for the proposed exception, a nonconvertible
debt, nonconvertible preferred, or asset-backed security would need to
be liquid relative to the market for that asset class. The Commission
believes that a high degree of liquidity is an important consideration
in determining which securities should be eligible for the proposed
exception from Rules 101 and 102. In general, the existence of
substantial liquidity is indicative of an established, efficient market
with a large number of participants, which is less likely to be subject
to the type of manipulation with which Regulation M is concerned. Since
this exception would apply primarily to a security for which the
distribution continues after the security begins to trade, the
Commission preliminarily believes that persons seeking to rely on this
exception would be able to adequately identify securities that meet
this standard.

    The Commission seeks comment on the standards that may be
indicative of relative liquidity, such as the size of the issuance, the
percentage of the average daily trading volume by persons other than
the persons seeking to rely on the exception, and the number of market
makers in the security being distributed other than those seeking to
rely on the exception.\74\ Other factors that could be considered
include the overall trading volume of the security, the number of
liquidity providers who participate in the market for the security,
trading volume in similar securities or other securities from the same
issuer, overall liquidity of all outstanding debt issued by the same
issuer, how quickly an investor could be expected to be able to sell
the security after purchase, and, in the case of asset-backed
securities, the liquidity and nature of the underlying assets.\75\
---------------------------------------------------------------------------

    \74\ See, e.g., Letter from Larry E. Bergmann, Senior Associate
Director, Division of Market Regulation, the Commission, to Alan J.
Sinsheimer, Sullivan & Cromwell (Jan. 12, 2000).
    \75\ This list is merely illustrative and should not be
considered a necessary or exhaustive list of the factors that could
reasonably be considered in evaluating liquidity.
---------------------------------------------------------------------------

ii. Trade in Relation to General Market Interest Rates and Yield
Spreads
    A nonconvertible debt security, nonconvertible preferred security,
or asset-backed security also would need to trade at prices that are
primarily driven by general market interest rates and spreads
applicable to a broad range of similar securities. This standard would
limit the exception's availability to those securities that trade in
relation to changes in broader interest rates (i.e., based on their
comparable yield spreads), as opposed to securities that trade in
relation to issuer-specific information or credit quality.\76\ This
characteristic affords market participants the ability to use general
market rates to make their own estimates of the value of such a
security and whether such security is trading at prices outside of
expected ranges. It would be more difficult for market participants to
make such an independent judgment if the security traded in an
idiosyncratic fashion based primarily on its specific characteristics,
such that the traded price of the security could not readily be
compared to similar issues. As noted above, investment grade
nonconvertible debt, investment grade nonconvertible preferred, and
investment grade asset-backed securities were originally excepted in
part because they trade in relation to general market interest rates
and yield spreads.
---------------------------------------------------------------------------

    \76\ This was an important distinction for the Commission when
adopting the current exceptions. ``Investors are therefore more
likely to compare yields of new non-investment grade debt offerings
with those of outstanding debt securities of the same issuer.''
Prohibitions Against Trading by Persons Interested in a
Distribution, Exchange Act Release No. 18528 (Mar. 3, 1982), 47 FR
11482 (Mar. 16, 1982).
---------------------------------------------------------------------------

