[Federal Register Volume 87, Number 61 (Wednesday, March 30, 2022)]
[Proposed Rules]
[Pages 18312-18338]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2022-06583]


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SECURITIES AND EXCHANGE COMMISSION

17 CFR Parts 240 and 242

[Release No. 34-94499; File No. S7-11-22]
RIN 3235-AL14


Removal of References to Credit Ratings From Regulation M

AGENCY: Securities and Exchange Commission.

ACTION: Proposed rule.

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SUMMARY: The Securities and Exchange Commission (``Commission'') is re-
proposing amendments to remove the references to credit ratings 
included in certain Commission rules. The Dodd-Frank Wall Street Reform 
and Consumer Protection Act (``Dodd-Frank Act''), among other things, 
requires the Commission to remove any references to credit ratings from 
its regulations. In one rule governing the activity of distribution 
participants, the Commission is proposing to remove the reference to 
credit ratings, substitute alternative measures of credit-worthiness, 
and impose related recordkeeping obligations in certain instances. In 
another rule governing the activity of issuers and selling security 
holders during a distribution, the Commission is proposing to eliminate 
the exception for investment-grade nonconvertible debt, nonconvertible 
preferred securities, and asset-backed securities.

DATES: Comments should be received on or before May 23, 2022.

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/submitcomments.htm); or
     Send an email to [email protected]. Please include 
File Number S7-11-22 on the subject line; or

Paper Comments

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

All submissions should refer to File Number S7-11-22. This file number 
should be included on the subject line if email is used. To help us 
process and review your comments more efficiently, please use only one 
method of submission. The Commission will post all comments on the 
Commission's website (http://www.sec.gov/rules/proposed.shtml). 
Comments are also available for website 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. Operating conditions may limit access to the Commission's Public 
Reference Room. All comments received will be posted without change; we 
do not edit personal identifying information from comment submissions. 
You should submit only information that you wish to make publicly 
available.
    Studies, memoranda, or other substantive items may be added by the 
Commission or staff to the comment file during this rulemaking. A 
notification of the inclusion in the comment file of any such materials 
will be made available on the Commission's website. To ensure direct 
electronic receipt of such notifications, sign up through the ``Stay 
Connected'' option at www.sec.gov to receive notifications by email.

FOR FURTHER INFORMATION CONTACT: John Guidroz, Branch Chief, Laura 
Gold, Special Counsel, Jessica Kloss, Attorney-Adviser, or Josephine 
Tao, Assistant Director, in the Office of Trading Practices, at (202) 
551-5777, Division of Trading and Markets, U.S. Securities and Exchange 
Commission, 100 F Street NE, Washington, DC 20549.

SUPPLEMENTARY INFORMATION: The Commission is proposing to amend the 
existing exceptions found in 17 CFR 242.101 (``Rule 101'') and 17 CFR 
242.102 (``Rule 102'') for investment-grade nonconvertible debt 
securities, nonconvertible preferred securities, and asset-backed 
securities. Specifically, the Commission is proposing to remove the 
requirement to qualify for the exception in each of these rules that 
these securities be rated investment grade by at least one nationally 
recognized statistical rating organization (``NRSRO''). In its place, 
in Rule 101, the Commission proposes to except (1) nonconvertible debt 
securities and nonconvertible preferred securities (collectively, 
``Nonconvertible Securities'') that meet a specified probability of 
default threshold, and (2) asset-backed securities that are offered 
pursuant to an effective shelf registration statement filed on the 
Commission's Form SF-3. In addition, the Commission is proposing to 
eliminate the existing exception in Rule 102 for investment-grade 
Nonconvertible Securities, and asset-backed securities. The Commission 
is also proposing amendments to 17 CFR 240.17a-4(b) (``Rule 17a-4(b)'') 
under the Securities Exchange Act of 1934 (``Exchange Act'') to require 
broker-dealers to maintain the written probability of default 
determination.

Table of Contents

I. Background
II. Prior Proposals To Remove References to Credit Ratings in 
Regulation M
    A. 2008 Proposal
    B. 2011 Proposal
III. Application of Regulation M to Distributions of Nonconvertible 
Securities and Asset-Backed Securities
IV. Proposed Amendments to Rules 101 and 102 To Remove References to 
Credit Ratings
    A. Rule 101
    B. Rule 102
V. Recordkeeping Requirement: Rule 17a-4(b)(17)
    A. Proposed Recordkeeping Requirement
    B. Request for Comment
VI. General Request for Comment
VII. Paperwork Reduction Act Analysis
    A. Background
    B. Proposed Use of Information
    C. Information Collections
    D. Collection of Information Is Mandatory
    E. Confidentiality
    F. Retention Period of Recordkeeping Requirement
    G. Request for Comment

[[Page 18313]]

VIII. Economic Analysis
    A. Baseline
    B. Benefits of the Proposed Amendment
    C. Costs of the Proposed Amendment
    D. Efficiency, Competition, and Capital Formation
    E. Reasonable Alternatives
    F. Request for Comment
IX. Regulatory Flexibility Act Certification
X. Consideration of Impact on the Economy
Statutory Basis and Text of Proposed Amendments
List of Subjects in 17 CFR Part 240 and 242

I. Background

    Title IX, Subtitle C, of the Dodd-Frank Act includes provisions 
regarding statutory and regulatory references to credit ratings in the 
Exchange Act and the rules promulgated thereunder.\1\ One such 
provision, Section 939A, requires the Commission to ``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.'' \2\ Upon completion of this review, the 
Commission must ``remove any reference to or requirement of reliance on 
credit ratings'' and ``substitute in such regulations such standard of 
credit-worthiness'' as the Commission determines to be appropriate for 
such regulations. In making such a determination, the Commission shall 
seek to establish, to the extent feasible, uniform standards of credit-
worthiness for use by the Commission, taking into account the entities 
it regulates and the purposes for which such entities would rely on 
such standards of credit-worthiness.\3\ The statute also requires the 
Commission to transmit a report to Congress upon the conclusion of the 
review required in Section 939A(a).\4\
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    \1\ See Public Law 111-203 secs. 931-939H, 124 Stat. 1376, 1872-
90 (2010). These provisions are designed ``[t]o reduce the reliance 
on ratings.'' Joint Explanatory Statement of the Committee of 
Conference, Conference Committee Report No. 111-517, to accompany 
H.R. 4173, 864-79, 870 (June 29, 2010).
    \2\ Public Law 111-203 sec. 939A(a); see infra note 4.
    \3\ See id. at sec. 939A(b).
    \4\ Id. at sec. 939A(c); see U.S. Securities and Exchange 
Commission Staff, Report on Review of Reliance on Credit Ratings: As 
Required by Section 939A(c) of the Dodd-Frank Wall Street Reform and 
Consumer Protection Act (2011), available at https://www.sec.gov/news/studies/2011/939astudy.pdf. Staff reports, Investor Bulletins, 
and other staff documents (including those cited herein) represent 
the views of Commission staff and are not a rule, regulation, or 
statement of the Commission. The Commission has neither approved nor 
disapproved the content of these documents and, like all staff 
statements, they have no legal force or effect, do not alter or 
amend applicable law, and create no new or additional obligations 
for any person.
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    In reference to the requirements in Section 939A, the Commission is 
proposing amendments to Rule 101 and Rule 102 to remove the existing 
exceptions for nonconvertible debt securities, nonconvertible preferred 
securities, and asset-backed securities, that are rated by at least one 
NRSRO, as that term is used in Rule 15c3-1 under the Exchange Act,\5\ 
in one of its generic rating categories that signifies investment 
grade.\6\ Throughout this release, this exception referencing an 
investment grade rating is referred to as the ``Investment Grade 
Exception,'' or the ``Investment Grade Exceptions'' when referencing 
the exception provided in Rule 101 and Rule 102 or the rules 
collectively, as applicable. In place of the Investment Grade Exception 
in Rule 101, the Commission proposes to substitute alternative 
standards of credit-worthiness with respect to the type of security 
that is the subject of a distribution. First, for distributions of 
Nonconvertible Securities, the Commission is proposing a standard that 
is based on the probability of default of the issuer.\7\ Second, for 
distributions of asset-backed securities, the Commission is proposing 
to except asset-backed securities that are offered pursuant to an 
effective shelf registration statement filed on Form SF-3. Finally, the 
Commission is proposing to eliminate the Investment Grade Exception in 
Rule 102 and not replace it with an alternative standard.
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    \5\ 17 CFR 240.15c3-1. In 1975, the Commission adopted the term 
NRSRO as part of its amendments to Exchange Act Rule 15c3-1. In 
2013, pursuant to Section 939A of the Dodd-Frank Act, the Commission 
adopted amendments to Rule 15c3-1 to remove the reference to NRSROs. 
See Removal of Certain References to Credit Ratings Under the 
Securities Exchange Act of 1934, Release No. 34-71194 (Dec. 27, 
2013) [79 FR 1522, 1527-28 (Jan. 8, 2014)].
    \6\ See 17 CFR 242.101(c)(2), 17 CFR 242.102(d)(2).
    \7\ To assist the Commission in conducting effective 
examinations and oversight of distribution participants and their 
affiliated purchasers, the Commission is also requiring the 
maintenance and preservation of the written probability of default 
determination. See infra Part V.
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    As a set of prophylactic anti-manipulation rules, Regulation M is 
designed to preserve the integrity of the securities trading markets as 
independent pricing mechanisms by prohibiting activities that could 
artificially influence the market for an offered security. Subject to 
exceptions, Rules 101 and 102 prohibit issuers, selling security 
holders, distribution participants,\8\ and any of their affiliated 
purchasers \9\ from, directly or indirectly, bidding for, purchasing, 
or attempting to induce another person to bid for or purchase a covered 
security \10\ during a specified period referred to as the ``restricted 
period.'' \11\
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    \8\ See 17 CFR 242.100 (``Rule 100'') (defining ``distribution 
participant'' as any ``underwriter, prospective underwriter, broker, 
dealer, or other person who has agreed to participate or is 
participating in a distribution'').
    \9\ Specifically, Rule 101 governs the activities of 
``distribution participants,'' while Rule 102 governs the activities 
of the issuer and selling security holders. Rules 101 and 102 also 
apply to the affiliated purchasers of underwriters and issuers or 
selling security holders, respectively.
    \10\ See 17 CFR 242.100 (defining ``covered security'' as any 
security that is the subject of a distribution or any reference 
security, and ``reference security'' as a security into which a 
security that is the subject of a distribution 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).
    \11\ The restricted period for any particular distribution 
commences one or five business days before the day of the pricing of 
the offered security and continues until the distribution is 
complete. The restricted period that applies to a particular 
offering is determined based on the trading volume value of the 
offered security and the public float value of the issuer. See Rule 
100. A person determines when it completes its participation in the 
distribution based on its role. See Rule 100; Anti-Manipulation 
Rules Concerning Securities Offerings, Release No. 34-38067 (Dec. 
20, 1996) [62 FR 520, 522 (Jan. 3 1997)] (``Regulation M Adopting 
Release''). In addition, securities acquired in the distribution for 
investment purposes by any person participating in a distribution, 
or any affiliated purchaser of such person, are deemed to be 
distributed. Rule 100; Regulation M Adopting Release, 62 FR 523.
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    The Investment Grade Exceptions are two of several exceptions to 
the general prohibitions of Rules 101 and 102. The Commission expressed 
its belief that certain securities and activities should be excepted 
from the prohibitions in order to allow for activities necessary for 
the distribution to occur; to limit adverse effects to the trading 
market that could result from these prohibitions absent such 
exceptions; and to allow conduct that is not likely to have a 
manipulative impact.\12\ The Commission did not except other securities 
and activities, however, expressing a belief that the application of 
Regulation M is appropriate ``where the incentive to manipulate can 
escalate.'' \13\ The securities and activities exceptions provided in 
Regulation M take into account the different types of interests that 
distribution participants, issuers, and selling security holders have 
regarding the outcome of a distribution by providing different and 
limited exceptions in Rule 102 to issuers and

[[Page 18314]]

selling security holders.\14\ Rule 102 contains fewer exceptions than 
Rule 101 because issuers and selling security holders have the greatest 
interest in an offering's outcome and generally do not have the same 
market access needs as underwriters.\15\
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    \12\ See Trading Practices Rules Concerning Securities 
Offerings, Release No. 33-7282 (Apr. 11, 1996) [61 FR 17108, 17111, 
17120 (Apr. 18, 1996)] (``Regulation M Proposing Release'').
    \13\ Regulation M Adopting Release, 62 FR 528. The Commission 
also stated more generally that Regulation M applies where there is 
a ``readily identifiable incentive to manipulate the price of an 
offered security.'' Id. at 540.
    \14\ See Regulation M Adopting Release, 62 FR 530.
    \15\ Id.
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II. Prior Proposals To Remove References to Credit Ratings in 
Regulation M

    The Commission has previously proposed two alternatives with 
respect to the Investment Grade Exceptions, once in 2008 (``2008 
Proposal'') \16\ and once in 2011 (``2011 Proposal'').\17\ The 
Commission did not adopt any rules based on the 2008 Proposal or the 
2011 Proposal.\18\
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    \16\ References to Ratings of Nationally Recognized Statistical 
Rating Organizations, Release No. 34-58070 (July 1, 2008) [73 FR 
40088, 40095-97 (July 11, 2008)] (``2008 Proposing Release'').
    \17\ Removal of Certain References to Credit Ratings Under the 
Securities Exchange Act of 1934, Release No. 34-64352 (Apr. 27, 
2011) [76 FR 26550 (May 6, 2011)] (``2011 Proposing Release'').
    \18\ See Removal of Certain References to Credit Ratings Under 
the Securities Exchange Act of 1934, Release No. 34-71194 (Dec. 27, 
2013) [79 FR 1522 (Jan. 8, 2014)].
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A. 2008 Proposal

    In 2008, prior to the enactment of the Dodd-Frank Act, the 
Commission proposed to substitute the Investment Grade Exceptions with 
a standard for Nonconvertible Securities based primarily on the well-
known seasoned issuers (``WKSI'') concept from Rule 405 of the 
Securities Act of 1933 (``Securities Act''), as well as a standard for 
asset-backed securities that were registered on Form S-3.\19\ 
Commenters expressed uniform opposition to the 2008 Proposal.\20\ Many 
of these commenters stated their view that changes to the Regulation M 
exceptions, such as those in the 2008 Proposal, were not necessary as 
the Regulation M exceptions did not raise the same concerns about 
investors' undue reliance on credit ratings as other rules could.\21\ 
Commenters also stated that a result of the 2008 Proposal would be new 
burdens on issuers and underwriters from imposing the restrictions of 
Regulation M on currently excepted investment grade securities.\22\ 
Additionally, commenters expressed the view that certain issuers of 
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.\23\ These commenters generally did not suggest specific 
alternatives to the proposed rule changes.\24\
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    \19\ 2008 Proposing Release, 73 FR 40095-97. More specifically, 
the 2008 Proposal--consistent with the definition of WKSI in 
Securities Act Rule 405--would have excepted Nonconvertible 
Securities of issuers who have issued at least $1 billion aggregate 
principal amount of nonconvertible securities, other than common 
equity, in primary offerings for cash, not exchange, registered 
under the Securities Act. See 17 CFR 230.405, paragraph (1)(i)(B)(1) 
of the definition of WKSI; see also 2008 Proposing Release, 73 FR 
40096.
    \20\ See 2011 Proposing Release at 26559 (discussing commenter 
views about the 2008 Proposal). Comments received in response to the 
2008 Proposal are contained in File No. S7-17-08, available at 
https://www.sec.gov/comments/s7-17-08/s71708.shtml. Comments that 
were received in response to the 2008 Proposal that are relevant to 
the substance or scope of the amendments being proposed in this 
release and are discussed below in Part IV. Comments that were 
received in response to the 2008 Proposal that are relevant to the 
economic effects of the amendments being proposed in this release 
and are discussed below in Part VIII.
    \21\ See, e.g., Letter from 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 (Sep. 4, 2008) (``SIFMA Letter 1'') at 
14 (``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.'').
    \22\ Letter from Keith F. Higgins, Chair, Committee on Federal 
Regulation of Securities, American Bar Association (``ABA''), to 
Florence E. Harmon, Acting Secretary (Oct. 10, 2008) (``ABA 
Letter'') and SIFMA Letter 1 at 13.
    \23\ ABA Letter at 16 and SIFMA Letter 1 at 13.
    \24\ The ABA did, however, suggest that should the Commission 
insist on using the WKSI standard for investment grade 
Nonconvertible Securities, it do so only as an alternative to the 
current exceptions in Rules 101(c)(2) and 102(d)(2). ABA Letter at 
17. However, the ABA expressed its ``strong[ ] belie[f] that the 
Commission should retain the current exceptions.'' Id. at 16.
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    In 2009, in light of the uniform opposition by commenters and 
continuing concern regarding the undue influence of credit ratings, the 
Commission reopened the comment period for the 2008 Proposal and 
invited comments suggesting alternative proposals to achieve the 
Commission's goals.\25\ The Commission received three additional 
comment letters. Of these, two reiterated earlier objections,\26\ and 
the third stated that the 2008 Proposal would have resulted in adverse 
effects on foreign sovereign issuers of debt securities.\27\ Although 
the Commission invited commenters to suggest alternative proposals, no 
new alternatives were suggested.\28\ As noted above, the Commission did 
not adopt any rules based on the 2008 Proposal.
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    \25\ References to Ratings of Nationally Recognized Statistical 
Rating Organizations, Release No. 34-60790 (Oct. 5, 2009) [74 FR 
52374, 52375 (Oct. 9, 2009)].
    \26\ Letter from Mary Keogh, Managing Director, Regulatory 
Affairs and Daniel Curry, President, DBRS, Inc., to Elizabeth M. 
Murphy, Secretary (Nov. 13, 2009); Letter from Sean C. Davy, 
Managing Director, Corporate Credit Markets Division, SIFMA, to 
Elizabeth M. Murphy, Secretary (Dec. 8, 2009).
    \27\ Letter from Steven G. Tepper, Arnold & Porter LLP, to the 
Honorable Mary L. Schapiro, Chairman (Dec. 8, 2009) (``Arnold & 
Porter Letter'').
    \28\ See 2011 Proposing Release, 76 FR 26559.
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B. 2011 Proposal

