[Federal Register Volume 77, Number 141 (Monday, July 23, 2012)]
[Rules and Regulations]
[Pages 42980-42988]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2012-17763]


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SECURITIES AND EXCHANGE COMMISSION

17 CFR Part 241

[Release No. 34-67448; File No. S7-06-12]


Commission Guidance Regarding Definitions of Mortgage Related 
Security and Small Business Related Security

AGENCY: Securities and Exchange Commission.

ACTION: Interpretation; solicitation of comment.

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SUMMARY: The Securities and Exchange Commission (the ``Commission'') is 
publishing interpretive guidance with respect to sections 3(a)(41) (the 
definition of ``mortgage related security'') and 3(a)(53)(A) (the 
definition of ``small business related security'') of the Securities 
Exchange Act of 1934 (the ``Exchange Act''), in light of section 939(e) 
of the Dodd-Frank Wall Street Reform and Consumer Protection Act (the 
``Dodd-Frank Act''). Section 939(e) strikes provisions in sections 
3(a)(41) and 3(a)(53)(A) of the Exchange Act that reference credit 
ratings issued by nationally recognized statistical rating 
organizations (``NRSROs''), and inserts new text that provides that in 
order to satisfy these definitions a security must meet ``standards of 
credit-worthiness as established by the Commission.'' Because more time 
is needed to develop and establish standards of creditworthiness for 
purposes of these definitions, the Commission is providing a 
transitional interpretation that will be applicable on and after July 
20, 2012, and until such time as final Commission rules establishing 
new standards of creditworthiness become effective. The Commission also 
is seeking comment on potential standards of creditworthiness that 
could be established to replace the use of NRSRO credit ratings in the 
definitions of the terms ``mortgage related security'' and ``small 
business related security.''

DATES: Effective Date: July 20, 2012.
    Comments: Comments should be received on or before August 22, 2012.

FOR FURTHER INFORMATION CONTACT: Michael A. Macchiaroli, Associate 
Director, at (202) 551-5525; Thomas K. McGowan, Deputy Associate 
Director, at (202) 551-5521; Randall W. Roy, Assistant Director, at 
(202) 551-5522; Mark M. Attar, Branch Chief, at (202) 551-5889; Carrie 
A. O'Brien, Special Counsel, at (202) 551-5640; and Rachel B. Yura, 
Attorney-Adviser, at (202) 551-5729, Office of Financial 
Responsibility, Division of Trading and Markets, Securities and 
Exchange Commission, 100 F Street NE., Washington, DC 20549-7010.

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/interp.shtml); or
     Send an email to [email protected]. Please include 
File Number S7-06-12 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 S7-06-12. This file number 
should be included on the subject line if email 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/interp.shtml). 
Comments also are 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 10:00 a.m. and 
3:00 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.

SUPPLEMENTARY INFORMATION:

I. Introduction

    Section 3(a)(41) of the Exchange Act defines the term ``mortgage 
related security'' as, among other things, a security that is rated in 
one of the two highest rating categories by at least one NRSRO.\1\ 
Section 3(a)(53)(A) of the Exchange Act defines the term ``small 
business related security'' as, among other things, a security that is 
rated in one of the four highest rating categories by at least one 
NRSRO.\2\ A ``rating category'' refers to a distinct level in an 
NRSRO's rating scale represented by a unique symbol, number, or score. 
For example, a rating scale consisting of AAA, AA, A, BBB, BB, B, CCC, 
CC, C, and D has ten rating categories, with the AAA and AA categories 
being the two

[[Page 42981]]

highest categories and the AAA through BBB categories being the four 
highest categories. Securities rated in the two highest categories of 
such a rating scale are sometimes colloquially referred to as ``highly 
rated'' and securities rated in the four highest categories as 
``investment grade.''
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    \1\ See 15 U.S.C. 78c(a)(41).
    \2\ See 15 U.S.C. 78c(a)(53)(A).
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    Section 939(e) of the Dodd-Frank Act strikes the text in sections 
3(a)(41) and 3(a)(53)(A) of the Exchange Act that reference NRSRO 
credit ratings and in its place inserts text providing that a 
``mortgage related security'' and a ``small business related security'' 
means a security that ``meets standards of creditworthiness as 
established by the Commission.'' \3\ The effective date of these 
amendments to the Exchange Act is July 20, 2012.\4\
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    \3\ See Public Law 111-203 Sec.  939(e).
    \4\ See Public Law 111-203 Sec.  939(g).
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    The Commission previously discussed and requested comment on 
section 939(e) of the Dodd-Frank Act and potential standards of 
creditworthiness that could be used for purposes of the terms 
``mortgage related security'' and ``small business related security.'' 
\5\ The Commission is continuing to work on rule proposals to establish 
standards of creditworthiness to implement section 939(e) of the Dodd-
Frank Act. However, as explained below, these definitions are 
referenced in numerous statutes and regulations--the majority of which 
are not Commission authorizing statutes or regulations administered by 
the Commission. Consequently, the new standards of creditworthiness 
established by the Commission under section 939(e) of the Dodd-Frank 
Act will impact different types of persons and transactions, including 
persons and transactions for which the Commission does not have 
oversight authority. This impact adds a layer of complexity to the 
process of developing and establishing a standard or standards of 
creditworthiness for each definition. The considerations involved in 
undertaking this difficult task include seeking to accommodate, to the 
extent practicable, the varied uses of the definitions of ``mortgage 
related security'' and ``small business related security'' in statutes 
and regulations without lowering protections for investors, disrupting 
the markets for these securities, increasing risk to financial 
institutions, or imposing undue burdens and costs to market 
participants.
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    \5\ See Removal of Certain References to Credit Ratings under 
the Securities Exchange Act of 1934, Exchange Act Release No. 64352 
(Apr. 27, 2011), 76 FR 26550 (May 6, 2011).
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    Furthermore, as explained below, the Commission and other Federal 
agencies are continuing their efforts to remove references to credit 
ratings in regulations they administer as mandated by section 939A of 
the Dodd-Frank Act.\6\ In the case of some proposed amendments under 
section 939A, commenters--as explained below--have raised concerns that 
replacing the benchmark of credit ratings with another standard could, 
among other things, be harmful to investors, increase risk to financial 
institutions, distort financial markets, and increase burdens and 
costs.
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    \6\ See Public Law 111-203 Sec.  939a.
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    For these reasons, the Commission needs additional time to analyze 
and understand the potential impact that could result from the 
establishment of new standards of creditworthiness in the definitions 
of the terms ``mortgage related security'' and ``small business related 
security.'' At the same time, under section 939(e) of the Dodd-Frank 
Act, the use of NRSRO credit ratings in sections 3(a)(41) and 
3(a)(53)(A) of the Exchange Act will be stricken from the statutory 
text on July 20, 2012. Absent further guidance from the Commission, 
this change could create uncertainty among market participants that 
rely on these definitions and potentially negatively impact the market 
for mortgage related securities and small business related securities. 
In this regard, the Commission does not believe that, in the absence of 
established standards of creditworthiness by the Commission, Congress 
intended for the statutory definitions to become unworkable or to 
create market uncertainty regarding the status or meaning of these 
definitions. Consequently, the Commission is issuing this transitional 
interpretation to ensure that the markets can continue to function 
while the Commission continues its work on rule proposals to establish 
standards of creditworthiness to implement section 939(e) of the Dodd-
Frank Act.
    Therefore, until new standards of creditworthiness are established 
by final rules, the Commission is providing a transitional 
interpretation that will be applicable beginning on July 20, 2012 with 
respect to section 3(a)(41) (the definition of ``mortgage related 
security'') and section 3(a)(53)(A) (the definition of ``small business 
related security'') of the Exchange Act. Specifically, for purposes of 
these sections, the Commission interprets the terms ``standards of 
creditworthiness as established by the Commission'' to mean that on and 
after July 20, 2012, and until such time as final Commission rules 
establishing new standards of creditworthiness are effective:
     The standard of creditworthiness for purposes of the 
definition of the term ``mortgage related security'' in section 
3(a)(41) of the Exchange Act is a security that is rated in one of the 
two highest rating categories by at least one NRSRO; and
     The standard of creditworthiness for purposes of the 
definition of the term ``small business related security'' in section 
3(a)(53)(A) of the Exchange Act is a security that is rated in one of 
the four highest rating categories by at least one NRSRO.