iii. Relatively Fungible With Securities of Similar Characteristics and
Interest Rate Yield Spreads
    Finally, a nonconvertible debt, nonconvertible preferred, or asset-
backed security would need to be relatively fungible (in terms of
trading characteristics) with similar securities, i.e., securities with
similar interest rate yield spreads, in order to qualify for the
proposed exception. This standard, along with the requirement that the
security trade in relation to general market interest rates and yield
spreads explained above, is an attempt to codify a further trading
characteristic of the investment grade securities that are currently
excepted from Rules 101 and 102. Together with the standard regarding
trading in relation to general market interest rates and yield spreads,
the Commission preliminarily believes that the fungibility requirement
would limit the proposed exception to those securities that pose little
risk of manipulation.
    Being ``relatively fungible'' for these purposes would not require
that the security, for example, be deliverable for a purchase order for
a different security, but rather that a portfolio manager would be
willing to purchase the security in lieu of another security that has
similar characteristics (i.e., yield spreads, credit risk, etc.).
Securities with these characteristics would be less prone to market
squeezes or other forms of manipulation. Note that in order to satisfy
this requirement, a security need not be completely fungible for all
purposes with another security that has similar characteristics.
    The Commission preliminarily believes that persons seeking to rely
on the exception would be able to objectively demonstrate these three
standards were met.
b. Evaluation of the Security
    The proposal would require the person seeking to rely on the
exception to make the determination that the security in question is
liquid relative to the market for the asset class, trades in relation
to general market interest rates and yield spreads, and is relatively
fungible with securities of similar characteristics and interest rate
yield spreads. The determination must be made utilizing reasonable
factors of evaluation and must be subsequently verified by an
independent third party.
    Each person seeking to rely on the exception would be required to
assess the standards laid out in the proposal with regard to the
specific nonconvertible debt, nonconvertible preferred, or asset-backed
security being distributed. Persons would be required to exercise
reasonable judgment in conducting this analysis. Sole reliance on a
third party's determination without any further analysis would not be
considered to be based on reasonable judgment. Persons seeking to rely
on the exception would need to demonstrate compliance with the
requirements of this provision.
c. Third Party Verification
    In addition to making a determination that the nonconvertible debt,
nonconvertible preferred, or asset-backed security reasonably meets the
standards of the proposed exception, a person seeking to rely upon the
exception also would be required to obtain a verification of this
determination by an independent third party. Each person seeking to
rely on the exception would be required to make a reasonable
determination of the independence and qualifications of a third party
for this purpose, based on the third party's relevant professional
background, experience, knowledge, and skills. Counsel to, or other
affiliates of, the underwriter or issuer, would not meet the
independence requirement.\77\ Persons seeking to rely on the exception
may be best positioned in the first instance to evaluate all of the
factors that would be relevant to the determination, but they also
would have an inherent conflict of interest. The third party
verification requirement is intended to provide a reliable check on the
reasonableness of that determination.
---------------------------------------------------------------------------

    \77\ This is not an exhaustive list of persons who would not be
considered to be independent.
---------------------------------------------------------------------------

    The Commission intends by this proposal generally to except the
same types and amounts of securities that are currently excepted in
Rules 101(c)(2) and 102(d)(2) without referencing credit ratings. To
that end, the Commission is interested in comments on any added costs
or other effects that the requirement of independent third party
verification in particular may have in distributions of nonconvertible
debt, nonconvertible preferred, and asset-backed securities that would
result in making the exception less available than it is today. To the
extent that the need to obtain a third party verification increases the
costs that a person must

incur in order to benefit from the exception for these securities from
Rules 101 and 102 of Regulation M, the Commission seeks comment as to
what those costs are and whether such costs in at least some cases
would result in persons who currently rely on the exception determining
not to do so. This in turn may effectively expand the circumstances in
which Rules 101 and 102 of Regulation M apply, as compared to the
status quo. Thus, an increase in costs resulting from the third party
verification that is sufficient to alter the behavior of market
participants may reduce the practical benefit of the exception.
    The Commission also specifically solicits comment regarding the
type of entity that would be considered an acceptable independent third
party for purposes of this exception. For example, the Commission seeks
comment as to whether to limit the acceptable independent third parties
to those who could meet the definition of ``qualified independent
underwriter'' for purposes of the SRO rules,\78\ which could provide a
familiar bright line standard. The Commission also seeks comment as to
whether to limit the acceptable independent third parties to only
entities that are registered with the Commission, which would ensure
that the Commission has examination authority over those persons acting
as independent third party verifiers. The Commission further seeks
comment as to whether the proposal should limit the number of times a
person seeking to rely on the exception could rely on the same
independent third party.
---------------------------------------------------------------------------