    In 2011, after the Dodd-Frank Act was signed into law, the 
Commission issued a different proposal, which would have replaced the 
Investment Grade Exceptions with a standard based on the trading 
characteristics that the Commission believed made the exceptions apply 
to securities that were less prone to the type of manipulation that 
Regulation M seeks to prevent. The 2011 Proposal would have replaced 
the Investment Grade Exceptions with an exception for Nonconvertible 
Securities and asset-backed securities that (1) were liquid relative to 
the market for that asset class, (2) traded in relation to general 
market interest rates and yield spreads, and (3) were relatively 
fungible with securities of similar characteristics and interest rate 
yield spreads.\29\ The 2011 Proposal would have required the person 
seeking to rely on the exception to make the determination that the 
security in question met these standards utilizing reasonable factors 
of evaluation. Further, this determination would have been required to 
be subsequently verified by an independent third party.\30\
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    \29\ 2011 Proposing Release, 76 FR 26559.
    \30\ Id. at 26560.
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    Almost all commenters expressed concerns about aspects of the 2011 
Proposal.\31\ For example, commenters generally had concerns regarding 
the practicality of the 2011 Proposal. More specifically, there were 
concerns that, because of the forward-looking and subjective nature of 
the proposed standards in this release, it would be impractical to make 
consistent determinations among market participants, even in the same 
distributions.\32\ Many commenters

[[Page 18315]]

contrasted these issues with the fact that using credit ratings under 
the existing standard establishes a bright-line for market 
participants.\33\ Many commenters also stated that the 2011 Proposal 
would have added costs and delays to the offering process.\34\
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    \31\ Comments received in response to the 2011 Proposal are 
contained in File No. S7-15-11, available at https://www.sec.gov/comments/s7-15-11/s71511.shtml. Comments that were received in 
response to the 2011 Proposal that are relevant to the substance or 
scope of the amendments being proposed in this release are discussed 
below, in Part IV. Comments that were received in response to the 
2011 Proposal that are relevant to the economic effects of the 
amendments being proposed in this release are discussed below, in 
Part VIII. One commenter expressed complete support for the 2011 
Proposal. See Letter from Kurt N. Schacht, Managing Director, 
Standards and Financial Markets Integrity, and Linda L. Rittenhouse, 
Director, Capital Markets Policy, CFA Institute to Elizabeth M. 
Murphy, Secretary (Dec. 20, 2011) (``CFA Letter'').
    \32\ Letter from Sullivan & Cromwell LLP to Elizabeth M. Murphy, 
Secretary (July 5, 2011) (``Sullivan & Cromwell Letter'') at 3; see 
also Letter from Suzanne Rothwell, Managing Member, Rothwell 
Consulting LLC to Elizabeth M. Murphy, Secretary (July 5, 2011) 
(``Rothwell Letter'') at 6-7 and Letter from Kenneth E. Bensten, 
Jr., Executive Vice President, Public Policy and Advocacy, SIFMA to 
Elizabeth M. Murphy, Secretary (July 5, 2011) (``SIFMA Letter 3'') 
at 3-10. SIFMA Letter 3 stated that this could lead to market 
participants being overly conservative in their analysis in fear of 
other distribution participants taking more negative views of the 
security or being overly optimistic regarding the security in order 
to gain a competitive advantage, leaving the application of the 
exceptions to something other than whether the security is less 
susceptible to manipulation. See SIFMA Letter 3 at 7.
    \33\ Letter from Davis Polk & Wardwell LLP to Elizabeth M. 
Murphy, Secretary (July 5, 2011) (``Davis Polk Letter'') at 2; 
Rothwell Letter at 7; Sullivan & Cromwell Letter at 3; SIFMA Letter 
3 at 3; see also Letter from Dennis M. Kelleher, President & CEO, 
and Stephen W. Hall, Securities Specialist, Better Markets, Inc., to 
Elizabeth M. Murphy, Secretary (July 5, 2011) (``Better Markets 
Letter'') at 5 (arguing for bright-line standards to ensure that 
manipulation does not occur). Some commenters also pointed to the 
success of the references to credit ratings in the current 
exceptions at creating workable exceptions to Regulation M. See 
Rothwell Letter at 2; Sullivan & Cromwell Letter at 3.
    \34\ Davis Polk Letter at 3; Rothwell Letter at 7; Sullivan & 
Cromwell Letter at 4; SIFMA Letter 3 at 7.
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    One commenter suggested that the risk of manipulation is low for 
the securities at issue.\35\ Another said that the 2011 Proposal was 
contrary to the approach in Regulation M in general and the exceptions 
specifically, which was to focus the restrictions of the regulation on 
those circumstances where the chance for manipulation was 
heightened,\36\ though others disagreed.\37\ One commenter suggested 
that all fixed income securities be excepted from Rules 101 and 
102.\38\ One commenter believed that the 2011 Proposal would have 
excluded some investment grade securities, changing the scope of the 
exception.\39\
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    \35\ Davis Polk Letter at 1.
    \36\ Davis Polk Letter at 1; SIFMA Letter 3.
    \37\ Sullivan & Cromwell Letter at 2 (stating that ``[a]s a 
purely conceptual matter, we think the new standard is logical and 
consistent with the principles underlying Regulation M, as they have 
been developed over time''); CFA Letter at 6-7 (stating that ``the 
exemptions . . . appear to be reasonably focused at preventing the 
types of manipulation that the regulation seeks to deter'').
    \38\ This commenter said that the rationale for the exceptions 
for investment grade fixed income securities applies equally to non-
investment grade fixed income securities. SIFMA Letter 3 at 14.
    \39\ Davis Polk Letter at 4.
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    Commenters also suggested that unintended consequences could have 
resulted from the 2011 Proposal. Some suggested that, in light of the 
fact that transactions in Rule 144A securities are generally excepted 
from Rules 101 and 102,\40\ the lack of a bright-line could have 
reduced the attractiveness of registered offerings because of the 
complications in using the exceptions from Regulation M as changed by 
the 2011 Proposal.\41\ However, one of these commenters agreed with the 
Commission's assessment that the ``impact of the change should not be 
substantial.'' \42\
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    \40\ See, e.g., 17 CFR 242.101(b)(10).
    \41\ Sullivan & Cromwell Letter at 4-5; SIFMA Letter 3 at 4.
    \42\ Sullivan & Cromwell Letter at 2. However, this commenter 
also stated that it did not ``perceive any real purpose being served 
by this proposed change'' and while the change would not be 
substantial, ``that is not a good reason to make it.'' Id. It also 
described the potential impact of the proposal on distributions that 
are not completed immediately after pricing. Id. at 3-5.
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    Some commenters questioned whether Section 939A of the Dodd-Frank 
Act requires that the Commission change Regulation M at all,\43\ 
whereas others suggested that the proposal did not go far enough to 
comply with that section.\44\ One commenter suggested that the 
Commission adopt amendments similar to those included in the 2008 
Proposal in response to the 2011 Proposal in light of the apparent 
mandate of 939A to not retain the status-quo.\45\ This commenter noted 
that it preferred a proposal that utilized an objective, bright-line 
standard.\46\ As noted above, the Commission did not adopt any rules 
based on the 2011 Proposal.
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    \43\ For example, commenters who questioned the need for the 
changes pointed out that the underlying concern with Section 939A, 
that market participants had become overly reliant on credit ratings 
as a substitute for their own credit analysis, was not present in 
the Regulation M exceptions at issue because Regulation M regulates 
trading practices. See Rothwell Letter at 4; Sullivan & Cromwell 
Letter at 3. One of these commenters also stated that, because the 
credit rating process has been improved by regulatory changes in 
recent years, including the Credit Rating Agency Reform Act of 2006, 
the Commission did not need the 2011 Proposal. See Rothwell Letter 
at 4.
    \44\ See SIFMA Letter 3 at 4 (suggesting adopting a modified 
version of the 2008 Proposal ``now that the Dodd-Frank Act requires 
removal of references to credit ratings'') (emphasis added); see 
also Letter from Chris Barnard to Elizabeth M. Murphy, Secretary 
(June 6, 2011); Better Markets Letter at 13 (questioning whether the 
2011 Proposal offered a sufficient ``standard of credit-worthiness'' 
as required in Section 939A).
    \45\ SIFMA Letter 3 at 7-8.
    \46\ SIFMA Letter 3 at 9; Letter from Sean C. Davy, Managing 
Director, Corporate Credit Markets Division, SIFMA, to Elizabeth M. 
Murphy, Secretary (Jan. 24, 2014) at 3.
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III. Application of Regulation M to Distributions of Nonconvertible 
Securities and Asset-Backed Securities

    The application of Regulation M's prohibitions to distributions of 
Nonconvertible Securities and asset-backed securities generally is 
limited because distribution participants and affiliated purchasers are 
restricted only from bidding for or purchasing securities that are 
identical in all of their terms to the security being distributed.\47\ 
In other words, the restrictions do not apply for a security if there 
is a single basis point difference in coupon rates or a single day's 
difference in maturity dates from the security in distribution.\48\
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    \47\ Regulation M Adopting Release, 62 FR 524.
    \48\ To illustrate with a simple example, absent an exception, a 
broker-dealer who is participating in a distribution of XYZ Corp.'s 
3% bonds maturing 12/31/2029 would be prohibited from making a 
market in bonds with those terms prior to completing the 
distribution. The broker-dealer would not, however, be prohibited 
from making a market in XYZ Corp.'s 3% bonds maturing 12/31/2030 
because the date of maturity, a term of the bond, is different from 
the security in distribution.
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    The Investment Grade Exceptions trace back to a 1975 no-action 
position taken by Commission staff regarding former Exchange Act Rule 
10b-6, the predecessor to Rules 101 and 102.\49\ This no-action letter 
was premised on the principle that investment grade Nonconvertible 
Securities and asset-backed securities are less likely to be subject to 
manipulation because they are traded on the basis of their yields and 
credit ratings rather than the identity of the particular issuer.\50\ 
This reasoning served as the basis for the Commission's adoption of the

[[Page 18316]]

Investment Grade Exceptions in Regulation M \51\ and continues to serve 
in part as the basis for the proposed amendments to Rule 101.
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    \49\ For a discussion of why the Commission considered replacing 
former Exchange Act Rule 10b-6 (and other predecessor trading 
practices rules) with Regulation M, see Review of Antimanipulation 
Regulation of Securities Offerings, Release No. 34-33924 (Apr. 19, 
1994) [59 FR 21681 (Apr. 26, 1994)].
    \50\ Letter from Robert C. Lewis, Associate Director, Division 
of Market Regulation, to Donald M. Feuerstein, General Partner and 
Counsel, Salomon Brothers (Mar. 4, 1975). The request letter to the 
staff states that debt securities ``are merely a right to receive a 
fixed amount of money no later than a specified future date, and the 
issuer's prospects are relevant only insofar as they reflect on its 
ability to meet its obligations to the debtholders. Thus, 
nonconvertible debt securities with similar economic terms and 
similar degrees of assurance of payment are substantially fungible 
even though their issuers may be different. The economic terms of 
particular debt issues are susceptible to precise comparison, 
particularly when mathematically translated into yield to maturity, 
average life or call. Although the degree of assurance of payment 
cannot be precisely quantified, debt investors are not influenced by 
many developments in the issuer's affairs that are material to 
equity investors. . . . Thus the identity of the issuers of 
corporate bonds with similar risk factors is not important in the 
analysis of fixed income securities.''
    \51\ See Regulation M Adopting Release, 62 FR 527.
---------------------------------------------------------------------------

    While the Commission carried over its reasoning from former 
Exchange Act Rule 10b-6 to serve as the premise of the Investment Grade 
Exceptions, it did not adopt the former rule's broad application. In 
contrast to Regulation M's limited applicability only to distributions 
of securities that have identical terms, former Exchange Act Rule 10b-6 
applied to distributions of ``any security of the same class and 
series.'' \52\ The phrase ``same class and series'' was construed 
broadly to encompass securities that were sufficiently similar in their 
terms to the security in a distribution to raise the possibility that 
bids for or purchases of the outstanding security might facilitate the 
distribution, even in the absence of an inherent mathematical 
relationship between the prices of the two securities.\53\
---------------------------------------------------------------------------

    \52\ Former Exchange Act Rule 10b-6(a)(3).
    \53\ See Review of Antimanipulation Regulation of Securities 
Offerings, Release No. 34-33924 (Apr. 19, 1994) [59 FR 21681, 21688 
(Apr. 26, 1994)]; see also Gamble Skogmo, Inc., SEC No-Action 
Letter, (Jan. 11, 1974), in which the staff took a no-action 
position to permit bids for or purchases of the issuer's outstanding 
debt securities that varied by at least 1% in coupon interest rate 
and by at least ten years in maturity from those of the debt 
securities being distributed.
---------------------------------------------------------------------------

    Accordingly, some commenters responding to the 2008 Proposal and 
the 2011 Proposal stated that reliance on the Investment Grade 
Exceptions largely is limited to two situations. The first situation is 
a so-called ``reopening,'' which is an offering of an additional 
principal amount of fixed-income securities that are identical to, and 
fungible with, the securities that are already outstanding.\54\ One 
commenter stated that an issuer may want to make a series of offerings 
of its fixed-income securities via a reopening to match its funding 
needs or the desires of its target investor class.\55\ Further, some 
foreign sovereign issuers may conduct a reopening for public finance 
purposes.\56\ The second situation identified by commenters is a so-
called ``sticky offering,'' which is an offering where a lack of demand 
results in an underwriter being unable to sell all of the securities in 
a distribution.\57\ One commenter stated that an investor failing to 
honor a previously given indication of interest is an example of a 
situation that can cause a sticky offering.\58\ Another example 
provided by a commenter is a ``best-efforts'' offering.\59\
---------------------------------------------------------------------------

    \54\ See SIFMA Letter 3 at 6.
    \55\ Id.
    \56\ See Arnold & Porter Letter at 2-3.
    \57\ Sullivan & Cromwell Letter at 4. The Commission also 
indicated that a sticky offering could be a circumstance in which 
Regulation M would impact debt securities, stating its belief 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.'' Regulation M 
Adopting Release, 62 FR 528.
    \58\ Sullivan & Cromwell Letter at 4.
    \59\ Rothwell Letter at 9. In a best-efforts offering, the 
underwriters are not required to sell any specific number or dollar 
amount of securities but will use their best efforts to sell the 
securities offered. See Plain English Disclosure, Release No. 34-
38164, (Jan. 14, 1997) [62 FR 3152 (Jan. 21, 1997)].
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    One commenter noted that, absent the Investment Grade Exceptions, 
underwriters would be prohibited from making a market in the 
distribution securities while the distribution continued.\60\ The 
implication of this is that underwriters would have to ``weigh (a) the 
risk of . . . a continuing distribution occurring, against (b) the 
possible disruptive effect of having no underwriters making a market in 
the immediate post-pricing period.'' \61\ Another commenter identified 
that the absence of an Investment Grade Exception from Rule 102 would 
disrupt the ability of foreign sovereign issuers and their affiliates 
to purchase any of the issuer's securities in connection with the 
sovereign issuer's own general trading and investment activities, or 
for other public purposes, during the applicable restricted period.\62\
---------------------------------------------------------------------------

    \60\ Sullivan and Cromwell Letter at 4.
    \61\ Id. (discussing the alternative to following the steps 
required for an underwriter to determine the availability of the 
exception from Regulation M under the 2011 Proposal).
    \62\ Arnold & Porter Letter at 3.
---------------------------------------------------------------------------

IV. Proposed Amendments to Rules 101 and 102 To Remove References to 
Credit Ratings

    As discussed below, the Commission is proposing to eliminate the 
Investment Grade Exceptions from both Rules 101 and 102. The Commission 
is proposing to replace the Investment Grade Exception in Rule 101 with 
two separate exceptions based on different standards: (1) With respect 
to Nonconvertible Securities, an exception that is based on a 
probability of default standard as an indicator of credit-worthiness, 
and (2) an exception for asset-backed securities that are offered 
pursuant to an effective shelf registration statement filed on Form SF-
3.