The Commission is not interpreting any other provisions of sections 
3(a)(41) and 3(a)(53)(A) of the Exchange Act herein.

II. Background

A. Use of the Definitions of These Securities

1. Mortgage Related Security
    Congress defined the term ``mortgage related security'' in section 
3(a)(41) of the Exchange Act as part of the Secondary Mortgage Market 
Enhancement Act of 1984 (``SMMEA'').\7\ SMMEA was intended to encourage 
private sector participation in the secondary mortgage market by, among 
other things, relaxing certain regulatory requirements for ``private-
label issuers'' \8\ to sell mortgage-backed securities.\9\ For example, 
SMMEA: (1) Pre-Empted certain state investment laws to permit state 
regulated institutions to invest in private-label mortgage-backed 
securities to the same

[[Page 42982]]

extent as agency securities;\10\ (2) granted authority for certain 
depository institutions to invest in these securities;\11\ and (3) 
required states to exempt private-label mortgage-backed securities from 
state registration to the same extent as agency securities, unless the 
state specifically deemed otherwise.\12\ A security that qualifies as a 
mortgage related security under section 3(a)(41) of the Exchange Act 
receives the benefits intended by SMMEA.\13\
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    \7\ Public Law 98-440, Sec.  101, 98 Stat. 1689 (1984).
    \8\ Most mortgage-backed securities are issued or guaranteed by 
the Government National Mortgage Association (``Ginnie Mae''), a 
U.S. government agency, or the Federal National Mortgage Association 
(``Fannie Mae'') and the Federal Home Loan Mortgage Corporation 
(``Freddie Mac''), U.S. government-sponsored enterprises. These 
securities are commonly referred to as ``agency'' mortgage-backed 
securities. Ginnie Mae, backed by the full faith and credit of the 
U.S. government, guarantees that investors receive timely payments. 
Fannie Mae and Freddie Mac also provide certain guarantees and, 
while not backed by the full faith and credit of the U.S. 
government, have special authority to borrow from the U.S. Treasury. 
Some private institutions, such as brokerage firms, banks, and 
homebuilders, also securitize mortgages, known as ``private-label'' 
mortgage-backed securities.
    \9\ The legislation was aimed at encouraging participation in 
the secondary mortgage market by investment banks, investment 
entities, mortgage bankers, private mortgage insurance companies, 
pension funds and other investors, depositary institutions, and 
federal credit unions. See Kenneth G. Lore & Cameron L. Cowan, 
Mortgage-Backed Securities; Developments and Trends in the Secondary 
Market 2-39 (2001), at 1-14. See also Edward L. Pittman, Economic 
and Regulatory Developments Affecting Mortgage Related Securities, 
64 Notre Dame L. Rev. 497, 499 (1989).
    \10\ See 15 U.S.C. 77r-1.
    \11\ See 12 U.S.C. 1464(c)(1), 12 U.S.C. 1757, and 12 U.S.C. 24.
    \12\ See 15 U.S.C. 77d. For further discussion of SMMEA, see 
also Protecting Investors: A Half Century of Investment Company 
Regulation, Division of Investment Management (May 1992).
    \13\ See Pittman, p. 514.
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    Currently, section 3(a)(41) of the Exchange Act defines the term 
``mortgage related security'' as a ``security that is rated in one of 
the two highest rating categories by at least one [NRSRO]'' and that: 
(1) Represents ownership of one or more promissory notes, or interests 
therein, which notes are directly secured by a first lien on a single 
parcel of real estate upon which is located a dwelling or mixed 
residential and commercial structure, or on a residential manufactured 
home or one or more parcels of real estate upon which is located one or 
more commercial structures and were originated by a savings or banking 
institution or other similar institution approved for insurance by the 
Secretary of the U.S. Department of Housing and Urban Development; or 
(2) is secured by one or more promissory notes, or interests therein, 
and provides for payments of principal in relation to payments, or 
reasonable projections of payments, on notes, or interests therein, 
meeting such requirements.\14\
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    \14\ See 15 U.S.C. 78c(a)(41).
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    Table 1 identifies examples of Federal statutes and regulations 
that refer to the term ``mortgage related security'' as defined under 
the Exchange Act and indicates the type of entity that is subject to 
the statute or regulation.