    \78\ See Financial Industry Regulatory Authority (``FINRA'')
Rule 5121(f)(12). This rule generally requires that a qualified
independent underwriter be a FINRA member, have no conflict of
interest in the offering, not be an affiliate of a FINRA member that
does have a conflict of interest, not beneficially own more than 5%
of the class of securities that would give rise to a conflict of
interest, have agreed in writing to be a qualified independent
underwriter and undertake the legal responsibilities and liabilities
of an underwriter under the Securities Act, have specific offering
experience, and not have any supervisory associated persons who are
responsible for organizing, structuring, or performing due diligence
with respect to corporate public offerings of securities that have
certain disciplinary histories.
---------------------------------------------------------------------------

5. Request for Comment
    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.
     How often are these exceptions utilized where no other
exception from Rules 101 or 102 of Regulation M exists?
     Should the Commission remove the exception from Rules 101
and 102 of Regulation M for nonconvertible debt securities,
nonconvertible preferred securities, and/or asset-backed securities
completely? Why or why not? What specific trading activities that
currently occur pursuant to the exception would then be prohibited
during the restricted period because no other exception is available?
What are the advantages and disadvantages of such trading activities?
Should the Commission explicitly except any such specific activities in
lieu of providing a generic exception for investment grade
nonconvertible debt securities, nonconvertible preferred securities,
and/or asset-backed securities? What benefits or challenges would this
approach create?
     Should the Commission expand the exception to cover all
nonconvertible debt securities, nonconvertible preferred securities,
and asset-backed securities? What activities would then be allowed that
were previously prohibited under Rules 101 and 102 of Regulation M?
Would these new activities have any manipulative risk? Why or why not?
     Would the nonconvertible debt, nonconvertible preferred,
and asset-backed securities excepted in the proposal be more vulnerable
to manipulation than securities that meet the existing investment grade
standard? Why or why not?
     Are the proposed standards an appropriate substitute for
credit ratings in this context? Would the proposal capture the same
type and quantity of securities that fall within the current Rule
101(c)(2) and Rule 102(d)(2) exceptions? What effect(s), if any, would
the proposed modifications to the current exception have on the markets
for nonconvertible debt, nonconvertible preferred and asset-backed
securities?
     How difficult and costly in practice would the
requirements of the proposed exception be to apply? If the requirements
are more difficult or costly to apply, how might this impact the scope
of securities subject to the restrictions of Regulation M? For example,
to what extent, if any, might a narrower range of securities meet the
exceptions as a result of the proposal, if adopted? If fewer securities
are excepted from the restrictions of Regulation M, in what ways and to
what extent, if any, would this impact the market for those securities
that would no longer qualify for the exception?
     Will fewer nonconvertible debt securities, nonconvertible
preferred securities, and asset-backed securities issues meet the
requirements for these exceptions? If so, what impact would this
proposal have on the market for new issues of these securities?
     Please discuss whether and to what extent investors rely
upon the current Rule 101(c)(2) and 102(d)(2) exceptions for investment
grade nonconvertible and asset-backed securities when making a decision
to invest in such securities. Please also discuss whether, given that
Rules 101 and 102 of Regulation M are directed at distribution
participants, issuers, and selling securities holders, Rules 101 and
102 of Regulation M pose any danger of undue reliance on NRSRO ratings.
     Are there factors other than those identified in the
proposed standards that influence the trading of such securities? Are
there additional standards that the Commission should consider? Are
there any that the Commission should remove from the proposal?
     Should the proposed standards apply equally to
nonconvertible debt, nonconvertible preferred, and asset-backed
securities, or are there other standards that would be relevant to
consider based on the type of security involved?
     Would persons needing to use the proposed exception have
access to adequate information to determine whether a particular
security meets the exception? Why or why not?
     Is the Commission's position (expressed at the time the
exception was initially adopted) \79\ that preferred securities are
generally fungible with similar quality preferred securities still
valid? Has the market for preferred securities changed to the extent
that these securities are no longer generally fungible with similar
quality preferred securities? If so, to what extent has the market
changed? Rules 101(c)(2) and 102(d)(2) of Regulation M currently except
investment grade nonconvertible preferred securities. Is this exception
still relevant in the current marketplace for preferred securities?
What would be the potential adverse consequences if preferred
securities were no longer excepted from Rules 101 and 102?
---------------------------------------------------------------------------