A. Rule 101

1. Excepted Securities: Nonconvertible Securities
    With respect to Nonconvertible Securities, the Commission is 
proposing to replace the NRSRO reference currently included in Rule 
101(c)(2) with a standard utilizing a specified probability of default 
threshold based on certain structural credit risk models (``Structural 
Credit Risk Models'').\63\
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    \63\ As discussed below, the term ``structural credit risk 
model'' for purposes of the proposed exception in Rule 101(c)(2)(i) 
shall mean any commercially or publicly available model that 
calculates the probability that the value of the issuer may fall 
below a threshold based on an issuer's balance sheet.
---------------------------------------------------------------------------

(a) Existing Exception for Investment Grade Nonconvertible Securities
    As discussed above, Rule 101(c)(2) currently provides an exception 
for Nonconvertible Securities that are rated by at least one NRSRO in 
one of its generic rating categories that signifies investment grade. 
The Commission excepted investment grade Nonconvertible Securities from 
Rule 101 ``based on the premise that these securities traded on the 
basis of their yield and credit ratings, are largely fungible and, 
therefore, are less likely to be subject to manipulation.'' \64\
---------------------------------------------------------------------------

    \64\ Regulation M Adopting Release, 62 FR 527.
---------------------------------------------------------------------------

(b) Overview of Structural Credit Risk Models
    In 1974, Robert C. Merton published a paper that provided a method, 
based on the Black-Scholes option pricing model,\65\ of analyzing a 
company's credit risk by modeling a company's equity as a call option 
on the company's assets (``Merton (1974) Model''), which is generally 
regarded as the first Structural Credit Risk Model.\66\ Since 1974, 
Structural Credit Risk Models, such as the Merton (1974) Model and

[[Page 18317]]

the Successor Models, have become widely relied upon to determine the 
probability of an issuer defaulting on its loan obligations.\67\ Many 
commercial data providers, as part of software suites that allow users 
to analyze securities, employ Structural Credit Risk Models as a way to 
measure the credit-worthiness of companies.\68\ Generally, these models 
assume that owners of a company's equity will continue to pay the 
company's liabilities if the company's value exceeds its liabilities. 
Equivalently, if the equity owners were considered to own a call option 
on the value of the company with a strike price equivalent to the 
liabilities owed, the equity owners would exercise the call on the 
value of the company. If, however, the company's liabilities exceed the 
company's value, the models assume that the equity owners will choose 
to default on the company's liabilities, or equivalently, the equity 
owners would not exercise the call on the value of the company. 
Accordingly, Structural Credit Risk Models, such as the Merton (1974) 
Model and the Successor Models, provide a method to estimate the 
probability that a company might default on its liabilities based on 
the Black-Scholes option pricing model.
---------------------------------------------------------------------------

    \65\ Fischer Black & Myron Scholes, The Pricing of Options and 
Corporate Liabilities, 81 J. Pol. Econ. 637, 637-54 (1973). The 
Black-Scholes option pricing model is used to determine the fair 
price or theoretical value for a call or put option based on a 
number of variables, including the volatility and price of the 
underlying stock, the type of option, time, the option's strike 
price, and the risk-free rate.
    \66\ Robert C. Merton, On the Pricing of Corporate Debt: The 
Risk Structure of Interest Rates, 29 J. Fin. 449, 449-70 (1974). The 
Merton (1974) Model has been expanded upon and used to develop new 
Structural Credit Risk Models that rely on its principles 
(``Successor Models''), such as the Black-Cox (1976) model and the 
Leland (1994) model. See, e.g., Suresh Sundaresan, A Review of 
Merton's Model of the Firm's Capital Structure with its Wide 
Applications, 5 Ann. Rev. Fin. Econ. 21, 21-41 (2013); Fischer Black 
& John C. Cox, Valuing Corporate Securities: Some Effects of Bond 
Indenture Provisions, 31 J. Fin. 351, 351-67 (1976); see also Hayne 
E. Leland, Corporate Debt Value, Bond Covenants, and Optimal Capital 
Structure, 49 J. Fin. 1213, 1213-52 (1994).
    \67\ See infra Part VIII.B. For example, the Merton (1974) Model 
and the Successor Models are included in the curriculum for such 
credentials as the Chartered Financial Analyst. See, e.g., Credit 
Analysis Models, CFA Inst. (2022), available at https://www.cfainstitute.org/en/membership/professional-development/refresher-readings/credit-analysis-models.
    \68\ See infra note 84.
---------------------------------------------------------------------------

    Structural Credit Risk Models typically use measures from firm 
accounting statements and firm-specific and aggregate market prices. 
Generally, Structural Credit Risk Models require input variables to 
calculate an estimated probability of default for a specified horizon, 
including market value and volatility of the assets, as well as 
assumptions regarding the threshold for firm asset values, below which 
the equity owner would default on its obligations (``Default 
Point'').\69\ Structural Credit Risk Models provide a probability that 
a firm's assets will fall below the Default Point at or by the 
expiration of a defined period of time. Generally, the following 
variables are needed to calculate the probability of default: (1) The 
value of the firm, which can be based on observed market prices of a 
firm's equity security or estimated based on a firm's balance sheet; 
(2) the volatility of the firm's equity or assets, which can also be 
based on market observations or estimated based on a firm's balance 
sheet; (3) the risk-free rate; (4) a time horizon; and (5) the Default 
Point. Application of Structural Credit Risk Models may be limited in 
the absence of a market for a firm's equity securities if the market 
price of the firm's assets, which is required to calculate the 
probability of default, is difficult to determine.\70\
---------------------------------------------------------------------------

    \69\ The Default Point is frequently calculated as all short-
term liabilities plus half of the long-term liabilities. See Mario 
Bondioli, Martin Goldberg, Nan Hu, Chengrui Li, Olfa Maalaoui, and 
Harvey J, Stein, The Bloomberg Corporate Default Risk Model (DRSK) 
for Public Firms (2021), available at https://ssrn.com/abstract=3911300.
    \70\ Structural Credit Risk Models calculate the probability of 
default based on inputs from an issuer's balance sheet. Transactions 
in equity securities are frequently used as a proxy to determine the 
value of the firm and the overall volatility of the issuer's assets 
in Structural Credit Risk Models. Even though a market for an 
issuer's equities may not exist, this alone does not preclude the 
ability for a distribution participant to use a Structural Credit 
Risk Model. Specifically, the issuer's balance sheet will include 
the liabilities, assets, and equity, which, with further analysis, 
can be used to determine the inputs for the models. Distribution 
participants, based on their activities as an underwriter, broker-
dealer, or other person who has agreed to participate in a 
distribution, would have access to an issuer's balance sheet to 
calculate the probability of default.
---------------------------------------------------------------------------

(c) Proposed Probability of Default Exception
    As discussed above, Section 939A of the Dodd-Frank Act requires the 
Commission to 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 is appropriate for that 
regulation.\71\ The Commission believes that credit-worthiness, which 
was the basis of the Investment Grade Exception for Nonconvertible 
Securities in Rule 101, is still appropriate to use as an exception to 
Rule 101.\72\ Specifically, securities of issuers of a certain credit 
quality trade based on yield and credit-worthiness \73\ and are less 
susceptible to manipulation because other similar Nonconvertible 
Securities are available to investors as an alternative to the security 
in distribution. If pricing of a Nonconvertible Security offering is 
inconsistent with pricing in the overall secondary market for similar 
Nonconvertible Securities, an investor may purchase alternative 
Nonconvertible Securities that have a better yield, yet are of 
comparable credit-worthiness, than the security being distributed. 
Accordingly, the ability to substitute similar Nonconvertible 
Securities in the market for the security in distribution limits the 
potential impact that a distribution participant might attempt to exert 
on the market and distribution of such security. Additionally, when 
debt has a very low probability of default, the cashflows are close to 
risk free. Thus, the price of the debt is mainly subject to 
fluctuations based on aggregate interest rates rather than firm-
specific or security-specific news. Thus, Nonconvertible Securities of 
credit-worthy issuers are less susceptible to the type of manipulation 
that Rule 101 seeks to prevent.\74\ Furthermore, as

[[Page 18318]]

distribution participants have relied on the Investment Grade 
Exception, which is based on credit-worthiness, to facilitate orderly 
distributions of Nonconvertible Securities, the proposed exception has 
limited potential to disrupt the trading market for securities that 
have been the subject of a reopening.\75\
---------------------------------------------------------------------------

    \71\ Although two commenters to the 2011 Proposal believed that 
Section 939A of the Dodd-Frank Act did not mandate the removal of 
credit rating references from Regulation M, the Commission believes 
that Section 939A of the Dodd-Frank Act requires the Commission to 
remove such references from Regulation M, without flexibility to 
retain the references, contrary to the suggestion made by these 
commenters. See supra note 43. Specifically, Section 939A of the 
Dodd-Frank Act requires the Commission to review ``any references to 
or requirements in such regulations regarding credit ratings'' and 
issue a report upon conclusion of the review. See Public Law 111-203 
sec. 939A(a) and (c); see supra note 4. It then requires the 
Commission to ``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 for such regulations. See Public Law 111-203 sec. 
939A(b) (emphasis added). Accordingly, the Commission believes that 
it does not have discretion to retain the Investment Grade 
Exceptions provided in Rules 101 and 102.
    \72\ See supra note 50 and accompanying text. Sticky offerings 
of Nonconvertible Securities issued by credit-worthy issuers might 
indicate that a security is not trading based upon its yield or 
credit quality, due to some reason, despite the perceived credit-
worthy nature of the issuer (based on a probability of default 
calculation or otherwise). As discussed below, a distribution 
participant should be able to find someone willing to purchase the 
Nonconvertible Securities of credit-worthy issuers because the 
securities would be trading based on their yield and price in 
relation to securities of similar credit-worthiness. The inability 
to sell securities of credit-worthy issuers could reflect, for 
example, a lag between the trading in the market for such 
Nonconvertible Securities and the credit rating, or more recent 
concerns related to the issuer of the securities reflected in the 
market but not yet absorbed in credit-worthiness assessments or 
inputs for such assessments. The Commission solicits comments below 
regarding this particular issue.
    \73\ Bonds trade among investors and dealers in secondary 
markets at prices that depend on economy-wide interest rates, as 
well as on market perceptions regarding the likelihood that the 
issuing company will make the promised payments. Hendrik 
Bessembinder & William Maxwell, Markets: Transparency and the 
Corporate Bond Market, 22 J. Econ. Persp. 217, 220 (2008).
    \74\ Some commenters to the 2008 Proposal, which would have 
replaced a credit-worthiness standard with a WKSI standard, believed 
that the 2008 Proposal would place burdens related to complying with 
Regulation M on issuers and underwriters who are currently able to 
rely on the Investment Grade Exceptions. The proposed exception 
using Structural Credit Risk Models, in contrast to the 2008 
Proposal, continues to rely on the premise underlying the Investment 
Grade Exception--that certain Nonconvertible Securities trade based 
on their yield and credit-worthiness. Accordingly, similar to how 
the prohibitions related to Regulation M do not exist for securities 
that currently meet the Investment Grade Exception, the prohibitions 
associated with Rule 101 would not exist under the proposed 
exception for Nonconvertible Securities that trade based on their 
yield and credit-worthiness.
    \75\ See Regulation M Proposing Release, 61 FR 17117 (stating 
reasons for the exceptions from Regulation M).
---------------------------------------------------------------------------

    As discussed below in Part VIII.B, Structural Credit Risk Models 
calculate a probability of default that provides a measure of the 
credit-worthiness of an issuer of a Nonconvertible Security. The 
Commission preliminarily believes that the probability of default as 
calculated by Structural Credit Risk Models is an appropriate 
substitute as a standard of credit-worthiness in Rule 101(c)(2). In 
particular, the probability of default \76\ as estimated by Structural 
Credit Risk Models is widely used by market and distribution 
participants to measure credit-worthiness of issuers.\77\ As such, the 
Commission preliminarily believes that the use of Structural Credit 
Risk Models to determine credit-worthiness could be used as an 
alternative for Nonconvertible Securities with an investment grade 
rating for purposes of proposed Rule 101(c)(2)(i).\78\
---------------------------------------------------------------------------

    \76\ The term ``probability of default'' as used in this release 
to describe the proposed requirement means the actual (or physical) 
probability, rather than the risk-neutral probability.
    \77\ See supra notes 65-68 and accompanying text; see also infra 
note 158. The Commission considered including reduced-form models in 
addition to Structural Credit Risk Models as part of the exception 
in Rule 101(c)(2)(i). Reduced-form models rely on statistical 
analysis rather than the balance sheet to determine a firm's 
creditworthiness. However, unlike Structural Credit Risk Models, 
they lack in rigorous theoretical justification as well as economic 
interpretation of the resulted relationships between the model 
inputs.
    \78\ Securities with low probability of default (by credit-
worthy issuers) do not need to price default risk (because it is 
very low) and therefore trade based on other, observable 
characteristics, such as yields or maturity. This implies less price 
uncertainty, which leaves less room for manipulation of prices.
---------------------------------------------------------------------------

    The probability of default can be independently determined by 
Structural Credit Risk Models based on observable market events and 
information available on a firm's balance sheet without reliance on an 
investment grade credit rating by an NRSRO. Probability of default can 
be used to identify securities that trade based on their yield and high 
credit-worthiness, similar to the Nonconvertible Securities that are 
excepted based on the existing Investment Grade Exception, and thus 
would be less susceptible to the manipulation that Rule 101 is designed 
to prevent.
    Commenters to the 2011 Proposal raised concerns regarding the 2011 
Proposal that the Commission preliminarily believes are not present 
regarding Structural Credit Risk Models. For example, commenters were 
concerned that it would be impractical under the 2011 Proposal to make 
consistent determinations among market participants even in the same 
distributions and that the standard proposed in the 2011 Proposal is 
impractical, forward-looking, and subjective.\79\ The Commission 
preliminarily believes the Structural Credit Risk Models can result in 
consistent determinations and can be replicated by distribution 
participants, particularly if distribution participants utilize the 
same model. Furthermore, the use of a bright-line test, such as a 
probability of default of 0.055% as discussed below, should address the 
concern of some commenters that the exception will impose new costs and 
delays in the offering process and reduce the attractiveness of 
registered offerings.\80\ Whereas the 2011 Proposal depended on a 
distribution participant's subjective expectations about the future 
regarding how a security would trade in the market, the proposed 
standard specifically includes a 0.055% probability of default 
threshold. The Commission acknowledges that the complex nature of the 
models, assumptions, and estimated inputs used to estimate the 
probability of default may not be comparable across different issuers 
or if the estimates are done using different Structural Credit Risk 
Models, the results may not be comparable. The Commission, however, 
believes that the assumptions and estimates that are used to determine 
the probability of default using Structural Credit Risk Models are 
appropriately practical, as well as objective, and accordingly the 
proposed standard is not impractical or overly subjective. In 
particular, as noted throughout the release, market participants 
currently rely on Structural Credit Risk Models to assess the credit-
worthiness of issuers.
---------------------------------------------------------------------------

    \79\ See supra note 32.
    \80\ See supra note 41.
---------------------------------------------------------------------------

    Under the proposed amendment to Rule 101, the exception would be 
available to the Nonconvertible Securities of issuers for which the 
probability of default, estimated as of the day of the determination of 
the offering pricing and over the horizon of 12 calendar months \81\ 
from such day, is less than 0.055%,\82\ as determined and documented in 
writing \83\ by the distribution participant using a Structural Credit 
Risk Model.\84\ As discussed in Part VIII.B, based on an analysis of 
the probability of default and investment grade ratings of a sample of 
Nonconvertible Securities available on the market as of October 22, 
2021, the Commission preliminary believes that a probability of 
default, estimated as of the day of the determination of the offering 
pricing and over the horizon of 12 calendar months from such day, that 
is less than 0.055%, as determined by a Structural Credit Risk Model, 
provides an appropriate substitute for investment grade ratings. 
Limiting the exception to issuers of Nonconvertible Securities that 
have a probability of default of less than 0.055% should limit the 
exception to Nonconvertible Securities that are less susceptible to the 
type of manipulation that Regulation M is designed to prevent.
---------------------------------------------------------------------------

    \81\ The proposed exception would specify 12 calendar months to 
provide a uniform time horizon to use in the Structural Credit Risk 
Models to calculate the probability of default. The Commission 
preliminarily believes that 12 calendar months would provide a 
minimum period of time for an estimation of probability of default 
that could address investor concerns that a Nonconvertible Security 
would default during or shortly after the distribution of the 
securities. Furthermore, the Commission preliminarily believes that 
12 calendar months is the appropriate horizon to include in the Rule 
to calculate probability of default because it is the horizon that 
corresponds with vendor models that use Structural Credit Risk 
Models to calculate probability of default and map to investment 
grade ratings. Specifying the time horizon in the rule is intended 
to limit the ability of a distribution participant to modify the 
time horizon to generate a more favorable probability of default if 
such distribution participant chooses to calculate the probability 
of default on its own.
    \82\ See infra Part VIII.B.
    \83\ See infra Part V.
    \84\ Vendors offer a number of commercial applications based on 
Structural Credit Risk Models. The Commission preliminarily believes 
that these models are relied upon by market participants to analyze 
the credit quality of Nonconvertible Securities or the issuers of 
such securities. Furthermore, the probability of default calculated 
by Structural Credit Risk Models, such as the Merton (1974) Model 
and the Successor Models, can be calculated by distribution 
participants without the use of a vendor.
---------------------------------------------------------------------------

    Exceptions for investment grade rated Nonconvertible Securities 
existed in former Exchange Act Rule 10b-6, which preceded the adoption 
of Regulation M. As discussed above, Regulation M excepts securities 
based on their credit-worthiness as determined by an investment grade 
rating from a NRSRO. As noted by commenters to the 2008 Proposal and 
2011 Proposal, the Investment Grade Exception has provided a bright-
line test to identify securities that are less prone to the type of 
manipulation that Regulation M is designed to prevent.\85\ The 
Commission preliminarily believes a standard utilizing a threshold 
derived from

[[Page 18319]]

Structural Credit Risk Models provides the advantage of serving as a 
bright-line test to identify securities that, similar to Nonconvertible 
Securities currently excepted from Rule 101 based on the Investment 
Grade Exception, trade based on their yield and credit-worthiness. In 
particular, based on the Commission's analysis comparing probabilities 
of default with NRSRO credit ratings, the Commission preliminarily 
believes that the 0.055% threshold would effectively identify 
securities that trade based on yield and credit-worthiness, because 
this threshold appropriately captures most of those securities that 
meet the credit-worthiness standard under the existing Investment Grade 
Exception.\86\ Accordingly, the Commission preliminary believes that 
the 0.055% threshold appropriately calibrates the probability of 
default to determine the credit-worthiness of an issuer whose 
Nonconvertible Securities would trade based on yield and credit-
worthiness, similar to the current Investment Grade Exception.\87\
---------------------------------------------------------------------------