                                 Table 1
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             Citation                  Entities subject to requirement
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11 U.S.C. 101(47).................  Participants in bankruptcy
                                     proceedings.
12 U.S.C. 24......................  National banking associations.
12 U.S.C. 1464....................  Federal savings associations.
12 U.S.C. 1757....................  Federal credit unions.
12 U.S.C. 1787....................  Federal credit unions.
12 U.S.C. 1821....................  Depository institutions insured by
                                     the Federal Deposit Insurance
                                     Corporation.
12 U.S.C. 4520....................  Fannie Mae and any affiliate thereof
                                     or Freddie Mac and any affiliate
                                     thereof.
12 U.S.C. 4617....................  Fannie Mae and any affiliate thereof
                                     or Freddie Mac and any affiliate
                                     thereof.
15 U.S.C. 77r-1...................  Any person, trust, corporation,
                                     partnership, association, business
                                     trust, or business entity created
                                     pursuant to or existing under the
                                     laws of the United States or any
                                     State.
15 U.S.C. 78g.....................  Broker-dealers.
15 U.S.C. 78k.....................  Broker-dealers.
12 CFR 1.2........................  National banks, District of Columbia
                                     banks, and federal branches of
                                     foreign banks, State banks that are
                                     members of the Federal Reserve
                                     System and foreign branches of
                                     national banks.
12 CFR Part 3, Appendix A.........  National banking associations.
12 CFR Part 208, Appendix A.......  State banks that are members of the
                                     Federal Reserve System.
12 CFR Part 225, Appendix A.......  Bank holding companies.
12 CFR Part 325, Appendix A.......  Depository institutions insured by
                                     the Federal Deposit Insurance
                                     Corporation.
12 CFR 567.1......................  Savings associations.
12 CFR 567.6......................  Savings associations.
12 CFR 703.2......................  Federal credit unions.
12 CFR 703.16(d)..................  Federal credit unions.
12 CFR 704, Appendix C............  Corporate credit unions.
12 CFR Part 1750, Appendix A to     Fannie Mae and any affiliate thereof
 Subpart B.                          and Freddie Mac and any affiliate
                                     thereof.
17 CFR 230.424....................  Persons filing a prospectus or
                                     prospectus supplement relating to
                                     an offering of mortgage related
                                     securities on a delayed basis.
17 CFR 240.15c3-1.................  Broker-dealers.
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    Numerous State laws also contain references to the definition of 
the term ``mortgage related security'' in section 3(a)(41) of the 
Exchange Act.\15\ The entities subject to these laws include insurance 
companies, banks, and trusts.\16\
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    \15\ See, e.g., ALA. CODE Sec. Sec.  10A-10-1.10 and 11-81-21; 
ARIZ. REV. STAT. ANN. Sec.  44-1843; ARK. CODE ANN. Sec.  23-42-503; 
COLO. REV. STAT. ANN. Sec.  11-59.5-101; CONN. GEN. STAT. Sec. Sec.  
36a-459a and 38a-905; DC CODE Sec. Sec.  31-1372.03 and 31-1372.04; 
HAW. REV. STAT. Sec.  412:10-502; KAN. STAT. ANN. Sec.  40-2a25; LA. 
REV. STAT. ANN. 6:611; ME. REV. STAT. 10, Sec.  969-A; ME. REV. 
STAT. 30-A, Sec.  4722; MD. CODE ANN., INS Sec.  9-229.1; MICH. 
COMP. LAWS Sec.  500.901; MISS. CODE ANN. Sec.  81-27-5.101; MO. 
ANN. STAT. Sec.  362.170; N.H. REV. STAT. ANN Sec. Sec.  392:25 and 
392-B:20; N.J. STAT. ANN. Sec.  17:9-41; N.Y. MUN. HOME RULE LAW 
Sec.  10; N.Y. INS. LAW Sec. Sec.  1401, 1404, and 1409; N.C. GEN. 
STAT. ANN. Sec.  53-342; OHIO REV. CODE ANN. Sec. Sec.  3907.141 and 
3925.081; OKLA. STAT. ANN. 6, Sec.  806; OKLA. STAT. ANN. 71, Sec.  
1-201; 7 PA. CONS. STAT. ANN. Sec. Sec.  315 and 502; S.C. CODE ANN. 
Sec. Sec.  38-12-220, 38-12-230, 38-12-430, and 38-12-440; TEX. FIN. 
CODE ANN. Sec. Sec.  34.101, 184.101, and 443.004; and UTAH CODE 
ANN. Sec.  61-1-11.
    \16\ Id.
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2. Small Business Related Security
    Congress defined the term ``small business related security'' in 
section 3(a)(53)(A) as part of the Riegle Community Development and 
Regulatory Improvement Act of 1994 (the ``CDRI'').\17\ Among other 
things, the CDRI removed limitations on purchases of certain small 
business-related securities by national banks.\18\ The CDRI was 
designed to increase small business access to capital by removing 
impediments in existing law to the securitizations of small business 
loans.\19\ The CDRI created a framework for small business related 
securities

[[Page 42983]]

similar to the SMMEA framework for mortgage related securities with the 
goal of stimulating the flow of funds to small businesses.
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    \17\ Public Law 103-325, Sec.  202, 108 Stat. 2198 (1994).
    \18\ See Conf. Rep. on H.R. 3474, 140 Cong. Rec. H6685, H6690 
(Aug. 2, 1994).
    \19\ Id. See also Remarks of Sen. Domenici, Vol. 140 Cong. 
Record, p. S11039 (Aug. 2, 1994).
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    Currently, section 3(a)(53)(A) defines the term ``small business 
related security'' as ``a security that is rated in one of the four 
highest rating categories by at least one [NRSRO]'' and that either: 
(1) Represents an interest in one or more promissory notes or leases of 
personal property evidencing the obligation of a small business concern 
and originated by an insured depository institution or other similar 
institution which is supervised and examined by federal or state 
authority or certain other regulated types of issuers; or (2) is 
secured by an interest in one or more promissory notes or leases of 
personal property (with or without recourse to the issuer or lessee) 
and provides for payments of principal in relation to payments, or 
reasonable projections of payments, on notes or leases of the type 
described in the preceding clause.\20\
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    \20\ See 15 U.S.C. 78c(a)(53)(A).
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    Table 2 identifies examples of Federal statutes and regulations 
that use the term ``small business related security'' and indicates the 
type of entity that is subject to the statute or regulation.

                                 Table 2
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             Citation                  Entities subject to requirement
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12 U.S.C. 24......................  National banking associations.
12 U.S.C. 1464....................  Federal savings associations.
12 U.S.C. 1757....................  Federal credit unions.
15 U.S.C. 77r-1...................  Any person, trust, corporation,
                                     partnership, association, business
                                     trust, or business entity created
                                     pursuant to or existing under the
                                     laws of the United States or any
                                     State.
15 U.S.C. 78g.....................  Broker-dealers.
15 U.S.C. 78k.....................  Broker-dealers.
12 CFR 1.2........................  National banks, District of Columbia
                                     banks, and federal branches of
                                     foreign banks, State banks that are
                                     members of the Federal Reserve
                                     System and foreign branches of
                                     national banks.
12 CFR 1.3........................  National banking associations.
12 CFR 703.2......................  Federal credit unions.
12 CFR 703.16.....................  Federal credit unions.
12 CFR 704.2......................  Corporate credit unions.
12 CFR 704.5......................  Corporate credit unions.
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    Several State laws also contain references to the definition of the 
term ``small business related security'' in section 3(a)(53)(A) of the 
Exchange Act.\21\ Banks and trust companies are subject to these 
laws.\22\
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    \21\ See, e.g., LA. REV. STAT. ANN. Sec.  6:611; MISS. CODE. 
ANN. 81-27-5.101; TEX. FIN. CODE ANN. Sec.  34.101; and TEX. FIN. 
CODE ANN. Sec.  184.101.
    \22\ Id.
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3. Use of the Definitions by the Commission and Other Agencies
    As identified in the tables set forth above, rules administered by 
the Commission and other Federal agencies reference the terms 
``mortgage related security'' and ``small business related security,'' 
as those terms are defined in Exchange Act Sections 3(a)(41) and 
3(a)(53)(A), respectively. Since the Dodd-Frank Act was adopted, 
several Federal agencies have proposed to continue to rely on the 
Exchange Act definitions of these terms. For example, the Office of the 
Comptroller of the Currency (the ``OCC'') proposed to retain rule 
provisions applicable to national banks that reference the statutory 
definitions of the terms ``mortgage related security'' and ``small 
business related security'' in the Exchange Act.\23\ Similarly, the 
National Credit Union Administration (the ``NCUA'') also proposed to 
continue to reference the Exchange Act definitions of the terms 
``mortgage related security'' and ``small business related security'' 
in its rules.\24\ However, the NCUA stated in its proposal that in the 
time period before the Commission moves to specify ``standards of 
creditworthiness'' for mortgage related securities and small business 
related securities, a Federal credit union is prohibited from 
purchasing such security unless the Federal credit union has specific 
evidence that the Commission considers that security to meet the 
requirements of section 3(a)(41) or section 3(a)(53)(A), as 
applicable.\25\
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    \23\ See Alternatives to the Use of External Credit Ratings in 
the Regulations of the OCC, 76 FR 73526, 73529 (Nov. 29, 2011), 
Docket OCC-2011-0019.
    \24\ See Removing References to Credit Ratings in Regulations; 
Proposing Alternatives to the Use of Credit Ratings, 76 FR 11164, 
11166 (Mar. 1, 2011).
    \25\ Id.
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B. Regulatory Initiatives To Remove References to Credit Ratings