    \79\ Prohibitions Against Trading by Persons Interested in a
Distribution, Exchange Act Release No. 19565 (Mar. 4, 1983), 48 FR
10628 (Mar. 14, 1983).
---------------------------------------------------------------------------

     With regard to asset-backed securities, should the
determination on behalf of the issuer that the security meets the
proposed factors be made by the sponsor or depositor of the asset-
backed security, or some other person? Please explain. What kinds of
conflicts

of interest may arise in this situation relating to sponsors or
depositors? For instance, the Commission could propose the following
rule text: ``With respect to an asset-backed security, the term issuer
includes a sponsor, as defined in Sec.  229.1011 of this chapter, or
depositor, as defined in Sec.  229.1011 of this chapter, that
participates in the issuance of an asset-backed security.'' Does this
further the goal of Regulation M and the reasons for the exception?
What benefits or costs would be associated with this change?
     What impact, if any, will the potential costs of obtaining
an independent third party verification have on the market for new
issues of nonconvertible debt securities, nonconvertible preferred
securities, and asset-backed securities? If these costs will have an
impact, please explain how.
     Other than NRSROs, are there entities such as independent
research firms or investment banks not involved in the distribution
that would be willing and able to serve as independent third parties
for these purposes?
     What additional costs, if any, will the requirement to use
an independent third party for purposes of the third party verification
proposal add to a distribution as compared to the current requirements
of Rules 101(c)(2) and 102(d)(2)?
     Would the independent third party verification, if
adopted, alter the amount or types of securities that can rely on the
exception?
     What factors should be considered in qualifying an
independent third party for purposes of the third party verification
proposal?
     Does the independent third party verification requirement
adequately address potential issuer, selling shareholder, distribution
participant, and affiliated purchaser conflicts of interest?
     Would it be appropriate to utilize the definition, in
whole or in part, of ``qualified independent underwriter'' from the SRO
rules in establishing who may be an independent third party for
purposes of the third party verification proposal? What are the
benefits or drawbacks to utilizing this standard? What other
alternatives should the Commission consider?
     The Commission would expect, if such an interpretation
would be adopted, that the definition of ``qualified independent
underwriter'' for these purposes would be similar to the requirements
of FINRA Rule 5121(f)(12) and generally require that such persons (1)
be registered with an SRO; (2) have no conflict of interest in the
offering; (3) not be an affiliate of a person that does have a conflict
of interest; (4) not beneficially own more than 5% of the class of
securities that would give rise to a conflict of interest; (5) have
agreed in writing to be a qualified independent underwriter and
undertake the legal responsibilities and liabilities of an underwriter
under the Securities Act; (6) have specific offering experience; and
(7) not have any supervisory associated persons who are responsible for
organizing, structuring, or performing due diligence with respect to
corporate public offerings of securities that have certain disciplinary
histories. Would all of these requirements be appropriate? Are any of
these requirements unnecessary?
     Should the Commission limit the eligibility to be an
independent third party for purposes of the third party verification
proposal to those registered with the Commission in some capacity? What
are the benefits or drawbacks to utilizing this standard? What other
alternatives should the Commission consider?
     In order to protect an independent third party verifier's
independence, should the Commission limit the frequency with which a