    \85\ See ABA Letter at 15-17; see also Rothwell at 2.
    \86\ See infra Part VIII.B. Although the proposed standard would 
include certain securities that are not investment grade as 
determined by an NRSRO, the model-implied probabilities of default 
generally use current estimates of equity valuation and volatility, 
and hence incorporate the most recent news affecting the valuation 
and perceived volatility of the firm. See infra Part VIII.B. As 
such, an estimate derived from Structural Credit Risk Models is more 
likely to reflect the most up-to-date indicator of an issuer's 
credit-worthiness without being hampered by the lag that may exist 
with NRSRO-determined credit ratings.
    \87\ See infra note 159.
---------------------------------------------------------------------------

    The Commission acknowledges that a probability of default less than 
0.055% could be both under- and over- inclusive in capturing the 
securities that are excepted under the existing Investment Grade 
Exception in Rule 101. As a result, the restrictions of Rule 101 would 
apply to certain Nonconvertible Securities that are currently excepted 
securities under Rule 101(c)(2). Furthermore, some securities that are 
not currently excepted securities under Rule 101 could become excepted 
securities under the proposed probability of default metric. The 
Commission preliminarily believes that it is appropriate to use a 
0.055% threshold because even if it does not capture exactly the same 
set of securities covered under the existing investment grade standard, 
this 0.055% threshold would identify Nonconvertible Securities that are 
less susceptible to the manipulation that Regulation M is designed to 
prevent because they trade based on their yield and credit-worthiness 
as determined by the current financial condition of the issuer.
    Rule 101(c)(2)(i) would define the term Structural Credit Risk 
Model to mean any commercially or publicly available model that 
calculates the probability that the value of the issuer may fall below 
the Default Point based on an issuer's balance sheet. These models, 
which estimate the probability of default related to the financial 
condition of the issuer based on the issuer's liabilities, provide a 
measure of credit-worthiness specific to that issuer. Additionally, the 
definition would include only commercially or publicly available 
models. The Commission understands that distribution participants, such 
as underwriters and broker-dealers, currently use commercially 
available models from various vendors to measure and manage credit 
risk. These commercially available vendor models estimate a probability 
of default based on the issuer's balance sheet information to set 
thresholds and market estimates of firm value and volatility. 
Furthermore, distribution participants can use commonly available 
spreadsheet software to calculate the probability of default based on 
publicly available models, which may be found in academic and 
professional journals.\88\ Limiting the definition of Structural Credit 
Risk Models to commercially or publicly available models is intended to 
capture these commercially and publicly available models that we 
understand distribution participants already use and have access to. At 
the same time, we intend to prevent parties with an interest in the 
price of the security that is the subject of a distribution and outcome 
of such distribution from developing their own models to achieve 
favorable results.
---------------------------------------------------------------------------

    \88\ See supra note 66.
---------------------------------------------------------------------------

(d) Request for Comment
    We solicit comments on all aspects of this proposal. We ask that 
commenters provide specific reasons and information to support their 
views. Commenters are requested to provide empirical data, economic 
studies, and other factual support for their views to the extent 
possible.
    1. Do commenters agree that the credit-worthiness of an issuer of 
Nonconvertible Securities reduces the risk of manipulation that Rule 
101 is designed to prevent? Please explain. Is an exception based on 
probability of default appropriate to preserve Rule 101's anti-
manipulation goals? Why or why not?
    2. Should the probability of default threshold be higher than 
0.055%? For example, should the probability of default threshold be 
0.06%, 0.07%, or some other threshold? If so, what should the 
probability of the default threshold be and why?
    3. Should the probability of default threshold be lower than 
0.055%? For example, should the probability of default threshold be 
0.05%, 0.04%, or some other threshold? If so, what should the 
probability of the default threshold be and why?
    4. Is the 12 calendar months used to calculate the probability of 
default an appropriate time horizon? Or should some other time horizon 
be used? Please explain. For example, should it be for the term of the 
Nonconvertible Security? If so, what should the time horizon be to 
calculate the probability of default for purposes of Rule 101? Please 
explain.
    5. Are there other models or model types besides Structural Credit 
Risk Models that the Rule should use to calculate the probability of 
default for purposes of Rule 101? If so, please provide the name of the 
model and provide support regarding why it would be an appropriate 
substitute for the Investment Grade Exception. Are there model types 
other than Structural Credit Risk Models that calculate a probability 
of default? For example, would a reduced-form model provide a 
probability of default calculation that would indicate a Nonconvertible 
Security is of such credit-worthiness that such security should be 
excepted from Rule 101? Please explain.
    6. What challenges, if any, would there be to relying on an 
exception to Rule 101 based on the probability of default as calculated 
using Structural Credit Risk Models, as defined in Rule 101(c)(2)(i)? 
Is the definition of Structural Credit Risk Model clear? Should the 
exception list which models would be considered Structural Credit Risk 
Models? Is the requirement for the models to be commercially or 
publicly available clear, or is further guidance needed? Should the 
exception provide a test regarding what makes a model a Structural 
Credit Risk Model? For example, should the test for a Structural Credit 
Risk Model be limited to models published in academic or trade journals 
that refine the Merton (1974) Model? Please explain.
    7. Is there a standard other than Structural Credit Risk Models 
that Rule 101 should use as a replacement for the Investment Grade 
Exception? If so, what other standard should proposed Rule 101(c)(2)(i) 
use and why?
    8. Should the calculation of the probability of default in proposed 
Rule

[[Page 18320]]

101(c)(2)(i) be limited to distribution participants? Should the Rule 
permit distribution participants to rely on the probability of default 
calculated by persons that are not distribution participants? If so, 
who should the Rule include and why should such a person be 
specifically included in proposed Rule 101(c)(2)(i)? Are there any 
reasons why the Rule should not permit a distribution participant to 
perform its own calculation (subject to recordkeeping requirements as 
proposed)? Please explain. Should distribution participants be required 
to post or make the probability of default public on their website to 
rely on the exception? Please explain.
    9. Do commenters disagree with the Commission's preliminary belief 
that market participants are currently relying on vendors' widely 
available commercial applications based on Structural Credit Risk 
Models to analyze the credit quality of Nonconvertible Securities or 
the issuers of such security? Do distribution participants currently 
have access to vendor probability of default determinations? Please 
explain why or why not.
    10. How often do distribution participants rely on the Investment 
Grade Exception for Nonconvertible Securities where no other exception 
from Rule 101 is available?
    11. As discussed in Part III, the Commission understands that the 
Investment Grade Exception is used in limited circumstances, i.e., re-
openings, sticky offerings, best efforts offerings, and foreign 
sovereign issuances. Are there other circumstances where distribution 
participants rely on the Investment Grade Exception? Please explain. 
Furthermore, as discussed above in this section, a sticky offering 
might indicate that an offering is not trading based upon its yield or 
credit quality. Specifically, the distribution participant is unable to 
sell its allotment. If the underlying premise of the exception were 
true, a distribution participant should be able to find someone willing 
to purchase the Nonconvertible Securities because the security would be 
trading based on its yield and price in relation to securities of 
similar credit-worthiness. Do sticky offerings of credit-worthy issuers 
disprove the underlying premise for excepting certain Nonconvertible 
Securities (i.e., that securities offerings that become sticky do not 
trade based on their yield and credit-worthiness, or are there other 
characteristics of sticky offerings that impact how these securities 
trade)? For example, do sticky offerings indicate that the credit-
worthiness of an issuer is not a sound basis on which to except 
Nonconvertible Securities, or that there may be other characteristics 
that may make the securities more at risk of manipulation? If so, what 
tools are available to distribution participants that could serve as an 
indicator of such characteristics that could be incorporated into the 
exception? Since whether a nonconvertible security will become sticky 
is unknown at the start of the Regulation M restricted period, should 
the Commission remove the exception from Rule 101 for investment grade 
Nonconvertible Securities completely? Why or why not?
    12. Would the Nonconvertible Securities proposed to be excepted be 
more vulnerable to manipulation than the securities that meet the 
existing investment grade standard? Why or why not?
    13. Please discuss whether and to what extent investors take into 
account reliance on the Investment Grade Exception for Nonconvertible 
Securities when making a decision to invest in such securities. Please 
also discuss whether, given that Rule 101 is directed at distribution 
participants and their affiliated purchasers, current Rule 101 poses 
any danger of undue reliance on NRSRO ratings.
    14. Are there factors other than those identified in the proposed 
exception that influence the trading of Nonconvertible Securities? Are 
there additional requirements that the Commission should consider with 
respect to the proposed exception? Are there any requirements that the 
Commission should remove from the proposal?
    15. Would persons needing to use the proposed exception have access 
to adequate information to determine whether a particular security 
meets the exception in proposed Rule 101(c)(2)(i)? Why or why not? 
Should the exception require the issuer's balance sheet to be audited?
    16. If the exception as proposed is adopted should the Commission 
include a period of time for distribution participants to implement the 
exception based on probability of default? For example, should the 
exception, if adopted, include a three month, nine month or twelve 
month implementation period? Please explain. Should the exception, if 
adopted, go into effect within a short period of time after 
publication, such as 30-calendar days from being published in the 
Federal Register? Please explain.
2. Excepted Securities: Asset-Backed Securities Offered Pursuant to an 
Effective Shelf Registration Statement Filed on Form SF-3
    To implement Section 939A(b) of the Dodd-Frank Act, the Commission 
is, among other things, proposing to replace the existing exception 
provided in Rule 101(c)(2) for investment grade asset-backed securities 
\89\ with an exception for asset-backed securities that are offered 
pursuant to an effective shelf registration \90\ statement filed on 
Form SF-3,\91\ as discussed below.
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    \89\ See 17 CFR 242.101(c)(2) (providing an exception for asset-
backed securities ``that are rated by at least one nationally 
recognized statistical rating organization, as that term is used in 
[Rule 15c3-1 under the Exchange Act], in one of its generic rating 
categories that signifies investment grade'').
    \90\ Shelf registration is a procedure that allows companies to 
file a single registration statement covering more than one issuance 
of the same security, subject to certain requirements. See generally 
17 CFR 230.415 (providing requirements for securities to be 
registered for an offering to be made on a continuous or delayed 
basis in the future).
    \91\ See Proposed Rule 101(c)(2)(ii). Currently, the exception 
for asset-backed securities is provided in the same paragraph as the 
exception for Nonconvertible Securities, in Rule 101(c)(2). See 17 
CFR 242.101(c)(2). The Commission is proposing to separate the 
existing exception into separate exceptions for Nonconvertible 
Securities and asset-backed securities in Proposed Rules 
101(c)(2)(i) and 101(c)(2)(ii), respectively.
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(a) Background: Form SF-3
    In 2014, the Commission adopted shelf eligibility criteria for 
asset-backed securities offerings registered on new Form SF-3 in part 
to implement Section 939A(b) of the Dodd-Frank Act.\92\ Form SF-3 
includes the following transaction requirements among other shelf 
eligibility criteria:
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    \92\ See Asset-Backed Securities Disclosure and Registration, 
Release No. 34-72982 (Sept. 4, 2014) [79 FR 57184 (Sept. 24, 2014)] 
(``Regulation AB II Adopting Release''). Form SF-3 also carried over 
shelf-eligibility requirements for asset-backed securities that 
previously were located in Form S-3, such as transaction 
requirements regarding the percentage of delinquent assets and, for 
certain lease-backed securitizations, the portion of the pool 
attributable to residual value. See Regulation AB II Adopting 
Release, 79 FR 57265, n.936.
---------------------------------------------------------------------------

     Delinquent assets do not constitute 20% or more, as 
measured by dollar volume, of the asset pool as of the measurement 
date;
     With respect to securities backed by certain leases, the 
portion of the securitized pool balance attributable to the residual 
value of the physical property underlying the leases does not 
constitute 20% or more, as measured by dollar volume, of the 
securitized pool balance as of the measurement date;
     A certification by the chief executive officer of the 
depositor is made at the time of each takedown;

[[Page 18321]]

     An asset review provision in the underlying transaction 
agreements requires review of the pool assets, upon the occurrence of 
certain trigger events, for compliance with the representations and 
warranties made with regard to those assets;
     A dispute resolution provision for repurchase requests is 
contained in the underlying transaction documents; and
     A disclosure provision, as required in an underlying 
transaction agreement, of investors' requests to communicate with other 
investors related to an investor's rights under the terms of the asset-
backed security was received during the reporting period by the party 
responsible for making Form 10-D filings.\93\
---------------------------------------------------------------------------

    \93\ See Registration Statement Under the Securities Act of 1933 
(Form SF-3), available at https://www.sec.gov/files/2017-03/formsf-3.pdf; Regulation AB II Adopting Release, 79 FR 57189.
---------------------------------------------------------------------------

    The Commission designed the shelf eligibility requirements to help 
ensure a certain ``quality and character'' in light of the requirement 
to reduce regulatory reliance on credit ratings.\94\ In particular, the 
shelf eligibility requirements were designed to help ensure that 
expected cash flows are sufficient to service payments or distributions 
in accordance with their terms; \95\ that obligated parties more 
carefully consider the characteristics and quality of the assets that 
are included in the pool; \96\ that asset-backed securities shelf 
offerings have transactional safeguards and features that make those 
certain securities appropriate to be issued without prior Commission 
staff review; \97\ and that issuers design and prepare asset-backed 
securities offerings with greater oversight and care.\98\ As discussed 
below, the Commission believes that the asset-backed securities offered 
pursuant to an effective shelf registration statement filed on Form SF-
3 trade primarily on the basis of yield and credit-worthiness. This 
proposed rule change would not limit a market participant's ability to 
substitute a security that is similar, and that is of comparable 
credit-worthiness, to the security that is the subject of a 
distribution if the pricing of the security were inconsistent with 
pricing in the overall secondary market for similar asset-backed 
securities, thereby limiting the potential for manipulation. The 
Commission continues to believe that its original basis for excepting 
securities of a certain quality and character is appropriate and that 
such securities are less at risk of the manipulation that Regulation M 
addresses.\99\
---------------------------------------------------------------------------

    \94\ See Regulation AB II Adopting Release, 79 FR 57189.
    \95\ See Regulation AB II Adopting Release, 79 FR 57265.
    \96\ See Regulation AB II Adopting Release, 79 FR 57278.
    \97\ See Regulation AB II Adopting Release, 79 FR 57283.
    \98\ Regulation AB II Adopting Release, 79 FR 57265, 57285.
    \99\ See Regulation M Adopting Release, 62 FR 527; see also 
Prohibitions Against Trading by Persons Interested in a 
Distribution, Release No. 34-19565 (Mar. 4, 1983) [48 FR 10628, 
10631 (Mar. 14, 1983)] (stating the Commission's belief that the 
``fungibility'' of certain types of securities makes manipulation of 
their price very difficult); supra note 50 and accompanying text.
---------------------------------------------------------------------------

(b) Existing Exception for Investment Grade Asset-Backed Securities
    As discussed above, Rule 101(c)(2) currently provides an exception 
for asset-backed securities that are rated by at least one NRSRO in one 
of its generic rating categories that signifies investment grade. The 
Commission excepted investment grade asset-backed securities from Rule 
101 because such securities trade primarily on the basis of yield and 
credit rating.\100\ In providing this rationale, the Commission stated 
that the principal focus of investors in the asset-backed securities 
market is on the structure of a class of securities and the nature of 
the assets pooled to serve as collateral for those securities rather 
than on the identity of a particular issuer.\101\ The Commission also 
stated that Rule 101 excepts investment grade securities that are 
``primarily serviced by the cashflows of a discrete pool of receivables 
or other financial assets, either fixed or revolving, that by their 
terms convert into cash within a finite time period plus any rights or 
other assets designed to assure the servicing or timely distribution of 
proceeds to the security holders.'' \102\
---------------------------------------------------------------------------

    \100\ See Regulation M Adopting Release, 62 FR 527.
    \101\ See Regulation M Adopting Release, 62 FR 527.
    \102\ See Regulation M Adopting Release, 62 FR 527 (citations 
omitted). The Commission stated that such rationale also applies to 
the existing identical exception provided in Rule 102(d)(2) of 
Regulation M. Regulation M Adopting Release, 62 FR 531.
---------------------------------------------------------------------------

(c) Proposed Amendments to Rule 101
    As discussed above, in accordance with Section 939A of the Dodd-
Frank Act, the Commission proposes to remove Rule 101's current 
exception for investment grade asset-backed securities based on NRSRO 
ratings. In place of that exception, the Commission is proposing a new 
exception in Rule 101(c)(2)(ii) for asset-backed securities that are 
offered pursuant to an effective shelf registration statement filed on 
Form SF-3. This proposed rule change, which would carry over the 
standard of credit-worthiness included in the Commission's Form SF-3, 
also helps to implement the mandate that, to the extent feasible, 
uniform standards of credit-worthiness be used.\103\
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    \103\ Public Law 111-203 sec. 939A(b) (requiring agencies to 
``seek to establish, to the extent feasible, uniform standards of 
credit-worthiness for use by each such agency, taking into account 
the entities regulated by each such agency and the purposes for 
which such entities would rely on such standards of credit-
worthiness'').
---------------------------------------------------------------------------

    The proposed rule is not based on a probability of default 
threshold derived from Structural Credit Risk Models with respect to 
asset-backed securities. An exception for asset-backed securities that 
is based on a probability of default threshold may be unfeasible due to 
the potential widespread inability of distribution participants and 
their affiliated purchasers to collect all of the information required 
to calculate the probability of default, such as the value and 
volatility of the assets underlying asset-backed securities. Therefore, 
the Commission is proposing an exception for certain asset-backed 
securities based on a separate standard that is more consistent with 
the existing Investment Grade Exception for asset-backed securities, as 
discussed below. The proposed rule does not contain a standard of 
credit-worthiness that relies on Form SF-3 with respect to 
Nonconvertible Securities because the transaction requirements included 
in Form SF-3 are relevant only to asset-backed securities. As discussed 
below, because the transaction requirements included in Form SF-3 serve 
as an indicator of credit-worthiness, the proposed exception that 
relies on Form SF-3 would not apply to securities that are not subject 
to those transaction requirements.
    The proposed exception continues to be derived from the premise 
that certain asset-backed securities are traded based on factors such 
as their yield and credit-worthiness.\104\ The Commission is proposing 
to except only the asset-backed securities offered pursuant to an 
effective shelf registration statement filed on Form SF-3 to further 
Regulation M's anti-manipulation goals. This proposed requirement 
regarding an effective Form SF-3 would except from Rule 101 the types 
of asset-backed securities that would trade based on their yield and 
credit-worthiness due to their qualities and characteristics and that 
are therefore less prone to the type of manipulation that Regulation M 
seeks to prevent.\105\
---------------------------------------------------------------------------

    \104\ See Regulation M Adopting Release, 62 FR 527.
    \105\ See supra note 50 and accompanying text. The ability of a 
market participant to substitute a security that is similar, and 
that is of comparable credit-worthiness, to the security that is the 
subject of a distribution limits the ability of a distribution 
participant or its affiliated purchaser from bidding up the price of 
the subject security.