1. Introduction
    The use of NRSRO credit ratings in statutes and regulations has 
been criticized as fostering undue reliance by investors on credit 
ratings.\26\ In addition, concerns have been raised that using NRSRO 
credit ratings in statutes and regulations impedes competition in the 
credit rating industry by giving NRSROs an unfair advantage over credit 
rating agencies that do not operate as NRSROs because entities subject 
to the statutes and regulations, or seeking favorable treatment under 
the statutes and regulations, must use NRSRO credit ratings.\27\
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    \26\ Id.; see also H.R. Rep. No. 111-517, Joint Explanatory 
Statement of the Committee of Conference, Title IX, Subtitle C 
``Improvement to the Regulation of Credit Rating Agencies,'' at 871-
72 (Conf. Rep.) (Jun. 29, 2010) (noting that ``[t]o reduce reliance 
on ratings, the report amends several statutes to remove references 
to credit ratings, credit rating agencies and NRSROs'') and 
Principles for Reducing Reliance on CRA Ratings, Financial Stability 
Board (Oct. 2010) (``The `hard wiring' of CRA ratings in standards 
and regulations contributes significantly to market reliance on 
ratings. This in turn is a cause of the `cliff effects' of the sort 
experienced during the recent crisis, through which CRA rating 
downgrades can amplify procyclicality and cause systemic 
disruptions. It can be also one cause of herding in market 
behaviour, if regulations effectively require or incentivise large 
numbers of market participants to act in similar fashion. But, more 
widely, official sector uses of ratings that encourage reliance on 
CRA ratings have reduced banks', institutional investors' and other 
market participants' own capacity for credit risk assessment in an 
undesirable way.'').
    \27\ See, e.g., Introduction of the Consumer Protection and 
Regulatory Enhancement Act, 155 Cong. Rec. E1965, E1965-67 (Jul. 23, 
2009) (statement of Rep. Bachus).
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    The Commission has for many years studied the issue of using NRSRO 
credit ratings in its rules and is engaged in an extensive rulemaking 
initiative to remove references to NRSRO credit ratings from its rules 
that commenced

[[Page 42984]]

prior to enactment of the Dodd-Frank Act. The development of 
alternatives to NRSRO credit ratings raises complex issues as indicated 
by comments received by the Commission and other Federal agencies.
2. Regulatory Initiatives
    In 1975, the Commission adopted the term ``nationally recognized 
statistical rating organization'' as part of amendments to the ``net 
capital rule'' for broker-dealers (Rule 15c3-1).\28\ The Commission's 
initial regulatory use of the term was intended to provide a method for 
determining net capital charges on different grades of debt securities 
under Rule 15c3-1.\29\ The Commission eventually inserted references to 
NRSRO credit ratings in other rules under the Securities Act of 1933 
(the ``Securities Act''), the Exchange Act, and the Investment Company 
Act of 1940 (the ``Investment Company Act'').\30\ In addition, credit 
ratings by NRSROs have been used as benchmarks in Federal and State 
legislation, rules administered by other Federal agencies, and foreign 
regulatory schemes.\31\
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    \28\ 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. The net capital rule prescribes minimum net 
capital requirements for broker-dealers and it uses NRSRO credit 
ratings to determine the amount of the charge to capital 
(``haircut'') a broker-dealer must apply to certain types of debt 
instruments. See 17 CFR 240.15c3-1.
    \29\ See 17 CFR 240.15c3-1.
    \30\ See, e.g., Report on Review of Reliance on Credit Ratings: 
As Required by Section 939A(c) of the Dodd-Frank Wall Street Reform 
and Consumer Protection Act, Commission Staff (Jul. 2011).
    \31\ See, e.g., Report to Congress on Credit Ratings, Board of 
Governors of the Federal Reserve System (Jul. 2011); References to 
Credit Ratings in FDIC Regulations, Federal Deposit Insurance 
Corporation (Jul. 2011); and Stocktaking on the use of credit 
ratings, the Joint Forum (Jun. 2009).
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    Concerns about the use of NRSRO credit ratings in statutes and 
regulations have prompted the Commission to study whether this use 
should be eliminated and whether there are practical alternatives to 
NRSRO credit ratings that could be used as benchmarks in regulations. 
For example, in 1994, the Commission published a concept release 
soliciting comment on whether references to NRSRO credit ratings should 
be eliminated from its rules.\32\ Commenters generally supported the 
continued use of NRSRO credit ratings.\33\ As summarized by the 
Commission, one commenter noted that the use of NRSRO credit ratings 
provides an objective, simple standard.\34\ Some commenters suggested 
that internal models could be used for purposes of determining net 
capital charges under the Commission's broker-dealer net capital 
rule.\35\
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    \32\ See Nationally Recognized Statistical Rating Organizations, 
Exchange Act Release No. 34616 (Aug. 31, 1994), 59 FR 46314 (Sep. 7, 
1994).
    \33\ See Capital Requirements for Brokers or Dealers Under the 
Securities Exchange Act of 1934, Exchange Act Release No. 39457 
(Dec. 17, 1997), 62 FR 68018 (Dec. 30, 1997).
    \34\ Id.
    \35\ Id.
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    In 2003, the Commission again sought comment on whether to 
eliminate the use of NRSRO credit ratings from Commission rules, and, 
if so, what alternative benchmarks could be used to meet the 
Commission's regulatory objectives.\36\ Commenters raised concerns 
about alternatives to credit ratings, highlighting the challenge of 
replacing credit ratings, though some commenters stated that 
alternatives such as internally developed credit ratings could be 
used.\37\
---------------------------------------------------------------------------

    \36\ See 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). See also Report of the Role and 
Function of Credit Rating Agencies in the Operations of the 
Securities Markets as Required by Section 702(b) of the Sarbanes-
Oxley Act of 2002, Commission (Jan. 2003).
    \37\ The comment letters are available on the Commission's 
Internet Web site at the following address: http://www.sec.gov/rules/concept/s71203.shtml. See, e.g., letter dated Jul. 28, 2003 
from Gregory V. Serio, Superintendent, New York Insurance 
Department, Chair, NAIC Rating Agency Working Group, National 
Association of Insurance Commissioners (stating that replacing NRSRO 
credit ratings ``could be costly and complicated''); letter dated 
Jul. 25, 2003 from Steven C. Nelson, Director of Taxable Money 
Market Research, Fidelity Investments Money Management, Inc. 
(stating that replacing NRSRO credit ratings in Rule 2a-7 under the 
Investment Company Act (``Rule 2a-7'') ``would not provide 
sufficient protection for investors'' in money market funds and 
``could lead to significant risk inequality across money market 
funds''); letter dated Jul. 24, 2003 from Charles M. Nathan, Chair, 
Committee on Securities Regulation and Nicolas Grabar, Committee on 
Securities Regulation, Association of the Bar of the City of New 
York (stating that with respect to replacing NRSRO credit ratings in 
Rule 2a-7 that a ``change to a more subjective standard could 
disrupt the market in unpredictable and undesirable ways.''); and 
letter dated Jul. 28, 2003 from Raymond W. McDaniel, Moody's 
Investors Service (suggesting internally generated credit ratings as 
an alternative).
---------------------------------------------------------------------------

    In July 2008, the Commission proposed amendments to remove 
references to NRSRO credit ratings from its rules under the Securities 
Act, Exchange Act, and Investment Company Act.\38\ Commenters again 
raised concerns about alternatives to credit ratings.\39\ In October 
2009, the Commission adopted several of the proposed amendments and re-
opened for comment the remaining amendments.\40\ Commenters to the 
October 2009 re-proposal continued to raise concerns about alternatives 
to NRSRO credit ratings.\41\
---------------------------------------------------------------------------