person could rely on the same independent third party for purposes of
the third party verification proposal?
     Should the Commission instead require only that persons
seeking to rely on the exception make a reasonable determination that
the proposed factors are present in the security being offered, without
any independent third party verification? If so, should the concern
about conflicts of interest be addressed and how? What benefits would
this approach provide? What other concerns could this approach raise?
     What are the risks of allowing parties to use internal
processes to make determinations of reasonableness? For example, would
parties be likely to adopt procedures that maximize the opportunity to
take advantage of the exception? Would increased cost efficiencies
arising from internal processes outweigh the conflicts of interest
presented? How likely are there to be instances where a determination
under the proposed amendments would result in a party qualifying for
the exception when it would not have qualified under the current
standard? How might the Commission attempt to mitigate such risks?
     Should the Commission, in lieu of the third party
verification requirement, require that any person seeking to rely on
the exception disclose in the offering documents relating to the
distribution: (1) That the person is relying on the relevant exception;
(2) that the person has undertaken diligent review and, utilizing the
factors identified in this proposal, reasonably concluded that the
security meets the proposed factors; (3) the factors identified in the
proposal and used by the person to make its conclusions; and (4) that
the person or affiliated purchasers will be purchasing or bidding
during the restricted period (if that is in fact the case)? Would this
approach also address concerns about the cost and effectiveness of
independent third party verification and have the added benefit of full
disclosure to investors? Would this approach present costs that do not
arise under the current exceptions? What other representations should
be included in the offering documents if this approach is taken? What
benefits would this approach provide? What other concerns could this
approach raise?
     Should the Commission permit the third party verification
requirement to be deemed satisfied if one of the purchasers of the
security is an unaffiliated regulated entity, such as a money market
fund \80\ or a broker-dealer that determines that the lesser haircut
would apply to the security under the Net Capital Rule proposal above?
\81\ Such entities might be required to make their own determination
regarding the creditworthiness of the security. Could this
creditworthiness determination provide the benefits of an independent
third party verifier (i.e., an independent assessment of the security)
without the cost of retaining such a verifier? What benefits would this
approach provide? What other concerns could this approach raise? Would
the timing of a distribution allow for this determination to be made
prior to the beginning of the restricted period? Are there other
entities that should be included under this alternative, and if so,
which entities and why?
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    \80\ See References to Credit Ratings in Certain Investment
Company Act Rules and Forms, Investment Company Act Release No.
29592 (Mar. 3, 2011), 76 FR 12896 (Mar. 9, 2011).
    \81\ See Section II.A.1, supra.
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     Should persons subject to Rules 101 or 102 be able to rely
on the determination of another person in the underwriting syndicate
who is seeking to rely on the exception in connection with the same
distribution or should all distribution participants, issuers, selling
security holders, or affiliated purchasers be required to make their
own determinations?
     The proposed criteria that, if satisfied, would except a
specific security from Rules 101 and 102 of Regulation M, are designed
to identify those characteristics of a security that