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

[[Page 18322]]

    The Commission believes that the transaction requirements included 
in Form SF-3 allow for shelf offerings of only those asset-backed 
securities that share the qualities and characteristics of the 
investment grade asset-backed securities currently excepted from the 
provisions of Rule 101: With respect to both sets of securities, the 
principal focus of investors is the structure of a class of securities 
and the nature of the assets pooled to serve as collateral for those 
securities, rather than on the identity of a particular issuer.\106\ 
First, eligibility for offering securities pursuant to a Form SF-3 is 
limited, in part, by the percentage of delinquent assets and, for 
certain lease-backed securitizations, by the portion of the pool 
attributable to the residual value.\107\ For an asset-backed securities 
offering with an effective Form SF-3, delinquent assets cannot 
constitute 20% or more of the asset pool. Delinquent assets may not 
convert into cash within a finite period of time, as required by the 
definition of ``asset-backed security,'' because they are not 
performing in accordance with their terms and management or that other 
action may be needed to convert the assets into cash. However, as 
expressed at the adoption of Form SF-3, in principle, asset-backed 
securities should be primarily dependent on the pool of assets self-
liquidating instead of on the ability of the entity performing 
collection services.\108\ The application of the limitation on 
delinquent assets included in Form SF-3 was designed to ensure that 
attention is focused on the ability of collateral of the underlying 
asset pool to generate cash flow rather than on the identity of the 
issuer and its ability to convert those assets into cash,\109\ 
consistent with the Commission's original basis for excepting 
investment grade asset-backed securities from Rule 101.\110\
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    \106\ See supra note 102.
    \107\ See 17 CFR 239.45(b)(v), (vi); Form SF-3, I.B.1(e).
    \108\ Asset-Backed Securities, Release No. 33-8518 (Dec. 22, 
2004) [70 FR 1506, 1517 (Jan. 7, 2005)] (``Regulation AB Release''). 
In adopting the 20% delinquency concentration level, the Commission 
codified a staff position that an asset-backed security will not 
fail to meet the definition of ``asset-backed security'' solely 
because such a security is supported by assets having total 
delinquencies of up to 20% at the time of the proposed offering. See 
Regulation AB Release, 70 FR 1517 (citing Bond Mkt. Ass'n, SEC Staff 
No-Action Letter, 1997 WL 634124 (Oct. 8, 1997)). This threshold was 
the same threshold that was applied to certain other matters 
affecting registration and disclosure requirements for asset-backed 
securities (e.g., non-recourse commercial mortgage securitizations, 
pooling of corporate debt securities, and securitizations involving 
third-party credit enhancement). See Bond Mkt. Ass'n, SEC Staff No-
Action Letter, 1997 WL 634124, at * 3. The staff position was based 
on the premise that such a threshold for total delinquency 
concentration would, by itself, not present a materially greater 
risk of asset non-performance or default at the security level. See 
Id., 1997 WL 634124, at * 4.
    \109\ See Regulation AB Release, 70 FR 1517.
    \110\ See Regulation M Adopting Release, 62 FR 527.
---------------------------------------------------------------------------

    Second, Form SF-3 includes certain transaction requirements with 
respect to the structure of the asset-backed security being offered. 
Such structural requirements include (1) a certification by the 
depositor's chief executive officer that, among other things, the 
securitization structure provides a reasonable basis to conclude that 
the expected cash flows are sufficient to service payments or 
distributions in accordance with their terms; (2) a review of the 
asset-backed security's pool of assets upon the occurrence of certain 
triggering events, including delinquencies, by a person that is 
unaffiliated with certain transaction parties, such as the sponsor, 
depositor, servicer, trustee, or any of their affiliates; and (3) a 
dispute resolution provision, contained in the underlying transaction 
documents, for any repurchase request. When adopting the requirements 
included in Form SF-3, the Commission stated that sponsors may have an 
increased incentive to carefully consider the characteristics of the 
assets underlying the securitization and accurately disclose these 
characteristics at the time of offering. The Commission also believed 
that investors should benefit from the reduced losses associated with 
nonperforming assets because, as a result of this new shelf 
requirement, sponsors will have less of an incentive to include 
nonperforming assets in the pool.\111\ Because the transactional 
safeguards included in Form SF-3 provide incentives for obligated 
parties to, among other things,\112\ more carefully consider the 
quality and character of the assets that are included in the pool,\113\ 
asset-backed securities that are offered pursuant to an effective Form 
SF-3 should trade based on their yield and credit-worthiness rather 
than on the identity of a particular issuer.\114\ The application of 
the transaction requirements included in the Commission's Form SF-3, 
therefore, should result in the offering of asset-backed securities 
that have similar qualities and characteristics to the investment grade 
asset-backed securities currently excepted under the existing provision 
in Rule 101(c)(2).
---------------------------------------------------------------------------

    \111\ See Regulation AB II Adopting Release, 79 FR 57283.
    \112\ See supra notes 94-98 and accompanying text.
    \113\ See Regulation AB II Adopting Release, 79 FR 57278.
    \114\ See, e.g., Regulation AB II Adopting Release, 79 FR 57277-
78.
---------------------------------------------------------------------------

    The Commission believes that the requirement regarding an effective 
shelf registration statement filed on Form SF-3 is an appropriate 
substitute for the Investment Grade Exception currently provided in 
Rule 101(c)(2) because the proposed standard intends to limit 
eligibility for that exception to only those asset-backed securities 
that trade based on their yield and credit-worthiness due to their 
particular qualities and characteristics. Because the ability of 
distribution participants and their affiliated purchasers to bid up the 
price of an asset-backed security offered pursuant to an effective Form 
SF-3, during a distribution, is limited by a market participant's 
ability to substitute the security with other securities that are 
similar and of comparable credit-worthiness,\115\ the Commission 
believes that such a security is less susceptible to the types of 
manipulation that Regulation M seeks to prevent.
---------------------------------------------------------------------------

    \115\ See Regulation M Adopting Release, 62 FR 527; see also 
supra note 50 and accompanying text.
---------------------------------------------------------------------------

(d) Request for Comment
    We solicit comments on all aspects of this proposal. We ask that 
commenters provide specific reasons and information to support their 
views. Commenters are requested to provide empirical data, economic 
studies, and other factual support for their views to the extent 
possible.
    17. How often and in which context is the Investment Grade 
Exception for asset-backed securities utilized where no other exception 
from Rule 101 is available?
    18. As discussed above, the existing Investment Grade Exception for 
asset-backed securities and the proposed exception provided in 
paragraph (c)(2)(ii) of Rule 101 are premised on the ability of a 
market participant to substitute a security (in distribution) with 
other securities that are similar and of comparable credit-worthiness 
if there is a pricing aberration in the secondary market for similar 
securities. What is the universe of securities that is likely to be 
substituted in such instance? Please explain.
    19. If the Investment Grade Exception for asset-backed securities 
is rarely, infrequently, or never used, or if the proposed standard for 
asset-backed securities has limitations in practice or otherwise, 
should the Commission

[[Page 18323]]

remove the exception for asset-backed securities completely? Why or why 
not?
    20. What specific trading activities that currently occur pursuant 
to the Investment Grade 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 asset-backed 
securities or an exception for asset-backed securities that are offered 
pursuant to an effective shelf registration statement filed on Form SF-
3? What benefits or challenges would this approach create?
    21. Should the proposed exception be expanded to apply to all 
asset-backed securities, such as asset-backed securities registered on 
Form SF-1? What activities would then be allowed that were previously 
prohibited under Rule 101? To what extent would these additional 
activities be at risk of manipulation? Why or why not?
    22. Are there any types of asset-backed securities that should not 
be covered by the proposed exception? Please explain.
    23. Would the asset-backed securities excepted in the proposal be 
more vulnerable to manipulation than the securities that meet the 
existing investment grade standard? Why or why not?
    24. Is the proposal to except only asset-backed securities that are 
offered pursuant to an effective shelf registration statement filed on 
the Commission's Form SF-3 an appropriate substitute for credit ratings 
in this context? What effect(s), if any, would the proposed 
modifications to the current exception have on the market for asset-
backed securities? Please explain.
    25. 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 prohibitions of Regulation M? For example, to 
what extent, if any, might a narrower range of securities meet the 
exception as a result of the proposal, if adopted? If fewer securities 
are excepted from the prohibitions 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 an exception?
    26. Will fewer asset-backed securities issuances meet the 
requirement for this exception? If so, what impact would this proposed 
exception have on the market for new issuances of these securities?
    27. Please discuss whether and to what extent investors take into 
account reliance on the current Rule 101(c)(2) exception for investment 
grade asset-backed securities when making a decision to invest in such 
securities.
    28. Are there factors other than those identified in the proposed 
exception that influence the trading of such securities? Are there 
additional requirements that the Commission should adopt with respect 
to the proposed exception? Are there any that the Commission should 
remove from the proposal?
    29. Would a probability of default standard be appropriate for the 
exception for asset-backed securities? Are there models used to 
calculate a probability of default threshold (e.g., reduced-form models 
or structural models of credit risk) for asset-backed securities that 
would be relevant to consider based on the type of security involved? 
If so, what threshold should be included in the exception to Rule 101 
for asset-backed securities? What benefits would this approach provide? 
What other concerns could this approach raise? How would this approach 
address potential conflicts of interest involving the distribution 
participant or affiliated purchaser? Please explain.
    30. Are there any concerns with regard to distribution participants 
and affiliated purchasers' ability to collect any of the information 
required for the probability of default calculation for asset-backed 
securities? If so, please explain.

B. Rule 102

1. Existing Investment Grade Exception
    Rule 102 contains fewer exceptions than Rule 101 does because 
issuers and selling security holders have the greatest interest in an 
offering's outcome (and thereby should be subject to Regulation M's 
prohibitions) but generally do not have the same market access needs as 
underwriters do (and as such are expected to have less of a desire to 
seek an exception).\116\ Despite these differences in the situation of 
issuers and selling security holders as compared to distribution 
participants, the exception for certain investment grade securities 
provided in former Exchange Act Rule 10b-6 was carried over to 
Regulation M as paragraph (d)(2) at the adoption of Rule 102.\117\
---------------------------------------------------------------------------

    \116\ Regulation M Adopting Release, 62 FR 530. Further, the 
Commission has also stated that ``[a]n issuer or selling shareholder 
may have a substantial incentive to raise improperly the price of 
offered securities.'' Regulation M Proposing Release, 61 FR 17120.
    \117\ The Commission initially proposed not to include the 
Investment Grade Exception in Rule 102. Regulation M Proposing 
Release, 61 FR 17120 (``[T]he Commission preliminarily believes that 
it may not be appropriate to extend the . . . the exception for 
investment grade debt and investment grade preferred securities 
provided in Rule 101, to issuers, selling security holders, or their 
affiliated purchasers.'') The Commission, however, adopted the 
Investment Grade Exception in Rule 102 ``based on commenters' views 
and the rationales indicated . . . for an identical exception to 
Rule 101.'' Regulation M Adopting Release, 62 FR 531.
---------------------------------------------------------------------------

2. Proposed Removal of Investment Grade Exception
    The Commission is proposing to amend Rule 102 to remove the 
Investment Grade Exception. As noted above, there are limited 
situations in which issuers, selling security holders, or their 
affiliated purchasers rely on the Investment Grade Exception provided 
in Rule 102.\118\ Given this apparent limited reliance, coupled with 
the incentive for issuers, selling shareholders, and their affiliated 
purchasers to manipulate the market for the distributed security exists 
regardless of the credit quality of the security,\119\ the Commission 
believes that the existing exception should be eliminated without 
replacement.\120\

[[Page 18324]]

Further, the Commission believes that, while substituting an 
alternative standard of credit-worthiness may except securities that 
have little manipulative potential, retention of such an exception is 
not likely necessary to facilitate orderly distributions of securities 
or to limit potential disruptions in the trading market in light of 
issuers' limited market access needs.\121\ Accordingly, the proposed 
amendment to Rule 102 should protect investors and further Regulation 
M's anti-manipulation goals in the rare event of an issuer or its 
affiliate desiring to purchase or bid for Nonconvertible Securities or 
asset-backed securities that are in distribution.
---------------------------------------------------------------------------

    \118\ No commenter responding to the 2011 Proposal mentioned 
issuers, selling security holders, or their affiliated purchasers 
relying on the Investment Grade Exception. However, one commenter to 
the 2008 Proposal commented that the substitution of the Investment 
Grade Exception with a WKSI standard would prevent foreign sovereign 
issuers or affiliated purchasers from purchasing the foreign 
sovereign's bonds for its own general trading and investment 
activities, or for other public purposes, during the applicable 
restricted period. See Arnold & Porter Letter at 3. Given that the 
prohibitions of Regulation M apply only to bonds with the exact same 
terms of the bond in distribution, as discussed above in Part III, 
the Commission believes that the concerns raised by this commenter 
would rarely occur. Furthermore, the bond in distribution could be 
structured by the foreign sovereign in a manner so that Rule 102's 
restrictions would not impede a foreign sovereign issuer or its 
affiliated purchasers from engaging in its own general trading and 
investment activities, or for other public purposes.
    \119\ See supra Part IV.B.1.
    \120\ Other than ``exempted securities,'' as defined in Section 
3(a)(12) of the Exchange Act, the Investment Grade Exception 
provided in Rule 102 is the only security-based exception that 
permits an issuer, selling shareholder, or its affiliates to 
purchase the securities in distribution absent a need for the issuer 
to facilitate an orderly distribution or to limit potential 
disruptions in the trading market. For example, the security-based 
exception for open-ended investment companies is designed to ensure 
that open-ended investment companies can redeem shares during a 
continuous distribution without (by itself engaging in that exact 
activity) violating Regulation M. See 17 CFR 242.102(d)(4). Rule 102 
does not provide an actively-traded securities exception like Rule 
101 does. Instead, the relevant exception provided in Rule 102 is 
based on actively-traded reference securities, which is designed to 
allow issuers or selling security holders to purchase an actively-
traded reference security issued by an unaffiliated entity in a 
hedging transaction. See Rule 101(c)(1) and Rule 102(d)(1). As the 
Commission stated in the adopting release regarding the actively-
traded reference securities exception, the Commission believes that 
persons subject to Rule 102 should not be able to trade in their 
securities. See Regulation M Adopting Release at 531. As stated in 
the Regulation M Adopting Release, the Commission's view is based on 
the issuers' and selling security holders' stake in the proceeds of 
the offering, and their generally lesser need to engage in 
securities transactions. Id.
    \121\ See Regulation M Proposing Release, 61 FR 17117 (stating 
reasons for exceptions from Regulation M). Disruption to the trading 
market may be limited because distribution participants would still 
be able to rely on the exception from Rule 101 if they meet the 
requirements of the proposed rules. While the one commenter that 
addressed sovereign issuers and Rule 102 pointed to certain 
exemptive orders issued in the early 2000s to support a contention 
that sovereign issuers should continue to be excepted from 
Regulation M because the securities trade primarily on the basis of 
a spread to a United States Treasury security, all but one of the 
exemptive orders cited by the commenter only exempted the recipient 
from Rule 101. See Arnold & Porter Letter at 3. For orders cited by 
this commenter that only provided an exemption from Rule 101, see 
Federative Republic of Brazil (Jan. 21, 2000; Apr. 29, 2003; July 3, 
2003; Sept. 9, 2003; Oct. 15, 2003). See also Regulation M--
Sovereign Bond Exemption (Jan. 12, 2003) (order exempting certain 
distributions of certain sovereign bonds from Rule 101, not Rule 
102). For the one order cited by this commenter that provided an 
exception from Rule 102, see United Mexican States (Feb. 17, 1999). 
Because the proposed amendments would place distribution 
participants in a similar position to distribution participants 
trading the securities issued by the sovereign issuers pursuant to 
existing Rule 101 exemptive orders, and given that the exception 
under Rule 102 appears seldom used, we believe it is appropriate to 
eliminate the exception in Rule 102 as proposed.
---------------------------------------------------------------------------

    Under the proposed amendment to Rule 102, an issuer of investment 
grade Nonconvertible Securities and asset-backed securities that is 
participating in a distribution of its own securities would not have an 
exception and would need to ensure that the applicable restricted 
period is complete before purchasing, bidding for, or attempting to 
induce others to purchase or bid for, the covered security. Market 
participants can structure their offerings to ensure compliance with 
Rule 102 by, for example, completing the distribution prior to 
purchasing any covered security and thus completing the applicable Rule 
102 restricted period, or distributing bonds with different terms from 
outstanding bonds. The Commission preliminarily believes that 
eliminating the exception is appropriate because it would decrease the 
risk of conduct raising improperly the price of an offered security 
without impeding the facilitation of orderly distributions of 
securities.\122\ For the same reason, while the Commission adopted the 
Investment Grade Exception in Rule 102 in response to commenters 
responding on the original Regulation M Proposing Release \123\ and 
received one comment discussing this exception in response to the 2008 
Proposal,\124\ the Commission is concerned that issuers and selling 
security holders have the greatest interest in an offering's outcome 
thereby heightening the risk of manipulation.
---------------------------------------------------------------------------