    \38\ See References to Ratings of Nationally Recognized 
Statistical Rating Organizations, Exchange Act Release No. 58070 
(Jul. 1, 2008), 73 FR 40088 (Jul. 11, 2008).
    \39\ The comment letters are available on the Commission's 
Internet Web site at the following addresses: http://www.sec.gov/comments/s7-18-08/s71808.shtml (Securities Act rules); http://www.sec.gov/comments/s7-19-08/s71908.shtml (Investment Company Act 
rules); and http://www.sec.gov/comments/s7-17-08/s71708.shtml 
(Exchange Act rules). See, e.g., letter dated Sep. 5, 2008 from 
Jeffrey T. Brown, Senior Vice President, Charles Schwab & Co., Inc. 
(stating that replacing NRSRO credit ratings ``may be destabilizing 
and inject risk and uncertainty into the operations of broker-
dealers, investment advisers and money market mutual funds.''); 
letter dated Sep. 4, 2008 from Deborah A. Cunningham, Chief 
Investment Officer, Federated Investors and Boyce I. Greer, 
President, Fixed Income & Asset Allocation, Fidelity, on behalf of 
the Securities Industry and Financial Markets Association (stating 
that replacing NRSRO credit ratings would ``be to the detriment of 
all investors''); letter dated Sep. 10, 2008 from Ronald W. Forbes 
and Rodney D. Johnson, The Independent Directors of The BlackRock 
Liquidity Funds (stating that replacing NRSRO credit ratings would 
``impose significant and unrealistic new burdens on money market 
fund boards''); letter dated Sep. 12, 2008 from Keith F. Higgins, 
Chair, Committee on Federal Regulation of Securities, and Vicki O. 
Tucker, Chair, Committee on Securitization and Structured Finance, 
Business Law Section, American Bar Association (stating that 
replacing NRSRO credit ratings would ``eliminate all objective 
indicia of credit quality and will provide greater opportunity for 
abuse.'').
    \40\ 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 (17 CFR 270.5b-3 and 17 CFR 270.10f-3). See 
also 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).
    \41\ The comment letters are available on the Commission's 
Internet Web site at the following address: http://www.sec.gov/comments/s7-17-08/s71708.shtml. See, e.g., letter dated Dec. 9, 2009 
from Steven G. Tepper, Arnold & Porter LLP, letter dated Dec. 8, 
2009 from Sean C. Davy, Managing Director, Corporate Credit Markets 
Division, Securities Industry and Financial Markets Association, and 
letter dated Dec. 8, 2009 from Karrie McMillan, General Counsel, 
Investment Company Institute (stating that the removal of ratings 
from Commission rules would result in ``serious unintended 
consequences.'').
---------------------------------------------------------------------------

    The Dodd-Frank Act--enacted in 2010--includes section 939A.\42\ 
This section requires Federal agencies to ``review any regulation 
issued by such agency that requires the use of an assessment of the 
creditworthiness of a security or money market instrument and any 
references to or requirements in such regulations regarding credit 
ratings.'' \43\ Once the agency has completed that review, the statute

[[Page 42985]]

provides that the agency ``remove any reference to or requirement of 
reliance on credit ratings, and to substitute in such regulations such 
standard of creditworthiness'' as the agency determines to be 
appropriate.\44\
---------------------------------------------------------------------------

    \42\ See Public Law 111-203 Sec.  939A.
    \43\ See Public Law 111-203 Sec.  939A(a)(1)-(2).
    \44\ See Public Law 111-203 Sec.  939A(b); see also Report on 
Review of Reliance on Credit Ratings: As Required by Section 939A(c) 
of the Dodd-Frank Wall Street Reform and Consumer Protection Act, 
Commission Staff (Jul. 2011).
---------------------------------------------------------------------------

    In response to section 939A of the Dodd-Frank Act, the Commission 
proposed amendments in 2011 to remove references to NRSRO credit 
ratings in its rules and forms under the Securities Act, the Exchange 
Act, and the Investment Company Act. In particular, in February 2011, 
the Commission proposed to remove references to credit ratings in rules 
and forms promulgated under the Securities Act and the Exchange Act 
related to offerings of securities or issuer disclosure.\45\ In March 
2011, the Commission proposed amending certain rules and forms under 
the Investment Company Act, including Rule 2a-7 governing the 
operations of money market funds.\46\ Further, in April 2011, the 
Commission proposed to amend additional rules and one form under the 
Exchange Act applicable to broker-dealer financial responsibility, 
distributions of securities, and confirmations of transactions.\47\ In 
that same release, the Commission also requested comment on potential 
standards of creditworthiness for purposes of Exchange Act sections 
3(a)(41) and 3(a)(53)(A), in order to consider how to implement section 
939(e) of the Dodd-Frank Act.\48\ Commenters to the various Commission 
proposals identified above continued to raise concerns about 
alternatives to NRSRO credit ratings.\49\ Other Federal agencies have 
proposed and, in some cases, adopted amendments to regulations that 
they administer that contain references to NRSRO credit ratings.\50\ 
Commenters have raised a number of concerns with respect to these 
proposals.\51\
---------------------------------------------------------------------------