would correlate with whether or not such a security was susceptible to
manipulation during a time when it was distributed. Previously these
criteria were considered to be met if the security had an investment
grade rating. In proposing the criteria above, the Commission has
focused on those trading-oriented characteristics of securities that
the Commission believes (a) may be typical of securities with an
investment grade rating, and (b) that are relevant to the question
about manipulation. However, the Commission also notes that another
common characteristic of securities with an investment grade rating is
credit quality, and hence price or yield spread. Is credit quality
alone a good determinant of whether or not a security is susceptible to
manipulation under the conditions in which Rules 101 and 102 of
Regulation M is concerned? Why or why not? If so, given the required
removal of any reference to a security's rating, how would credit
quality be measured for the purposes of this rule? Would the price or
yield of a security be a good proxy for credit quality? If so, should
the Commission except nonconvertible debt securities, nonconvertible
preferred securities, and asset-backed securities based on a specific
premium to the London Interbank Offered Rate (``LIBOR'') at pricing?
Would the defined yield spread be difficult to determine for securities
that are difficult to price? Would this approach lead to market
participants adjusting the price of securities at issuance, delaying
issuance, or engaging in other activities solely to obtain the
exception? Is LIBOR an appropriate rate on which to base this test or
would other rates be more appropriate? If such an approach was
utilized, is at pricing the appropriate time at which to compare the
rates? How should the spreads be calculated? Would nonconvertible
preferred securities and asset-backed securities be able to continue to
rely on the exception under this proposal? Would persons seeking to
rely on the exception be able to determine this information before the
beginning of the restricted period? What benefits would this approach
provide? What other concerns could this approach raise? How difficult
will it be to predict, ahead of issuance, what the new issue's yield
spread to the reference rate will be at the time the issue is priced?
What is the expected economic effect of difficulty in predicting the
yield spread at the time of pricing? Would the number of issues brought
to market be impacted?
     With regard to asset-backed securities, should the
Commission, in place of or in addition to the proposed amendment,
except asset-backed securities that would meet the requirements for
shelf eligibility for such securities as recently proposed by the
Commission? \82\ This would provide a bright line test for these
securities but may alter the universe of asset-backed securities that
could rely on the exceptions. What benefits would this approach
provide? What other concerns could this approach raise? How would this
approach address potential conflicts of interest involving the issuer,
selling shareholder, distribution participant, or affiliated purchaser?
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    \82\ Asset-Backed Securities, Exchange Act Release No. 61858
(Apr. 7, 2010), 75 FR 23328 (May 3, 2010). This proposal would
extend shelf eligibility to asset-backed securities where (1) a
certification is filed at the time of each offering off of a shelf
registration statement by the chief executive officer of the
depositor that the assets in the pool have characteristics that
provide a reasonable basis to believe that they will produce, taking
into account internal credit enhancements, cash flows to service any
payments due and payable on the securities as described in the
prospectus; (2) the sponsor retains a specified amount of each
tranche of the securitization, net of the sponsor's hedging; (3) a
provision in the pooling and servicing agreement requires the party
obligated to repurchase the assets for breach of representations and
warranties to periodically furnish an opinion of an independent
third party regarding whether the obligated party acted consistently
with the terms of the pooling and servicing agreement with respect
to any loans that the trustee put back to the obligated party for
violation of representations and warranties and which were not
repurchased; and (4) the issuer makes an undertaking to file
Exchange Act reports so long as non-affiliates of the depositor hold
any securities that were sold in registered transactions backed by
the same pool of assets.
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     Should the Commission except nonconvertible debt
securities and nonconvertible preferred securities based on trading
volume and outstanding relevant securities of the issuer? For example,
the Commission could except nonconvertible debt securities where the
issuer has at least $1 billion in outstanding debt and the trading
volume of the outstanding debt securities of that issuer equaled or
exceeded 100% turnover over a six month period, excluding trading by
persons claiming the exception. This would have the benefit of
establishing a bright line standard and is similar to the actively-
traded securities exception found in Rule 101,\83\ but may except a
different universe of securities, be difficult to determine for
securities that are hard to value, and would not be available to
securities of new issuers. What benefits would this approach provide?
What other concerns could this approach raise? Would such an exception
tailored for nonconvertible preferred (referencing $1 billion
outstanding equity and trading volume of the issuer's nonconvertible
preferred securities) be appropriate? What other changes would need to
be made in order to make the exception available to preferred
securities generally? Are there different numerical thresholds that are
better able to replicate the universe of currently excepted
nonconvertible debt securities and preferred securities? If the
Commission replaced the current criteria with a volume test, how much
effort on the part of intermediaries would be required to demonstrate
that a volume threshold was met? How difficult would it be for
financial intermediaries to gather volume statistics? What would the
range of associated costs be? If it was necessary under the volume test
to exclude trading by persons subject to Rules 101 or 102, would that
information be available to financial intermediaries? Are there other
numerical tests of this type that would be more appropriate? How would
this approach address potential conflicts of interest involving the
issuer, selling shareholder, distribution participant, or affiliated
purchaser?
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    \83\ 17 CFR 242.101(c)(1).
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     Should underwriters be required to keep records
demonstrating their eligibility for the exception as modified by the
proposal? Should underwriters be required to obtain records from the
issuer or selling shareholder demonstrating eligibility for the
exception as modified by the proposal and keep them? What records
should be kept?
     Please comment generally on any relevant changes to the
debt markets since Regulation M was adopted in 1996 and how these
developments should affect the Commission's evaluation of the proposed
amendments.