    \122\ Regulation M Proposing Release, 61 FR 17120. See also 
Review of Antimanipulation Regulation of Securities Offerings, 
Release No. 34-33924 (Apr. 19, 1994) [59 FR 21681, 21686 (Apr. 26, 
1994)] (stating ``issuers and selling shareholders have a clear 
incentive to manipulate the price of the securities to be 
distributed. A very small change in the market price of a security, 
which in some circumstances may be accomplished at relatively little 
expense, can result in a substantial increase in offering 
proceeds.'').
    \123\ See Regulation M Adopting Release at 531.
    \124\ See Arnold & Porter Letter.
---------------------------------------------------------------------------

3. 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.
    31. Do issuers, selling security holders, and their affiliated 
purchasers have an incentive to manipulate securities that currently 
qualify for the Investment Grade Exception from Rule 102? If yes, would 
substituting the probability of default approach for the current 
exception address this incentive to manipulate?
    32. If commenters are aware of situations where issuers, selling 
security holders, or their affiliated purchasers are currently relying 
on the Investment Grade Exception in Rule 102, do these activities 
raise improperly the price of the offered securities? Why or why not?
    33. If the Investment Grade Exception in Rule 102 proposed to be 
removed is adopted, would it result in potential disruptions to trading 
and if so, please explain. Can market participants structure their 
distributions to comply with Regulation M? In light of the proposed 
removal of the exception, would any alternative structures be 
detrimental to the capital raising process?
    34. Would the proposed removal of the Investment Grade Exception in 
Rule 102 impede the facilitation of orderly distributions of securities 
or result in potential disruptions to trading markets? Why or why not?
    35. Should the Commission adopt an exception based on either the 
probability of default standard for Nonconvertible Securities or asset-
backed securities that are offered pursuant to an effective shelf 
registration statement filed on Form SF-3 for Rule 102 instead of 
removing the Investment Grade Exception without substituting an 
alternative? Why or why not? Should the Commission adopt an exception 
for Rule 102 if a distribution participant determines that a security 
is an excepted security pursuant to Rule 101(c)(2)?
    36. As discussed above, one commenter to the 2008 Proposal believed 
that the removal of the Investment Grade Exception for foreign 
sovereign bonds would impede a foreign sovereign or its affiliated 
purchasers from engaging in its own general trading and investment 
activities, or other public purposes. Should the Commission adopt an 
exception from Rule 102 for bonds issued by a foreign government or 
political subdivision thereof? For example, should the Commission 
except from Rule 102 any bond issued by a foreign sovereign or 
political subdivision thereof filed with a registration statement 
pursuant to Schedule B of the Securities Act? Do all bonds issued by 
foreign sovereigns or political subdivisions thereof trade based on a 
spread to U.S. Treasury securities? Please explain.

V. Recordkeeping Requirement: Rule 17a-4(b)(17)

A. Proposed Recordkeeping Requirement

    The Commission is proposing a new recordkeeping requirement that 
broker-dealers who are distribution participants or affiliated 
purchasers must keep certain records pursuant to Rule 17a-4 under the 
Exchange Act, the Commission's broker-dealer record retention rule. 
Proposed paragraph (b)(17) of Rule 17a-4 would require broker-dealers 
relying on the exception for Nonconvertible Securities to preserve the 
written probability of default determination made pursuant to proposed 
paragraph (c)(2)(i) of Rule 101. Accordingly, broker-dealers relying on

[[Page 18325]]

the exception in proposed paragraph (c)(2)(i) of Rule 101 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 probability 
of default determination made pursuant to proposed paragraph (c)(2)(i) 
of Rule 101.
    Under proposed paragraph (c)(2)(i) of Rule 101, broker-dealers 
relying on the exception would need to determine and document in 
writing that the probability of default of the issuer of Nonconvertible 
Securities is, estimated as of the day of the determination of the 
offering pricing and over the horizon of 12 calendar months from such 
day, less than 0.055% using a Structural Credit Risk Model. Broker-
dealers relying on the exception in proposed Rule 101(c)(2)(i) would be 
required to preserve the written probability of default determination 
pursuant to Rule 17a-4. The proposed amendment to Rule 17a-4 would 
modify the existing practices of broker-dealers who are distribution 
participants or affiliated purchasers to impose new recordkeeping 
burdens when relying on the exception in proposed Rule 101(c)(2)(i). A 
broker-dealer that uses a vendor to determine the probability of 
default threshold could satisfy this recordkeeping requirement by 
maintaining documentation of the assumptions used in the vendor model, 
as well as the output provided by the vendor supporting the probability 
of default determination. A broker-dealer calculating the probability 
of default on its own could satisfy the recordkeeping requirement by 
maintaining documentation of the value of each variable used to 
calculate the probability of default, along with a record identifying 
the specific source(s) of such information for each variable.
    The proposed requirement to preserve the written probability of 
default determination pursuant to Rule 17a-4 is consistent with other 
retention obligations of records that Exchange Act rules impose on 
broker-dealers.\125\ Exchange members and broker-dealers are currently 
required to comply with the three-year preservation period in Rule 17a-
4 for other records and should have procedures to satisfy such 
preservation requirements in place.\126\
---------------------------------------------------------------------------

    \125\ See id.
    \126\ 17 CFR 240.17a-4(b).
---------------------------------------------------------------------------

    The proposed recordkeeping requirement is intended to aid the 
Commission in its oversight of broker-dealers who are distribution 
participants or affiliated purchasers and rely on the exception in 
proposed paragraph (c)(2)(i) of Rule 101 by requiring such broker-
dealers to retain the written probability of default determination 
supporting their reliance on the exception. The written records 
documenting the probability of default determination would be subject 
to review in regulatory examinations by Commission staff and self-
regulatory organizations.

B. Request for Comment

    We solicit comments on all aspects of this proposal. We ask that 
commenters provide specific reasons and information to support their 
views.
    37. Is the retention of information by distribution participants or 
affiliated purchasers for a period of three years, the first two years 
in an easily accessible place, in proposed paragraph (b)(17) of Rule 
17a-4 appropriate? If not, what would be a more appropriate period of 
time, and why? Would investors, the Commission, or the public benefit 
from a retention period that is longer than three years? What would the 
costs be for broker-dealers who are distribution participants or 
affiliated purchasers for a retention period that is longer than three 
years?
    38. Is the retention requirement in proposed paragraph (b)(17) of 
Rule 17a-4 burdensome or costly? Please explain. If so, in what ways 
could modifications to the Rule as proposed reduce these burdens and 
costs? What would the costs be for broker-dealers who are distribution 
participants or affiliated purchasers to preserve the written 
probability of default determination?
    39. Should broker-dealers who are distribution participants or 
affiliated purchasers relying on the exception in proposed paragraph 
(c)(2)(i) of Rule 101 be required to document information in addition 
to the proposed required documentation (i.e., the written probability 
of default determination)? For example, should a broker-dealer be 
required to retain the documentation governing the probability of 
default estimation if the broker-dealer uses a vendor model?

VI. General Request for Comment

    The Commission solicits comment on all aspects of the proposed 
amendments to Rule 101, Rule 102, and Rule 17a-4, as well as any other 
matter that may impact any of the proposals discussed above. Please 
provide empirical data, when possible, and cite to economic studies, if 
any, to support alternative approaches. In particular, the Commission 
asks commenters to consider the following questions:
    40. In proposing the criteria above, the Commission has focused on 
indicators of credit-worthiness. Is credit-worthiness alone an 
appropriate signifier of whether a security is susceptible to 
manipulation under the conditions in which Rule 101 is concerned? Why 
or why not?
    41. Please comment in particular on any relevant changes to the 
Nonconvertible Securities or asset-backed securities markets since 
Regulation M was adopted in 1996 and how these developments should 
affect the Commission's evaluation of the proposed amendments. How do 
these changes fit within the relevant changes to the debt markets (more 
generally) since Regulation M's adoption?

VII. Paperwork Reduction Act Analysis

A. Background

    Certain provisions of proposed amendments impose ``collection of 
information'' requirements within the meaning of the Paperwork 
Reduction Act of 1995 (``PRA'').\127\ Specifically, the Commission 
estimates that respondents would incur PRA burden when determining 
whether a distribution of a nonconvertible security qualifies for the 
proposed exception from Regulation M. The Commission also believes that 
there would be PRA burdens associated with documenting this 
determination. These PRA burdens would be distinct from the existing 
OMB-approved collection of information burden estimates under Rule 101 
and Rule 17a-4 because the Commission has not estimated that 
respondents incur PRA burdens when determining whether a security 
qualifies for the current Investment Grade Exception.\128\ The 
Commission is submitting the proposed amendments to the Office of 
Management and Budget (``OMB'') for review in accordance with the PRA. 
An agency may not conduct or sponsor, and a person is not required to 
respond to, a collection of information unless it displays a current 
valid control number.
---------------------------------------------------------------------------

    \127\ See 44 U.S.C. 3501 et seq. The burden associated with the 
information collection requirements are referred to as ``PRA 
burdens.''
    \128\ The Commission preliminarily believes that the proposed 
amendment to Rule 102 would not change the PRA burden estimates 
under the current OMB-approved collections of information for that 
rule because those estimates do not include any collections of 
information or burden related to the determination of whether a 
security qualifies for the Investment Grade Exception. The proposed 
amendment would eliminate the exception under Rule 102, so 
respondents would continue to incur no burden making a determination 
because they would not be making one. See Supporting Statement for 
the Paperwork Reduction Act Information Collection Submission for 
Rule 102 of Regulation M (OMB Control No. 3235-0467) (Feb. 5, 2020), 
available at https://www.reginfo.gov/public/do/PRAViewDocument?ref_nbr=201911-3235-012 (discussing the burden 
estimates under Rule 102).

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

[[Page 18326]]

    The titles and control numbers for these collections of information 
are as follows:

------------------------------------------------------------------------
                                                            OMB control
              Rule                        Title                 No.
------------------------------------------------------------------------
Rule 101.......................  Rule 101, 17 CFR              3235-0464
                                  242.101 (Activities by
                                  Distribution
                                  Participants).
Rule 17a-4.....................  Records to be Preserved       3235-0279
                                  by Certain Brokers and
                                  Dealers.
------------------------------------------------------------------------

    As discussed above, 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. Subject to exceptions, Rule 101 
prohibits distribution participants and their affiliated purchasers 
from directly or indirectly bidding for, purchasing, or attempting to 
induce another person to bid for or purchase a covered security during 
a restricted period. Rule 17a-4 requires a broker-dealer to preserve 
certain records if it makes or receives them.
    In reference to the requirement in Section 939A, the Commission is 
proposing amendments to Rules 101 and 102 to remove the existing 
exceptions for nonconvertible debt securities, nonconvertible preferred 
securities, and asset-backed securities that are rated by at least one 
NRSRO in one of its generic rating categories that signifies investment 
grade. With respect to Nonconvertible Securities in Rule 101, the 
Commission proposes to substitute a standard that would except 
securities for which the probability of default, estimated as of the 
day of the determination of the offering pricing and over the horizon 
of 12 calendar months from such day, is less than 0.055%, as determined 
by a Structural Credit Risk Model. Broker-dealers who are distribution 
participants and their affiliated purchasers that would be relying on 
the proposed exception from Rule 101 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 probability of default determination. The 
Commission is also proposing to except asset-backed securities that are 
offered pursuant to an effective shelf registration statement filed on 
Form SF-3.
    The discussion of estimates that follows is limited to a discussion 
of the new information collection requirements that result from the 
proposed amendments. The Commission is not estimating that the proposed 
amendments would increase or decrease the existing approved information 
collections under Rule 101 and Rule 17a-4 because those information 
collections are not related to making a determination about whether a 
security qualifies for the Investment Grade Exceptions. The information 
collections in the proposed amendments are distinct, so they are the 
only information collections discussed herein.

B. Proposed Use of Information

    The information collected under the proposal would be used to 
ensure that the nonconvertible debt securities most resistant to 
manipulation are excepted from Rule 101. Further, the Commission 
preliminarily believes that the information contained in the records 
required to be retained and kept pursuant to the proposed amendment to 
Rule 17a-4 would be used to assist the Commission in conducting 
effective examinations and oversight of distribution participants and 
their affiliated purchasers.

C. Information Collections

    The proposed amendments that impose information collection burdens 
would apply to distribution participants and affiliated purchasers that 
choose to rely on the exception for a distribution of Nonconvertible 
Securities. As noted in Part VIII.A.1, there were 237 underwriters of 
Nonconvertible Securities in 2020. The Commission preliminarily 
believes that this number will remain roughly consistent because of the 
capital, expertise, and relationships needed to underwrite a 
Nonconvertible Security. The Commission, therefore, is estimating that 
237 respondents would be subject to PRA burdens under the proposed 
amendments.
    As discussed below, the Commission preliminarily believes that 
respondents would incur PRA burdens under the proposed amendments 
because distribution participants and their affiliated purchasers would 
be required to analyze each distribution of Nonconvertible Securities 
to determine whether the distribution qualifies for the exception. 
Respondents would also incur PRA burdens under Rule 17a-4 because 
distribution participants would be required to keep certain records 
documenting this determination that support their reliance on the 
exception.
1. Rule 101
    Under the proposed amendment to Rule 101, respondents wishing to 
rely on the exception for a distribution of Nonconvertible Securities 
would be required to gather the data serving as the inputs and then 
perform the analysis necessary to calculate the probability of default 
of the issuer whose securities are the subject of the 
distribution.\129\ This requirement would result in respondents 
incurring recordkeeping burden. The Commission preliminarily believes 
that this process would likely be highly automated, and that 
respondents would initially comply with this requirement by 
reprograming systems to create a means to calculate electronically the 
probability of default based on manually gathered and entered inputs 
for financial modeling. The Commission preliminarily believes that all 
respondents would be broker-dealers who have experience using their own 
proprietary version of a publicly available Structural Credit Risk 
Model so the initial configuration of systems will be handled 
internally and take 3 hours per respondent. The Commission also 
preliminarily believes that broker-dealers already have the software 
and systems in place that would be required to make the 
calculations.\130\

[[Page 18327]]

Accordingly, the Commission estimates that the total industry-wide 
initial burden for the proposed amendment to Rule 101 would be 711 
hours.\131\
---------------------------------------------------------------------------

    \129\ The Commission recognizes that some respondents may choose 
to utilize the probability of default estimates calculated and made 
available by a third-party vendor rather than perform the 
calculations themselves. The Commission's burden estimate for the 
proposed amendment to Rule 101 is based upon respondents gathering 
the required data and calculating the probability of default 
internally without the use of third-party vendors, because the 
Commission lacks granular information from which to base an estimate 
of the proportion of respondents that would use vendors. The 
Commission welcomes comments on this approach, including regarding 
the likelihood and cost of using third-party vendors, including any 
time burden associated with using such services.
    \130\ Further, the Commission preliminarily believes that 
respondents that choose to utilize the probability of default 
estimates calculated and made available by a third-party vendor 
would already have access to the vendor's software and systems 
containing these estimates, typically as part of an existing 
subscription, so they would not need to procure further services or 
subscriptions from these vendors. The Commission welcomes comments 
on this preliminary belief and on any related costs and burdens.
    \131\ 237 respondents x 3 hours = 711 hours.
---------------------------------------------------------------------------

    An issuer's probability of default is forward-looking and changes 
over time, so the Commission preliminarily believes that respondents 
would manually gather the inputs required to calculate probability of 
default each time it participates in a distribution of debt securities. 
There were 19,076 offerings of Nonconvertible Securities in 2020.\132\ 
Because financial modeling generally, and the probability of default 
calculation more specifically, is well-known by industry participants, 
the Commission preliminarily believes that respondents would have 
employees that are familiar with how to gather the required inputs. The 
Commission, therefore, estimates that would take respondents roughly 1 
hour per distribution of Nonconvertible Securities on this requirement. 
Accordingly, the Commission estimates that the amendment to Rule 101 
will result in an aggregate annual ongoing industry-wide burden of 
19,076 hours. The Commission, therefore, estimates that the total PRA 
burden resulting from the proposed amendment to Rule 101 would be 
19,787 hours in the first year \133\ and 19,076 hours thereafter.
---------------------------------------------------------------------------

    \132\ This number was obtained from Mergent, a financial data 
provider. Data for 2021 is not yet available in Mergent.
    \133\ 711 hours (initial burden) + 19,076 hours (ongoing annual 
burden) = 19,787 hours.
---------------------------------------------------------------------------

    The Commission preliminarily believes that the proposed amendments 
would not result in respondents incurring PRA burden when participating 
in distributions of asset-backed securities because whether an asset-
backed security has an effective registration statement on Form SF-3 is 
an objective, observable fact.\134\ Further, under the proposed 
amendments, there is no requirement for distribution participants or 
their affiliated purchasers to keep records documenting its reliance on 
the exception for distributions of asset-backed securities.
---------------------------------------------------------------------------

    \134\ See 17 CFR 239.45.
---------------------------------------------------------------------------

2. Rule 17a-4
    The proposed amendment to Rule 17a-4 would require broker-dealers 
relying on the exception in proposed paragraph (c)(2)(i) to preserve 
for a period of not less than three years, the first two years in an 
easily accessible place, the written probability of default 
determination. Because the burden to make these records is accounted 
for in the PRA estimates for the amendment to Rule 101, the burden 
imposed by these proposed new requirements under Rule 17a-4 is limited 
to the maintenance and preservation of the written records.\135\ The 
Commission estimates that this recordkeeping requirement would impose 
an initial burden of 25 hours per respondent for updating the 
applicable policies and systems required to account for capturing the 
records made pursuant to proposed paragraph (c)(2)(i). Accordingly, the 
Commission estimates that the total industry-wide initial burden for 
this requirement would be 5,925 hours.\136\ The Commission also 
estimates that respondents would incur an ongoing annual burden of 10 
hours per firm for maintaining such records as well as to make 
additional updates to the applicable recordkeeping policies and systems 
to account for the proposed rules, leading to a total ongoing industry-
wide burden of 2,370 hours.\137\ The Commission, therefore, estimates 
that the total PRA burden resulting from the proposed amendment to Rule 
17a-4 would be 8,295 hours in the first year \138\ and 2,370 hours 
thereafter.
---------------------------------------------------------------------------

    \135\ As noted above, for the purposes of these estimates, the 
Commission assumes that no registrants are using vendors to rely on 
the proposed exceptions, however, the Commission also preliminarily 
believes that the burden associated with the proposed amendment to 
Rule 17a-4 would not differ between respondents that rely on a 
third-party vendor and those that do not.
    \136\ 237 respondents x 25 hours = 5,925 hours.
    \137\ 237 respondents x 10 hours = 2,370 hours.
    \138\ 5,925 hours (initial burden) + 2,370 hours (ongoing annual 
burden) = 8,295 hours.