    \45\ See Security Ratings, Securities Act Release No. 9186 (Feb. 
9, 2011), 76 FR 8961 (Feb. 16, 2011). See also Security Ratings, 
Securities Act Release No. 9245 (Jul. 27, 2011), 76 FR 46603 (Aug. 
3, 2011) (adopting amendments to Rules 134 (17 CFR 230.134), 138 (17 
CFR 230.138), 139 (17 CFR 230.139), 168 (17 CFR 230.168), Form S-3 
(17 CFR 239.13), Form S-4 (17 CFR 239.25), Form F-3 (17 CFR 239.33), 
and Form F-4 (17 CFR 230. 34) under the Securities Act, rescinded 
Form F-9 (17 CFR 239.39) and adopted amendments to the Securities 
Act and Exchange Act forms and rules that referred to Form F-9 to 
eliminate those references, and amended Schedule 14A (17 CFR 
240.14a-101) under the Exchange Act).
    \46\ See References to Credit Ratings in Certain Investment 
Company Act Rules and Forms, Securities Act Release No. 9193 (Mar. 
3, 2011), 76 FR 12896 (Mar. 9, 2011). In particular, the Commission 
requested public comment on proposed amendments to rules 2a-7 (17 
CFR 270.2a-7) and 5b-3 (17 CFR 270.5b-3) under the Investment 
Company Act, to Forms N-1A (17 CFR 239.15A and 17 CFR 274.11A), N-2 
(17 CFR 239.14 and 17 CFR 274.11a-1) and N-3 (17 CFR 239.17a and 17 
CFR 274.11b) under the Investment Company Act and the Securities 
Act, and Form N-MFP (17 CFR 274.201) under the Investment Company 
Act.
    \47\ See Removal of Certain References to Credit Ratings under 
the Securities Exchange Act of 1934, 76 FR 26550. In particular, the 
Commission requested public comment on proposed amendments to 
Exchange Act Rule 15c3-1 (17 CFR 240.15c3-1), 15c3-3 (17 CFR 
240.15c3-3), 17a-4 (17 CFR 240.17a-4), 101 and 102 of Regulation M 
(17 CFR 242.101 and 242.102), and 10b-10 (17 CFR 240.10b-10), and 
one Exchange Act form--Form X-17A-5, Part IIB (17 CFR 249.617)--to 
remove references to credit ratings and, in certain cases, 
substitute alternative standards of creditworthiness.
    \48\ Id.
    \49\ See comment letters to the proposals available on the 
Commission's Internet Web site at the following addresses: (1) 
http://www.sec.gov/comments/s7-18-08/s71808.shtml (letters 
commenting on Security Ratings, 76 FR 8961); (2) http://sec.gov/comments/s7-07-11/s70711.shtml (letters commenting on References to 
Credit Ratings in Certain Investment Company Act Rules and Forms, 76 
FR 12896); and (3) http://sec.gov/comments/s7-15-11/s71511.shtml 
(letters commenting on Removal of Certain References to Credit 
Ratings under the Securities Exchange Act of 1934, 76 FR 26550). 
See, e.g., letter dated Apr. 25, 2011 from Dennis M. Kelleher, 
President & CEO of Better Markets, Inc., commenting on References to 
Credit Ratings in Certain Investment Company Act Rules and Forms, 76 
FR 12896 (``In theory, incorporating alternative standards of 
credit-worthiness into the Commission's rules can be accomplished in 
one of two ways: Either incorporating by reference some reliable, 
external measure of credit-worthiness other than credit ratings, or 
setting forth in the rules the actual standards of credit-worthiness 
that market participants must apply * * * As a practical matter, a 
reliable and objective shorthand measure of credit risk, which could 
be incorporated by reference into the Commission's regulations, is 
not currently available.'').
    \50\ See, e.g., Alternatives to the Use of External Credit 
Ratings in the Regulations of the OCC, Department of the Treasury, 
Office of the Comptroller of the Currency, 76 FR 73526 (Nov. 29, 
2011).
    \51\ See, e.g., comments submitted in response to Alternatives 
to the Use of External Credit Ratings in the Regulations of the OCC, 
76 FR 73526, available at http://www.regulations.gov/#!searchResults;a=OCC;rpp=25;po=0;dktid=OCC-2011-0019.
---------------------------------------------------------------------------

    As noted above, in its April 2011 proposal to amend rules under the 
Exchange Act, the Commission sought comment on potential standards of 
creditworthiness for purposes of sections 3(a)(41) and 3(a)(53)(A) of 
the Exchange Act.\52\ One specific alternative that the Commission 
discussed and requested comment on was whether a more subjective 
standard of creditworthiness--modeled on the ``minimal amount of credit 
risk'' standard proposed with respect to the broker-dealer net capital 
rule--would be a practical and workable standard of creditworthiness 
for purposes of the definition of ``mortgage related security'' in 
section 3(a)(41) of the Exchange Act and ``small business related 
security'' in section 3(a)(53)(A) of the Exchange Act.\53\ Four comment 
letters addressed this general request for comment.\54\ One commenter 
suggested that using the same standard of creditworthiness as proposed 
for the net capital rule would be too subjective and that a more 
objective standard is needed.\55\ According to this commenter, a 
standard that is too subjective could create uncertainty in the 
markets, which in turn would reduce liquidity and ``limit buyside 
demand, distribution and secondary trading, thereby further harming the 
ability of non-Agency securitization to fund mortgage credit.'' \56\ 
Another commenter stated that using the single standard proposed for 
the net capital rule--the ``minimal amount of credit risk'' standard--
may not work given that the definition of ``mortgage related security'' 
refers to a security that is rated in the two highest categories by an 
NRSRO and the definition of ``small business related security'' refers 
to a security that is rated in the four highest categories.\57\ The 
commenter suggested potential alternative standards based on the 
characteristics of assets underlying the securities.\58\ A third 
commenter acknowledged the ``challenge facing the Commission here is an 
especially important one, since the alternative standards of credit-
worthiness ultimately adopted will undoubtedly

[[Page 42986]]

have an impact on a huge number of investors.'' \59\ The commenter 
supported using the ``minimal amount of credit risk'' standard provided 
that an appropriate set of factors were incorporated into the test.\60\ 
The fourth commenter supported the ``minimal amount of credit risk'' 
standard without elaboration.\61\
---------------------------------------------------------------------------

    \52\ See Removal of Certain References to Credit Ratings under 
the Securities Exchange Act of 1934, 76 FR at 26566.
    \53\ Id.
    \54\ See letter dated Jun. 6, 2011 from Chris Barnard (the 
``Barnard Letter''); letter dated Jul. 5, 2011 from Dennis M. 
Kelleher, President & CEO, and Stephen W. Hall, Securities 
Specialist, Better Markets, Inc. (the ``Better Markets Letter''); 
letter dated Sep. 23, 2011 from Richard A. Dorfman, Managing 
Director, Head of Securitization, and Christopher B. Killian, Vice 
President, Securitization Group, Securities Industry and Financial 
Markets Association (the ``SIFMA Letter''); and letter dated Dec. 
20, 2011 from Kurt N. Schacht, Managing Director, Standards and 
Financial Market Integrity, and Linda L. Rittenhouse, Director, 
Capital Markets Policy, CFA Institute (the ``CFA Letter'').
    \55\ See the SIFMA Letter.
    \56\ Id.
    \57\ See the CFA Letter.
    \58\ Id. (``With respect to objective measures that could be 
used to determine whether securities qualify as mortgage-related 
securities or small business-related securities, we suggest 
consideration of the following factors: Average loan-to-value for 
borrowers in secured borrowings; Term to maturity of the security; 
Regional concentrations of loans within the pools; Loan category 
concentration of loans within the pools, such as loans secured with 
either commercial or residential real estate, commercial and 
industrial loans, or small business credit card loans; Average debt-
to-equity ratios for the loan pools supporting small business-
related securities; Guarantees for bond guarantors.'').
    \59\ See the Better Markets Letter.
    \60\ Id.
    \61\ See the Barnard Letter.
---------------------------------------------------------------------------

III. Solicitation of Comment

    The Commission solicits comment on section 939(e) of the Dodd-Frank 
Act and potential standards of creditworthiness that could be used for 
the definition of the terms ``mortgage related security'' in section 
3(a)(41) of the Exchange Act and ``small business related security'' in 
section 3(a)(53)(A) of the Exchange Act in order to assist the 
Commission in developing proposed standards of creditworthiness to 
replace NRSRO credit ratings. The Commission seeks comment from all 
interested parties, including: (1) Persons that are subject to, or rely 
on, Federal or State statutes and/or regulations that use these 
definitions; (2) Federal and State agencies that oversee persons that 
are subject to, or rely on, Federal or State statutes and/or 
regulations that use these definitions; (3) Federal and State agencies 
that administer regulations that use these definitions; (4) persons 
that participate in the markets for mortgage related securities and/or 
small business related securities, including issuers, underwriters, 
investors, and NRSROs; (5) originators of mortgages and/or small 
business loans that are securitized into mortgage related securities 
and/or small business related securities; and (6) any other interested 
persons, including persons that will need to rely on the standards of 
creditworthiness the Commission establishes to replace the use of NRSRO 
credit ratings.
    The Commission invites commenters to provide their views and 
recommendations on all aspects of section 939(e) of the Dodd-Frank Act, 
including identifying approaches for developing new standards and 
creditworthiness to be used in the definitions and the benefits, costs, 
and competitive impacts of such approaches. To supplement the April 
2011 proposing release and its formal solicitation of comments,\62\ the 
Commission seeks comments on the following questions and topics:
---------------------------------------------------------------------------