D. Proposed Amendments to Rule 10b-10

    Exchange Act Rule 10b-10,\84\ the Commission's customer
confirmation rule, generally requires broker-dealers effecting
transactions for customers in securities, other than U.S. savings bonds
or municipal securities,\85\ to provide those customers with a written
notification, at or before completion of the securities transaction,
disclosing certain information about the terms of the transaction.
Specifically, Rule 10b-10 requires the disclosure of the date, time,
identity, and number of securities bought or sold; the capacity in
which the broker-dealer acted (e.g., as agent or

principal); yields on debt securities; and under specified
circumstances, the amount of compensation the broker-dealer will
receive from the customer and any other parties. By requiring these
disclosures, the rule serves a basic customer protection function by
conveying information that: (1) Allows customers to verify the terms of
their transactions; (2) alerts customers to potential conflicts of
interest; (3) acts as a safeguard against fraud; and (4) allows
customers a means of evaluating the costs of their transactions and the
quality of the broker-dealer's execution.
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    \84\ 17 CFR 240.10b-10.
    \85\ Municipal securities are covered by Municipal Securities
Rulemaking Board rule G-15, which applies to all municipal
securities brokers and dealers.
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    Paragraph (a)(8) of Rule 10b-10, which the Commission adopted in
1994, requires a broker-dealer to inform the customer in the
confirmation if a debt security, other than a government security, is
unrated by an NRSRO.\86\ As explained in the 1994 Adopting Release,
paragraph (a)(8) was intended to alert customers to the potential need
to obtain more information about a security from a broker-dealer; \87\
it was not intended to suggest that an unrated security is inherently
riskier than a rated security. Rule 10b-10 does not require broker-
dealers to disclose in customer confirmations the NRSRO rating for
securities that are rated, although the Commission understands that
some broker-dealers may do so voluntarily. The Commission has
previously proposed, and re-proposed, the deletion of paragraph (a)(8)
from Rule 10b-10.\88\ The Commission's previous proposals to delete
paragraph (a)(8) were prompted by concerns regarding the undue reliance
on NRSRO ratings and confusion about the significance of those ratings.
Section 939A of the Dodd-Frank Act requires the Commission to replace
references to NRSRO ratings in its rules, where these act as a proxy
for creditworthiness, with a different standard of creditworthiness.
Because paragraph (a)(8) of Rule 10b-10 does not refer to NRSRO ratings
as a means of determining creditworthiness, this provision does not
come strictly within Section 939A's requirements. Nevertheless, the
Commission preliminarily believes that to the extent that the provision
is intended to focus investor attention on ratings issued by NRSROs, as
distinct from other items of information, deleting it is consistent
with the intent of the Dodd-Frank Act. Accordingly, the Commission is
now re-proposing to delete paragraph (a)(8) from Rule 10b-10.\89\
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    \86\ See Confirmation of Transactions, Exchange Act Release No.
34962 (Nov. 10, 1994), 59 FR 59612 (Nov. 17, 1994) (``1994 Adopting
Release'').
    \87\ Id. The Commission stated that ``[i]n most cases, this
disclosure should verify information that was disclosed to the
investor prior to the transaction. If the customer was not
previously informed on the security's unrated status, the
confirmation may prompt a dialogue between the customer and the
broker-dealer.''
    \88\ See, e.g., References to Ratings of Nationally Recognized
Statistical Rating Organizations, Exchange Act Release No. 60790
(Oct. 5, 2009), 74 FR 52374 (Oct. 9, 2009); Proposed Rule:
References to Ratings of Nationally Recognized Statistical Rating
Organizations, Exchange Act Release No. 58070 (Jul. 1, 2008), 73 FR
40088 (Jul. 11, 2008).
    \89\ Consistent with that change, the Commission is also
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).
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    However, the Commission wishes to consider the relative benefits of
retaining this information in the customer confirmation against the
benefits of removing it. The Commission notes that the current
requirement to disclose the unrated status of a debt security provides
investors with an item of factual information that is conveyed together