                                                PRA Summary Table
----------------------------------------------------------------------------------------------------------------
                                                                                  Ongoing annual
                                                                                   burden hours      Total PRA
                                                                  Initial burden     per year      burden hours
                                                                       hours       (after first    in first year
                                                                                       year)
----------------------------------------------------------------------------------------------------------------
Industry-Wide Burden due to Proposed Amendment to Rule 101......             711          19,076          19,787
Industry-Wide Burden due to Proposed Amendment to Rule 17a-4....           5,925           2,370           8,295
----------------------------------------------------------------------------------------------------------------

D. Collection of Information Is Mandatory

    Each collection of information discussed above would be a mandatory 
collection of information.

E. Confidentiality

    The Commission would not typically receive confidential information 
as a result of this collection of information. To the extent that the 
Commission receives--through its examination and oversight program, 
through an investigation, or by some other means--records or 
disclosures from a distribution participant regarding the probability 
of default determination, such information would be kept confidential, 
subject to the provisions of applicable law.

F. Retention Period of Recordkeeping Requirement

    Pursuant to proposed Rule 17a-4(b)(17) a broker-dealer who is a 
distribution participant or affiliated purchaser would be required to 
retain information for a period of not less than three years, the first 
two years in an easily accessible place.

G. Request for Comment

    Pursuant to 44 U.S.C. 3506(c)(2)(B), the Commission solicits 
comments to (1) evaluate whether the proposed collections of 
information are necessary for the proper performance of the functions 
of the Commission, including whether the information would have 
practical utility; (2) evaluate the accuracy of the Commission's 
estimate of the burden of the proposed collections of information and 
assumptions used therein; (3) determine whether there are ways to 
enhance the quality, utility, and clarity of the information to be 
collected; (4) determine whether there are ways to minimize the burden 
of the collections of information on those who are to respond, 
including through the use of automated collection techniques or other 
forms of information technology; and (5) evaluate whether the proposed 
amendments would have any effects on any other collection of 
information not

[[Page 18328]]

previously identified in this section. The Commission also requests 
that commenters provide data to support their discussion of the burden 
estimates.
    While the Commission welcomes any public input on this topic, the 
Commission asks commenters to consider the following questions:
    42. Is the Commission adequately capturing the respondents that 
would be subject to burdens under the proposed amendments? 
Specifically, would more or fewer than the 237 respondents determine 
the probability of default?
    43. Is the Commission accurately estimating the amount of time it 
would take to program systems and gather the data required to perform 
the probability of default calculations?
    44. Would any aspects of the proposed amendments that are not 
discussed in this PRA Analysis affect the burden associated with the 
collection of information?
    45. Do commenters agree with the Commission's preliminary belief 
that the proposed amendment to Rule 102 would not change PRA burdens?
    46. Do commenters agree with the Commission's preliminary belief 
that the proposed amendments would not result in respondents incurring 
PRA burden when participating in distributions of asset-backed 
securities?
    Any member of the public may direct to us any comments concerning 
the accuracy of these burden estimates and any suggestions for reducing 
the burdens. Persons submitting comments on the collection of 
information requirements should direct the comments to the Office of 
Management and Budget, Attention: Desk Officer for the Securities and 
Exchange Commission, Office of Information and Regulatory Affairs, 
[email protected], and send a copy to Vanessa 
Countryman, Secretary, Securities and Exchange Commission, 100 F Street 
NE, Washington, DC 20549-1090, with reference to File No. S7-11-22. OMB 
is required to make a decision concerning the collection of information 
between 30 and 60 days after publication of this release. Consequently, 
a comment to OMB is best assured of having its full effect if OMB 
receives it within 30 days of publication. Requests for materials 
submitted to OMB by the Commission with regard to these collections of 
information should be in writing, refer to File No. S7-11-22, and be 
submitted to the Securities and Exchange Commission, Office of FOIA 
Services, 100 F Street NE, Washington, DC 20549-2736.

VIII. Economic Analysis

    The Commission is sensitive to the economic consequences and 
effects, including costs and benefits, of its rules. Some of these 
costs and benefits stem from statutory mandates, while others are 
affected by the discretion exercised in implementing the mandates. 
Section 3(f) of the Exchange Act provides that whenever the Commission 
is engaged in rulemaking pursuant to the Exchange Act and is required 
to consider or determine whether an action is necessary or appropriate 
in the public interest, the Commission shall also consider, in addition 
to the protection of investors, whether the action will promote 
efficiency, competition, and capital formation.\139\ Additionally, 
Section 23(a)(2) of the Exchange Act requires the Commission, when 
making rules under the Exchange Act, to consider the impact such rules 
would have on competition. Section 23(a)(2) also provides that the 
Commission shall not adopt any rule which would impose a burden on 
competition that is not necessary or appropriate in furtherance of the 
purposes of the Exchange Act.
---------------------------------------------------------------------------

    \139\ See 15 U.S.C. 78c(f).
---------------------------------------------------------------------------

    The analysis below addresses the likely economic effects of the 
proposed amendments, including the anticipated benefits and costs of 
the amendments, and their likely effects on efficiency, competition, 
and capital formation. The Commission also discusses the potential 
economic effects of certain alternatives to the approach taken by these 
amendments. Some of the benefits and costs discussed below are 
difficult to quantify. For example, sticky offerings are generally not 
identified in the available data and may be difficult to trace in the 
appropriate records of the distribution participants. Therefore, much 
of the discussion of economic effects is qualitative.

A. Baseline

1. The Investment Grade Fixed Income Market
    To assess the economic effects of the proposed amendments, the 
Commission is using as the baseline the nonconvertible debt, 
nonconvertible preferred, and asset-backed securities markets as they 
exist at the time of this release, including applicable rules that the 
Commission has already adopted.
    The affected parties include Nonconvertible Security and asset-
backed security (collectively ``fixed-income securities'') \140\ 
distribution and market participants, such as issuers, selling security 
holders, underwriters, banks, broker-dealers, and their affiliated 
purchasers; fixed-income security investors, such as retail investors, 
mutual funds, exchange traded funds, and separate investment accounts; 
vendors of the relevant market data; and NRSROs. Currently a majority 
of the distribution participants in the relevant markets are subscribed 
to a major vendor of the market data necessary to evaluate various 
aspects of the distribution. Further, a rating by an NRSRO is necessary 
in order for distribution participants to rely on the Investment Grade 
Exception. Today there are nine credit rating agencies registered with 
the Commission as NRSROs.\141\ Three large NRSROs (S&P Global Ratings, 
Moody's Investors Services, Inc., and Fitch Ratings, Inc.) have 
historically accounted for most of the market share in this market. As 
of December 31, 2020, these three market participants accounted for 
94.7% of all of the NRSRO credit ratings outstanding.\142\
---------------------------------------------------------------------------

    \140\ The term ``fixed-income'' in the Economic Analysis section 
refers to nonconvertible debt securities, nonconvertible preferred 
securities, and asset-backed securities.
    \141\ U.S. Sec. and Exch. Comm'n, Annual Report on Nationally 
Recognized Statistical Rating Organizations 2 (2022), available at 
https://www.sec.gov/files/2022-ocr-staff-report.pdf.
    \142\ Id. at 24.
---------------------------------------------------------------------------

    The affected securities are nonconvertible debt, nonconvertible 
preferred, and asset-backed securities. In 2020, there were 19,076 
issues of nonconvertible debt, with 694 issuers and 237 participating 
underwriters involved.\143\ Additionally, in 2020, there were 152,069 
issues of mortgage-backed securities with 195 underwriters involved and 
7,255 issues of other asset-backed securities with 155 
underwriters.\144\
---------------------------------------------------------------------------

    \143\ The statistics are based on the data from Mergent.
    \144\ The data for the asset-backed securities (including 
mortgage-backed securities) comes from Bloomberg.
---------------------------------------------------------------------------

2. The Investment Grade Exception to Regulation M
    Regulation M is designed to prevent manipulative activities that 
could artificially influence the demand and pricing of covered 
securities.\145\ In particular, Rules 101 and 102 of Regulation M 
prohibit distribution and market participants from bidding for or 
purchasing a covered security, unless an exception, such as the 
Investment Grade Exception, applies.\146\ At the time the exception was 
included, the investment grade securities, that is securities 
characterized by sound credit-worthiness, were considered to be

[[Page 18329]]

traded primarily on yield and maturity, rather than the factors that 
determine credit-worthiness of the issuer and add uncertainty to the 
pricing of the issue.\147\ Thus sound credit-worthiness was considered 
to be a good proxy for manipulation risk. Such issues were presumed to 
have low probability of default and were thus considered to have low 
pricing uncertainty and low manipulation risk, which formed the basis 
for the exception. The Commission continues to believe that sound 
credit-worthiness is a good proxy for manipulation risk since 
securities issued by firms with sound credit-worthiness trade primarily 
on yield and maturity and not on issuer-specific characteristics that 
may increase pricing uncertainty.
---------------------------------------------------------------------------

    \145\ See supra Part 0.
    \146\ See 17 CFR 242.101(a), 102(a); see, e.g., 17 CFR 
242.101(c)(2), 102(d)(2).
    \147\ See Regulation M Adopting Release, 62 FR 527.
---------------------------------------------------------------------------

    The Commission believes that the application of the Investment 
Grade Exception to Rules 101 and 102 is primarily limited to two 
cases:\148\ Reopenings (an offering of an additional principal amount 
of securities that are identical to the securities already outstanding) 
and sticky offerings (an offering where a lack of demand results in an 
underwriter being unable to sell all of the securities in a 
distribution). Reopenings are used infrequently and constitute about 3% 
of the relevant securities' markets' issuance volume.\149\ Sticky 
offerings are not identified in the relevant databases, making it 
difficult to assess their relative magnitude.
---------------------------------------------------------------------------

    \148\ Some commenters note that best efforts offerings (see 
supra note 59) and foreign sovereign offerings (see supra note 62) 
could also be affected by the exceptions in Rules 101 and 102.
    \149\ The estimate is obtained using Mergent data for the 
relevant fixed income securities during the past five years as of 
Oct. 2021.
---------------------------------------------------------------------------

    Reopenings are used in situations when such financing method offers 
the benefit of cost-effectiveness. For example, it may be cheaper for 
an issuer to offer a series of small offerings as opposed to one large 
offering, as the latter could result in a lower offering price due to 
the supply pressure. Further, since a reopening issue is fungible with 
securities already in circulation and can be traded interchangeably 
with these securities in the secondary market, it provides additional 
liquidity benefits to the investors.\150\
---------------------------------------------------------------------------

    \150\ See SIFMA Letter 3 at 6; John Berkery & Remmelt 
Reigersman, Re-openings: Issuing Additional Debt Securities of an 
Outstanding Series, Mayer Brown 1-2 (2020), available at https://www.mayerbrown.com/-/media/files/perspectives-events/publications/2020/05/reopenings_-issuing-additional-debt-securities-of-an-outstanding-series.pdf. See also Arnold & Porter Letter at 3.
---------------------------------------------------------------------------

    Sticky offerings typically result when a large investor fails to 
fulfill its expressed purchase interest in the issue,\151\ which could 
be due to a negative factor that transpired in regard to the issue or 
issuer. In such cases it may become challenging to trade the issue 
based solely on the yield and maturity (otherwise it would have become 
possible to find another purchaser in a timely manner). This may give 
rise to a heightened risk of manipulation even if the security is rated 
as investment grade.
---------------------------------------------------------------------------

    \151\ Sullivan & Cromwell Letter at 4.
---------------------------------------------------------------------------

    The Commission preliminarily believes that the exception based on 
investment grade rating is rarely used in practice in Rule 102. Rule 
102 prohibits trading of the securities fungible with the securities 
being issued by issuers, selling security holders, and their affiliated 
purchasers.\152\ However, issuers and selling security holders 
generally do not have the same market access needs as underwriters and 
are not expected to buy the securities they are issuing.\153\
---------------------------------------------------------------------------

    \152\ See supra Part IV.A.1.c. for a relevant discussion.
    \153\ See supra Part IV.B.
---------------------------------------------------------------------------

    The Investment Grade Exception was included in the regulation as it 
was considered a good proxy for the likelihood of manipulation 
risk.\154\ However, the reference to NRSRO ratings in the Commission's 
rules may encourage investors to place undue reliance on the NRSRO 
ratings. Additionally, even though credit-worthiness has been 
historically considered a good proxy for manipulation risk, it is still 
not a precise measure of such risk and therefore there are costs 
associated with using such a proxy that currently exist in the relevant 
markets. Specifically, in some instances distribution participants may 
choose to engage in manipulative activities of the securities of 
issuers with sound credit-worthiness. As a result, under the existing 
rules, situations may arise in which securities with high manipulation 
risk are excepted from Regulation M.
---------------------------------------------------------------------------

    \154\ See supra Part III (discussing the history of the 
Investment Grade Exceptions).
---------------------------------------------------------------------------

B. Benefits of the Proposed Amendment

    As mentioned above, Section 939A of the Dodd-Frank Act requires the 
Commission to ``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.'' 
\155\ In this proposed rule, the Commission proposes to rely upon the 
Structural Credit Risk Models to measure credit-worthiness.\156\ These 
models have become widely used to estimate the probability of default 
of an issuer.\157\
---------------------------------------------------------------------------

    \155\ Public Law 111-203 sec. 939A(a). The Commission has issued 
several releases concerning the removal of references to credit 
ratings: Security Ratings, Release No. 34-64975 (July 27, 2011) [76 
FR 46603 (Aug. 3, 2011)]; Removal of Certain References to Credit 
Ratings Under the Securities Exchange Act of 1934, Release No. 34-
71194 (Dec. 27, 2013) [79 FR 1522 (Jan. 8, 2014)]; Removal of 
Certain References to Credit Ratings under the Investment Company 
Act, Release No. IC-30847 (Dec. 27, 2013) [79 FR 1316 (Jan. 8, 
2014)]; Asset-Backed Securities Disclosure and Registration, Release 
No. 34-72982 (Sept. 4, 2014) [79 FR 57184 (Sept. 24, 2014)]; Removal 
of Certain References to Credit Ratings and Amendment to the Issuer 
Diversification Requirement in the Money Market Fund Rule, Release 
No. IC-31828 (Sept. 16, 2015) [80 FR 58124 (Sept. 25, 2015)].
    \156\ See for example the seminal model by Robert C. Merton, On 
the Pricing of Corporate Debt: The Risk Structure of Interest Rates, 
29 Journal of Finance 449, 449-70 (1974), along with related 
successive refinement models such as Fischer Black & John C. Cox, 
Valuing Corporate Securities: Some Effects of Bond Indenture 
Provisions, 31 J. Fin. 351, 351-67 (1976); Robert Geske, The 
Valuation of Corporate Liabilities as Compound Options, 12 J. Fin. & 
Quantitative Analysis 541, 541-52 (1977); and Oldrich A. Vasicek, 
Credit Valuation, KMV (Mar. 22, 1984), among others.
    \157\ See supra note 67.
---------------------------------------------------------------------------

    Structural Credit Risk Models typically take the issuer balance 
sheet measures of debt obligations as given and estimate a probability 
of default based on the market value and volatility of the firm's 
equity. The value of equity is viewed in these models as the value of a 
call option on firm assets where the strike price is the total notional 
value of debt. Since the market value of equity, the volatility of 
equity, and the notional value of debt can be calculated from the 
market and balance sheet data, under the Structural Credit Risk Models 
the volatility of the value of the assets and the market value of 
assets, which are not observable, can be estimated. The probability of 
default can be calculated as the probability that the call option will 
expire out-of-the-money, which occurs when the value of the company 
falls below the book value of the debt.
    As discussed above, Structural Credit Risk Models are based on the 
structure of the balance sheet.\158\ The key

[[Page 18330]]

assumption of a Structural Credit Risk Model is that default occurs 
when the value of the company falls below the book value of the debt. 
Since the future value of the firm is unknown, a Structural Credit Risk 
Model must make assumptions about the probability distribution of 
possible firm values in different scenarios, some of which may trigger 
default. These assumptions include the current firm value and the 
volatility of firm value, for which the observed market value of equity 
and the volatility of equity is often an input. Some models include 
assumptions over the firm's dividend policy.
---------------------------------------------------------------------------