    \62\ See Removal of Certain References to Credit Ratings under 
the Securities Exchange Act of 1934, 76 FR 26550.
---------------------------------------------------------------------------

    1. To help the Commission obtain relevant market information, 
commenters are invited to provide data and statistics on the nature of 
the market for ``mortgage related securities'' as defined in section 
3(a)(41) of the Exchange Act, including the size of the market in terms 
of the number and aggregate principal amount of issuances per year.
    2. To help the Commission obtain relevant market information, 
commenters are invited to provide data and statistics on the nature of 
the market for ``small business related securities'' as defined in 
section 3(a)(53)(A) of the Exchange Act, including the size of the 
market in terms of the number and aggregate principal amount of 
issuances per year.
    3. With respect to establishing a standard of creditworthiness to 
be used in the definition of the term ``mortgage related security,'' 
would any of the proposals or final rules by the Commission and other 
Federal agencies under section 939A of the Dodd-Frank Act serve as a 
model to develop a practical and workable new standard of 
creditworthiness in section 3(a)(41) of the Exchange Act? If so, 
identify the proposal and explain how it may accommodate the varied 
uses of the definition of the term ``mortgage related security'' in 
statutes and regulations as well as how it may impact protections for 
investors, the market for these securities, risk to the financial 
system, and burdens and costs to market participants. Are there other 
approaches that could serve as models for developing a practical and 
workable new standard of creditworthiness in section 3(a)(41) of the 
Exchange Act? If so, identify the approach and explain how it would 
meet the Commission's objective.
    4. With respect to establishing a standard of creditworthiness to 
be used in the definition of ``small business related security,'' would 
any of the proposals or final rules by the Commission and other Federal 
agencies under section 939A of the Dodd-Frank Act serve as a model to 
develop a practical and workable new standard of creditworthiness in 
section 3(a)(53)(A) of the Exchange Act? If so, identify the proposal 
and explain how it may accommodate the varied uses of the definition of 
the term ``small business related security'' in statutes and 
regulations as well as how it may impact protections for investors, the 
market for these securities, risk to the financial system, and burdens 
and costs to market participants. Are there other approaches that could 
serve as models for developing a practical and workable new standard of 
creditworthiness in section 3(a)(53)(A) of the Exchange Act? If so, 
identify the approach and explain how it would meet the Commission's 
objective.
    5. Should the new standards of creditworthiness in sections 
3(a)(41) and 3(a)(53)(A) of the Exchange Act be modeled on Commission 
proposals under section 939A of the Dodd-Frank Act that would replace 
the use of NRSRO credit ratings with definitional standards? For 
example, as discussed above, the Commission proposed to remove 
references to NRSRO credit ratings in the net capital rule for purposes 
of determining whether lower haircuts apply to certain debt 
instruments.\63\ In place of credit ratings, the Commission proposed a 
new standard of creditworthiness; namely, that the debt instrument has 
only ``a minimal amount of credit risk'' as determined by the broker-
dealer pursuant to written policies and procedures the broker-dealer 
establishes, maintains, and enforces to assess creditworthiness. Would 
such a definitional approach be a practical and workable standard of 
creditworthiness for sections 3(a)(41) and 3(a)(53)(A) of the Exchange 
Act? In this regard, the Commission seeks comment in response to the 
following questions:
---------------------------------------------------------------------------

    \63\ See Removal of Certain References to Credit Ratings under 
the Securities Exchange Act of 1934, 76 FR at 26552-54.
---------------------------------------------------------------------------

    a. Would there need to be different creditworthiness definitions 
for the terms ``mortgage related security'' and ``small business 
related security'' given that the current standard in section 3(a)(41) 
of the Exchange Act is a security that is rated in one of the two 
highest rating categories by at least one NRSRO and the current 
standard in section 3(a)(53)(A) of the Exchange Act is a security that 
is rated in one of the four highest rating categories by at least one 
NRSRO? For example, should the standard of creditworthiness for 
purposes of the definition of the term ``mortgage related security'' 
require a more stringent level of creditworthiness than the standard of 
creditworthiness in the definition of the term ``small business related 
security''? If so, should the Commission use the ``minimal amount of 
credit risk'' standard proposed for the net capital rule for a small 
business related security and a different, more stringent standard of 
creditworthiness for a mortgage related security?
    b. Under the Commission's net capital rule proposal, the broker-
dealer holding the security would be required to determine whether the 
security has a ``minimal amount of credit risk.'' As noted above, the 
statutes and

[[Page 42987]]

regulations using the definitions of ``mortgage related security'' and 
``small business related security'' implicate a range of market 
participants. Consequently, who could be responsible for making the 
determination that a security meets the definitional creditworthiness 
standard used for purposes of sections 3(a)(41) and 3(a)(53)(A) of the 
Exchange Act? For example, could the issuer or underwriter represent 
that the security meets the definitional standard? If so, should the 
representation be made as of a point in time (e.g., at or before 
issuance of the security) and/or would it need to be updated throughout 
the term of the debt security? Alternatively, if the investor in the 
security is subject to oversight and inspection by a Federal or State 
agency, could the investor be required to make the determination 
(subject to review by the agency) as to whether the security meets the 
definitional standard of creditworthiness in order to obtain favorable 
treatment under an applicable statute or regulation using the 
definition of ``mortgage related security'' or ``small business related 
security''? Could the issuer or underwriter be required to make the 
representation that the security meets the definitional standard at 
issuance and, thereafter, the investor be responsible for determining 
on an on-going basis whether the security continues to meet the 
definitional standard? Issuers, underwriters, and investors may have 
incentives to determine that a security meets the definitional standard 
in order to get favorable treatment under statutes and regulations 
using the terms ``mortgage related security'' or ``small business 
related security.'' Given this potential conflict, could a third-party 
be required to verify that the security meets the definitional 
standard? If so, what type of entity could perform the verification and 
who would be responsible for compensating the third-party for this 
work?
    c. The following examples of different possible definitional 
standards are designed to provide context to assist commenters in 
responding to the questions above:

Mortgage Related Security

Example 1

    For purposes of section 3(a)(41) of the Act (15 U.S.C. 
78c(a)(41)), a ``mortgage related security'' means a security that 
has virtually no credit risk, including virtually no vulnerability 
to changes in business or economic circumstances.

Example 2

    For purposes of section 3(a)(41) of the Act (15 U.S.C. 
78c(a)(41)), a ``mortgage related security'' means a security that 
the issuer or underwriter of the security represents has virtually 
no credit risk, including virtually no vulnerability to changes in 
business or economic circumstances.

Example 3

    For purposes of section 3(a)(41) of the Act (15 U.S.C. 
78c(a)(41)), a ``mortgage related security'' means a security that 
the issuer or underwriter of the security represents at the time of 
issuance has virtually no credit risk, including virtually no 
vulnerability to changes in business or economic circumstances, and 
thereafter has virtually no credit risk, including virtually no 
vulnerability to changes in business or economic circumstances.

Example 4

    For purposes of section 3(a)(41) of the Act (15 U.S.C. 
78c(a)(41)), a ``mortgage related security'' means a security that 
the issuer or underwriter of the security represents has virtually 
no credit risk, including virtually no vulnerability to changes in 
business or economic circumstances. The representation of the issuer 
or underwriter must be verified by an independent third party that 
is in the business of performing credit analysis.