with additional factual information about the terms of the transaction.
The Commission also notes that if this provision were deleted from Rule
10b-10, broker-dealers would not be prohibited from continuing to
provide this disclosure on a voluntary basis.\90\ The Commission
requests comment on the following:
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    \90\ Indeed, based on a limited review of customer
confirmations, the Commission understands that in addition to
disclosing the unrated status of a security, some broker-dealers may
also voluntarily include the NRSRO ratings for rated securities.
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     Would the investor protection function of Rule 10b-10 be,
in any way, diminished by deleting paragraph (a)(8) from the rule? Are
there are any alternative means of providing this information to
customers?
     What types of securities would typically be unrated by an
NRSRO? What types of issuers would typically not have their securities
rated by an NRSRO?
     Could the disclosure that a security is unrated be removed
from a customer confirmation without causing customer confusion? If so,
given the historical use and investor expectations related to this
disclosure, could it be removed without implying that a security is in
fact rated? Should broker-dealers be required to alert customers that
the unrated status of a security is no longer being disclosed? If so,
for how long?
     The preliminary note to Rule 10b-10 provides: ``This
section requires broker-dealers to disclose specified information in
writing to customers at or before completion of a transaction. The
requirements under this section that particular information be
disclosed is not determinative of a broker-dealer's obligation under
the general antifraud provisions of the federal securities laws to
disclose additional information to a customer at the time of the
customer's investment decision.'' If paragraph (a)(8) were deleted,
would the preliminary note to Rule 10b-10 affect a broker-dealer's
decision to nonetheless continue to voluntarily disclose whether a
security is unrated?
     If paragraph (a)(8) were deleted, is there a disclosure
that should be required in the confirmation on a transitional or
permanent basis that would help prevent customer confusion? For
example, should the Commission require broker-dealers, either
permanently or temporarily for a transition period, to disclose that
broker-dealers are no longer required to include on the confirmation
the fact that a security is unrated? Should such a disclosure be made
on the confirmation, the account statement, or in a separate document
accompanying the confirmation or account statement? What are the costs
associated with providing this disclosure on the confirmation, the
account statement or in a separate document?
     If the requirement to disclose that a security is unrated
were deleted from Rule 10b-10, would broker-dealers nevertheless feel
compelled to include the disclosure in order to satisfy their sales
practice obligations?
     Should the requirement to disclose that a security is
unrated be replaced by a requirement to provide a general statement
regarding the importance of considering an issuer's creditworthiness?
     If the requirement to disclose that a security is unrated
were deleted from the rule, are there alternative external or objective
measures of credit risk that could be substituted for ratings by an
NRSRO? Is it practicable to replace it with a requirement to disclose
specific information regarding an issuer's creditworthiness? If so,
what specific information should the Commission consider including?

III. Requests for Comment on Section 939(e) of Dodd-Frank

    Section 939(e) of the Dodd-Frank Act \91\ deleted Exchange Act
references to credit ratings by NRSROs in Exchange Act Section
3(a)(41),\92\ which defines the term ``mortgage related security,'' and
in Exchange Act Section 3(a)(53),\93\ which defines the term ``small
business related security.'' The credit rating references in Sections
3(a)(41) and 3(a)(53) effectively exclude from the respective
definitions

securities that otherwise meet the definitions but are not rated by at
least one NRSRO in the top two credit rating categories in the case of
mortgage related securities or in the top four credit rating categories
in the case of small business related securities. In place of the
credit rating references, Congress added language stating that a
mortgage related security and a small business related security will
need to satisfy ``standards of credit-worthiness as established by the
Commission.'' \94\ This replacement language will go into effect on