Small Business Related Security

Example 1

    For purposes of section 3(a)(53)(A) of the Act (15 U.S.C. 
78c(a)(53)), a ``small business related security'' means a security 
that has only a minimal amount of credit risk.

Example 2

    For purposes of section 3(a)(53)(A) of the Act (15 U.S.C. 
78c(a)(53)), a ``small business related security'' means a security 
that the issuer or underwriter of the security represents has only a 
minimal amount of credit risk.

Example 3

    For purposes of section 3(a)(53)(A) of the Act (15 U.S.C. 
78c(a)(53)), a ``small business related security'' means a security 
that the issuer or underwriter of the security represents at the 
time of issuance has only a minimal amount of credit risk and 
thereafter has only a minimal amount of credit risk.

Example 4

    For purposes of section 3(a)(53)(A) of the Act (15 U.S.C. 
78c(a)(53)), a ``small business related security'' means a security 
that the issuer or underwriter of the security represents has only a 
minimal amount of credit risk. The representation of the issuer or 
underwriter must be verified by an independent third party that is 
in the business of performing credit analysis.

    d. Provide additional examples of definitions that could be used as 
standards of creditworthiness. For any example provided, explain why it 
would be a practical and workable standard for purposes of the 
definitions of mortgage related security and small business related 
security.
    6. Rather than using a definitional standard, could the new 
standards of creditworthiness in sections 3(a)(41) and 3(a)(53)(A) of 
the Exchange Act be based on objective criteria? For example, could the 
criteria be based on structural characteristics of securities that meet 
the current definitions of the terms ``mortgage related security'' and 
``small business related security'' such as the features, underlying 
asset pool quality, and the performance of the underlying assets after 
issuance that are typical of such securities? If so, what 
characteristics could be used to develop the criteria? In this regard, 
the Commission seeks comment in response to the following questions:
    a. What are the typical features of mortgage related securities 
that meet the current standard of creditworthiness in section 3(a)(41) 
of the Exchange Act (i.e., rated in the top two rating categories by at 
least one NRSRO)?
    b. What are the characteristics of the loans underlying mortgage 
related securities that meet the current standard of creditworthiness 
in section 3(a)(41) of the Exchange Act (i.e., rated in the top two 
rating categories by at least one NRSRO)? Would the characteristics of 
a ``qualified mortgage,'' as that term is defined under the Truth in 
Lending Act section 129C(b)(2), meet the current standard of 
creditworthiness in section 3(a)(41)? Could the criteria for a mortgage 
related security be tied to that definition? Could the criteria be tied 
to the definition of a ``qualified residential mortgage,'' as is used 
in section 15G of the Exchange Act? \64\ If so, explain how.
---------------------------------------------------------------------------

    \64\ On April 29, 2011, the Commission, together with the Office 
of Comptroller of the Currency, Treasury, Board of Governors of the 
Federal Reserve System, Federal Deposit Insurance Corporation, and 
Department of Housing and Urban Development, published a joint 
notice of public comment to implement the risk retention 
requirements of Section 15G, including the proposed requirements for 
a qualified residential mortgage. See Credit Risk Retention, 
Exchange Act Release No. 64148 (Mar. 30, 2011), 76 FR 24090 (Apr. 
29, 2011). The proposed definition has been the subject of 
significant comment.
---------------------------------------------------------------------------

    c. What is typical of the level of performance of the loans 
underlying mortgage related securities that meet the current standard 
of creditworthiness in section 3(a)(41) of the Exchange Act (i.e., 
rated in the top two rating categories by at least one NRSRO)?
    d. What are the typical features of small business related 
securities that meet the current standard of creditworthiness in 
section 3(a)(53)(A) of the Exchange Act (i.e., rated in the top four 
rating categories by at least one NRSRO)?
    e. What are the characteristics of the loans underlying small 
business related securities that meet the current standard of 
creditworthiness in section 3(a)(53)(A) of the Exchange Act (i.e.,

[[Page 42988]]

rated in the top four rating categories by at least one NRSRO)?
    f. What is typical of the level of performance of the loans 
underlying small business related securities that meet the current 
standard of creditworthiness in section 3(a)(53)(A) of the Exchange Act 
(i.e., rated in the top four rating categories by at least one NRSRO)?
    7. Could the requirements of Regulation AB or the proposed shelf 
eligibility requirements described below serve, in whole or in part, as 
a standard for creditworthiness for a mortgage related security? In 
2010, the Commission proposed to eliminate the provision for shelf 
eligibility for mortgage related securities regardless of the form that 
can be used for registration of the securities.\65\ Under the proposal, 
offerings of mortgage related securities would only be eligible for 
shelf registration on a delayed basis if, like other asset-backed 
securities, they meet the proposed criteria for eligibility for shelf 
registration that would be contained in new proposed Form SF-3. Note 
that the proposed requirements for shelf eligibility would replace, in 
part, the requirement that the securities be investment grade 
rated.\66\ Could the standards distinguish between issuers that meet 
the shelf eligibility requirements and those that do not? If so, why 
and how should the conditions differ? Could we require that a mortgage 
related security be required to be registered on existing Form S-3 or, 
if adopted, Form SF-3? Commentators should be specific in their 
responses and provide data and statistics, if possible.
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    \65\ See Asset-Backed Securities, Securities Act Release No. 
9117 (Apr. 7, 2010), 75 FR 23328 (May 3, 2010).
    \66\ In July 2011, in light of the Dodd-Frank Act and comments 
received, the Commission re-proposed the shelf eligibility 
requirements that would replace the investment grade ratings 
criteria. See Re-proposal of Shelf Eligibility Conditions for Asset-
Backed Securities and Other Additional Requests for Comment, Release 
No. 33-9244 (Jul. 26, 2011), 76 FR 47948 (Aug. 5, 2011).
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IV. Conclusion

    For the foregoing reasons, the Commission is providing a 
transitional interpretation that will be applicable on and after July 
20, 2012, and until such time as final Commission rules establishing 
new standards of creditworthiness are effective. The Commission's 
interpretation herein does not address any other provisions of the 
definitions of ``mortgage related security'' or ``small business 
related security'' in sections 3(a)(41) and 3(a)(53)(A) of the Exchange 
Act, respectively.

List of Subjects in 17 CFR Part 241

    Securities.

Amendment to the Code of Federal Regulations

    For the reasons set forth above, the Commission is amending title 
17, chapter II of the Code of Federal Regulations as set forth below:

PART 241--INTERPRETIVE RELEASES RELATING TO THE SECURITIES EXCHANGE 
ACT OF 1934 AND GENERAL RULES AND REGULATIONS THEREUNDER

0
Part 241 is amended by adding Release No. 34-67448 to the list of 
interpretive releases as follows:

----------------------------------------------------------------------------------------------------------------
                                                                                       Federal Register vol. and
                Subject                    Release No.               Date                        page
----------------------------------------------------------------------------------------------------------------
Commission Guidance Regarding                  34-67448   July 17, 2012.............  75 FR [INSERT FR PAGE
 Definitions of Mortgage Related                                                       NUMBER].
 Security and Small Business Related
 Security.
----------------------------------------------------------------------------------------------------------------


    By the Commission.

    Dated: July 17, 2012.
Elizabeth M. Murphy,
Secretary.
[FR Doc. 2012-17763 Filed 7-20-12; 8:45 am]
BILLING CODE 8011-01-P