    \158\ An alternative set of models used to derive probability of 
default are `reduced-form models'. The reduced-form models rely on 
statistical analysis rather than the balance sheet to determine a 
firm's creditworthiness. However, compared to Structural Credit Risk 
Models, they lack in rigorous theoretical justification as well as 
economic interpretation of the resulted relationships between the 
model inputs. See, e.g., Edward Altman, Andrea Resti, & Andrea 
Sironi, Default Recovery Rates in Credit Risk Modeling: A Review of 
the Literature and Empirical Evidence, 33 Econ. Notes 183 (2004) 
(discussing the competing models), available at https://onlinelibrary.wiley.com/doi/10.1111/j.0391-5026.2004.00129.x.
---------------------------------------------------------------------------

    The Commission preliminarily believes that the probability of 
default based on the Structural Credit Risk Models is an appropriate 
proxy for credit-worthiness. As discussed previously, the Commission 
continues to believe that credit-worthiness is an appropriate standard 
to reflect manipulation risk since securities issued by firms with 
sound credit-worthiness trade primarily on yield and maturity and have 
low pricing uncertainty. Thus, the probability of default based on 
Structural Credit Risk Models is a reasonable proxy for manipulation 
risk.
    The Commission calibrated the 0.055% threshold in the sample of 
nonconvertible fixed income securities so as to capture approximately 
90% of the investment grade securities in our sample of nonconvertible 
fixed income securities (2436 distinct investment grade issues with 
probability of default below 0.055% out of 2710 total investment grade 
rated issues in the sample). This threshold also captures 125 distinct 
non-investment grade issues with probability of default below 0.055%. 
Overall, 2561 issues meet the proposed exception as compared with the 
2710 issues under the current exception.\159\ The securities with 
probability of defaults within the first 12 months, as estimated based 
on a widely accepted Structural Credit Risk Model, below the 0.055% 
threshold are proposed to be excepted from Rule 101.
---------------------------------------------------------------------------

    \159\ The most recent available investment grade status (as of 
the last available Mergent update through Dec. 2020) for 
nonconvertible securities issued between 2016 and 2020 was obtained 
from Mergent while the probability of default estimates were 
obtained for a cross-section of securities available in Bloomberg as 
of Oct. 22, 2021, which represents an average trading day with 
respect to the relevant market metrics. Since the cross-section of 
the relevant securities does not change considerably from day to day 
and the relevant metrics are typically calculated based on the data 
over a several months period or longer, it is unlikely that the 
results of the analysis are considerably affected by the specific 
day selected for the analysis. Please refer to Mario Bondioli, 
Martin Goldberg, Nan Hu, Chngrui Li, Olfa Maalaoui, & Harvey J. 
Stein, The Bloomberg Corporate Default Risk Model (DRSK) for Private 
Firms (working paper Aug. 27, 2021), available at https://ssrn.com/abstract=3911330 (retrieved from SSRN Elsevier database), for 
methodology description of Bloomberg probability of default measure.
---------------------------------------------------------------------------

    An advantage of using probabilities of default implied by 
Structural Credit Risk Models instead of NRSRO credit ratings is that 
these model-implied probabilities of default generally use current 
estimates of equity valuation and volatility, and hence incorporate 
most recent news affecting the valuation and perceived volatility of 
the firm. In contrast, credit rating agencies are generally slower than 
the market in updating credit ratings and outlooks and thus may reflect 
less up-to-date information.\160\ \161\
---------------------------------------------------------------------------

    \160\ This is consistent with the following SEC staff statement 
in COVID-19 Market Monitoring Group, Credit Ratings, Procyclicality 
and Related Financial Stability Issues: Select Observations, SEC 
(July 15, 2020) (``Cost of debt capital is driven by a wide range of 
financial and non-financial factors and forces; ratings downgrades 
are generally lagging indicators of cost of debt capital.''), 
available at https://www.sec.gov/news/public-statement/covid-19-monitoring-group-2020-07-15.
    \161\ Some academic studies find evidence that Structural Credit 
Risk Models may be able to respond to aggregate and firm specific 
news faster than credit ratings. Also, such models are able pick up 
on differences in default risk within a credit rating bucket. 
However, credit ratings do not necessarily imply probabilities of 
default and thus may not be directly comparable to probability of 
default estimated using a Structural Credit Risk Model. See Jing-zhi 
Huang & Hao Zhou, Specification Analysis of Structural Credit Risk 
Models (Fed. Res. Bd., Fin. & Econ. Discussion Series, 2008-552008), 
available at https://www.federalreserve.gov/pubs/feds/2008/200855/200855pap.pdf; Moody's Analytics, EDF Overview (2011) (outlining the 
approach by Moody's KMV), available at https://www.moodysanalytics.com/-/media/products/EDF-Expected-Default-Frequency-Overview.pdf; Giuseppe Montesi & Giovanni Papiro, Risk 
Analysis Probability of Default: A Stochastic Simulation Model, 10 
J. Credit Risk 29 (2014).
---------------------------------------------------------------------------

    Distribution participants should be able to calculate the 
probability of default internally using Structural Credit Risk Models. 
One of the benefits of the proposed amendment is that the distribution 
participants will have the flexibility of selecting the model they find 
most convenient to assess the credit-worthiness of issuers for the 
purposes of using the exception. This means the distribution 
participants will no longer have to rely on an NRSRO rating for the 
issue for purposes of the Regulation M exception and will no longer 
have to rely on an NRSRO's choice of the model for such purposes. 
Furthermore, the Commission preliminarily believes that multiple 
vendors currently provide estimates of the probability of default based 
upon Structural Credit Risk Models as a part of default packages that 
include various market data and metrics.\162\
---------------------------------------------------------------------------

    \162\ See a relevant discussion in supra Part IV.A.1.c).
---------------------------------------------------------------------------

    Removing the reference to credit ratings from Rules 101 and 102 of 
Regulation M may also have a benefit of expanded options available to 
distribution participants compared to the Regulation M Investment Grade 
Exception requirement, as the proposed requirement will no longer rely 
on a limited number of vendors providing credit ratings, which may 
reduce possible negative consequences from limited competition. 
Structural Credit Risk Models as a measure for credit-worthiness could 
therefore serve as a better proxy for manipulation risk than credit 
ratings because, by prescribing a methodology rather than a metric 
generated by only a certain category of regulated vendors (that is, 
NRSROs), distribution participants may have more options for either 
using a vendor supplied Structural Credit Risk Model or using their own 
proprietary version of a publicly available Structural Credit Risk 
Model.
    Under the proposed amendments, the Structural Credit Risk Models 
cannot, as a practical matter, apply to asset-backed securities due to 
the complexity of the structure of such instruments. In the case of 
asset-backed securities, the Commission preliminarily believes that 
securities that are offered pursuant to an effective shelf registration 
statement filed on Form SF-3 should also be excepted from Rule 101. 
Form SF-3 requirements provide objective criteria that also ensure that 
the securities with the least amount of manipulation risk are allowed 
to rely on the Regulation M exception. Specifically, Form SF-3 
requirements limit the number of nonperforming assets in the asset-
backed security pool, require review of the pool assets, and require 
certification by the chief executive officer, among other things. The 
Commission continues to believe, as noted when it adopted these 
requirements, that use of Form SF-3 incentivizes sponsors to carefully 
review and disclose the underlying assets' characteristics, reducing 
the overall uncertainty about the asset-backed security and therefore 
the risk of manipulation. Accordingly, asset-backed securities that are 
offered pursuant to an effective shelf registration statement filed on 
Form SF-3 have similar qualities and characteristics to the investment-
grade asset-backed securities currently excepted from Rule 101(c)(2). 
Further, an analysis of a merged sample of Form SF-3 filers and 
Bloomberg credit ratings

[[Page 18331]]

for year 2021 asset-backed securities issuances demonstrates that 78% 
of Form SF-3 filers' issuances have investment grade status (362 out of 
464 rated issuances), while the remaining 22% of issuances have non-
investment grade status (102 issuances).\163\ To the extent that asset-
backed securities for which a Form SF-3 is filed includes securities 
that have low manipulation risk but lack an investment grade rating, 
the additional benefit of the proposed amendments is allowing such low 
manipulation risk issues to rely on the exception and encouraging 
participation in the relevant market.
---------------------------------------------------------------------------

    \163\ We note that 770 investment grade asset-backed security 
issuances (by 191 issuers) from the 2021 Bloomberg sample did not 
merge with the sample of Form SF-3 filers in part due to necessarily 
present imperfections in issuer name matching and in part due to a 
much smaller number of Form SF-3 filers (62 issuers). This may imply 
a possibility that a fairly large number of issuances that are able 
to rely on the exception currently will be excluded under the 
proposed standard. The asset-backed securities eligible for Rule 
144A were excluded from the analysis as they are able to rely on a 
different exception.
---------------------------------------------------------------------------

    The Commission is proposing to eliminate the exception entirely 
from Rule 102, as discussed above, given the heightened risk of 
manipulation that exists for issuers and selling security holders and 
absence of a need to facilitate an orderly distribution or to limit 
potential disruptions in the trading market, coupled with our 
understanding that the Investment Grade Exception is generally not 
relied upon in practice, as issuers and selling security holders who 
are subject to Rule 102, unlike broker-dealers, typically do not trade 
outstanding issues of their own securities that are identical to the 
issue being distributed in the secondary market.\164\ The economic 
benefit of the proposed amendment is that it may contribute to the 
Dodd-Frank Act goals of reducing perceived government endorsement of 
NRSROs and over-reliance on credit ratings by market participants in 
Regulation M by removing the relevant reference to credit ratings.
---------------------------------------------------------------------------

    \164\ See also a relevant discussion in supra note 120. 
Eliminating the Investment Grade Exception, however, could affect 
the ability of foreign sovereign issuers to purchase any of such 
issuer's securities. See discussion in infra Part VIII.C.5 and 
Arnold & Porter Letter at 3.
---------------------------------------------------------------------------

C. Costs of the Proposed Amendment

    The Commission recognizes that some of the affected distribution 
participants may bear costs from the proposed amendments. The proposed 
amendments may alter the universe of securities that can rely on the 
exception and additionally may prevent issuers from using the exception 
in some cases potentially leading to fewer issues of the affected 
securities. If some distribution participants decide not to participate 
in certain issues as a result of the proposed amendments, the costs of 
the affected issues may increase. For example, when fewer banks or 
broker-dealers are available, these distribution participants may be 
able to charge higher fees. Additionally, as the result of the proposed 
amendments fewer issues may take place, potentially limiting issuers' 
ability to raise capital and affecting investors in the relevant 
securities as the available security selection and liquidity may be 
reduced.
    There are several types of costs that could arise: (1) Costs 
associated with calculations or obtaining the probability of default 
estimate; (2) costs associated with maintaining records related to the 
probability of default estimation; (3) costs due to the probability of 
default being an imperfect proxy for credit-worthiness, (4) asset-
backed securities' costs associated with the proposed amendments, (5) 
costs related to Rule 102 amendments (6) indirect and other costs of 
the amendments. We discuss these costs in detail below.
1. Costs Associated With Obtaining the Estimate of the Probability of 
Default
    Distribution participants may incur costs related to determining 
the probability of default. Consistent with the PRA section,\165\ the 
Commission estimates that it would take a distribution participant 3 
hours to establish a system to gather the data serving as the inputs 
and then perform the analysis necessary to calculate the probability of 
default of the issuer whose securities are the subject of the 
distribution, for an aggregate cost of $240,318.\166\ Consistent with 
the PRA section,\167\ the Commission also estimates that it would take 
a distribution participant one hour to gather the inputs required to 
calculate probability of default each time it participates in a 
distribution of Nonconvertible Securities. There were 19,076 offerings 
of Nonconvertible Securities in 2020. Therefore, it is estimated that 
annually distribution participants would spend $6,447,688 \168\ in the 
aggregate complying with this requirement.
---------------------------------------------------------------------------

    \165\ See supra Part VII.C.1.
    \166\ The Commission estimates the wage rate based on salary 
information for the securities industry compiled by SIFMA. See 
Management & Professional Earnings in the Securities Industry--2013, 
SIFMA (Oct. 7, 2013), available at https://www.sifma.org/resources/research/management-and-professional-earnings-in-the-securities-industry-2013/. These estimates are modified by the Commission staff 
to account for an 1800 hour work-year and multiplied by 5.35 
(professionals) or 2.93 (office) to account for bonuses, firm size, 
employee benefits and overhead. These figures have been adjusted for 
inflation through the end of 2021 using data published by the Bureau 
of Labor Statistics. 237 distribution participants x 3 hours x $338 
hour for a compliance manager = $240,318.00.
    \167\ See supra Part V.C.1.
    \168\ 19,076 offerings x 1 hour x $338 hour for a compliance 
manager = $6,447,688.
---------------------------------------------------------------------------

    Any costs associated with using a vendor to obtain probability of 
default estimate should be minimal, as the Commission preliminarily 
believes that distribution participants engaged in the offering of 
Nonconvertible Securities would typically already have subscriptions to 
vendors that provide calculations regarding the probability of default 
based on Structural Credit Risk Models.\169\ Furthermore, we believe 
that distribution participants, in particular those that choose to 
determine the probability of default estimate internally, would already 
have the computational resources necessary to conduct such analysis 
internally.\170\
---------------------------------------------------------------------------

    \169\ See supra note 84.
    \170\ See supra Part IV.A.1.c).
---------------------------------------------------------------------------

2. Costs Associated With Maintaining Records Related to the Probability 
of Default Estimation
    Distribution participants would also incur costs related to 
capturing and maintaining records regarding the probability of default 
determination. Consistent with the PRA section,\171\ the Commission 
estimates that it would take a distribution participant 25 hours to 
update the applicable policies and systems required to account for 
capturing the records made pursuant to proposed Rule 101(c)(2)(i), for 
an aggregate cost of $2,002,650.\172\ Consistent with the PRA 
section,\173\ the Commission also estimates that it would take a 
distribution participant 10 hours to maintain such records as well as 
to make additional updates to the applicable recordkeeping policies and 
systems to account for the proposed rules. Therefore, it is estimated 
that annually broker-dealers would spend $801,060 \174\ in the 
aggregate complying with this requirement.
---------------------------------------------------------------------------

    \171\ See supra Part VII.C.2.
    \172\ 237 distribution participants x 25 hours x $338 hour for a 
compliance manager = $2,002,650.
    \173\ See supra Part V.C.1.
    \174\ 237 distribution participants x 10 hours x $338 for a 
compliance manager = $801,060.
---------------------------------------------------------------------------

3. Costs Associated With Structural Credit Risk Model Based Probability 
of Default Being an Imperfect Proxy for Credit-Worthiness
    As discussed previously, the proposed Structural Credit Risk Models 
are designed to measure credit-worthiness, and credit-worthiness itself

[[Page 18332]]

is considered to be a good measure of manipulation risk. There are 
costs that are currently present in the relevant markets associated 
with credit-worthiness being an imperfect proxy for manipulation risk. 
However, in the absence of a better proxy for manipulation risk, 
credit-worthiness has continued to successfully serve the purpose of 
measuring such risk for many years. This is also supported by the 
comments stating that investment grade standard has been successfully 
used in Rules 101 and 102 exception.\175\ The proposed amendments are 
not expected to alter those costs and the discussion that follows 
focuses instead on the costs associated with the proposed Structural 
Credit Risk Models as a proxy for credit-worthiness.
---------------------------------------------------------------------------

    \175\ See, for example, Rothwell at 2 and ABA at 15 -17.
---------------------------------------------------------------------------

    The use of any model to estimate credit-worthiness necessarily 
provides an imperfect measure. Structural credit risk models are no 
exception. We note, however, that NRSROs similarly may rely on 
imperfect models of estimating issuer credit-worthiness. Moreover, 
models such as Structural Credit Risk Models often are a part of the 
analysis involved in obtaining a credit rating.\176\
---------------------------------------------------------------------------

    \176\ See, e.g., John Y. Campbell, Jens Hilscher, & Jan 
Szilagyi, In Search of Distress Risk, 63 J. Fin. 2899 (2008), 
available at https://scholar.harvard.edu/files/campbell/files/campbellhilscherszilagyi_jf2008.pdf.
---------------------------------------------------------------------------

    Some ways to implement Structural Credit Risk Models make use of 
historical trading data to produce a reliable estimate of the model 
input parameters. These data may not be available for certain 
infrequently traded securities. In some circumstances the market for a 
security has not yet been established and sufficient trading data are 
unavailable, making it difficult to apply the exception.
    Additionally, Structural Credit Risk Models rely on a number of 
parameter estimates such as firm market value and volatility, which 
could be difficult to assess as these values change with market 
conditions and business fluctuations. A changing term structure of 
interest rates and noise trading in the market can further distort the 
probability of default estimates. Incorrect parameter estimates may 
result in the incorrect estimates of default probability and allow 
distribution participants to rely on the exception for risky issues or 
prevent distribution participants from relying on the exception for 
safe issues. Implied probabilities of default are sensitive to market 
prices and estimates of market volatility and consequently tend to be 
counter cyclical, increasing during market downturns, which are often 
also periods of increased uncertainty. A constant threshold which is 
not time-varying would potentially result in fewer firms qualifying for 
the exception during market downturns, which may result in more 
issuances during this period not qualifying or firms choosing not to 
issue, hence increasing their cost of capital or limiting their access 
to capital. While credit rating downgrades are also counter cyclical, 
they tend to be slow in incorporating updates \177\ and relatively 
fewer firms will have an investment grade credit rating during 
downturns, the impact of the counter cyclicality of default 
probabilities implied by Structural Credit Risk Models would be 
stronger relative to using credit ratings: During periods of distress, 
using these probabilities of default will likely result in fewer firms 
with an investment grade credit rating falling below the threshold, and 
thus fewer firms qualifying for the exception relative to using credit 
ratings. Distribution participants would, however, be able to adjust 
the required estimated model parameters and inputs frequently as market 
conditions change, mitigating the costs discussed above.
---------------------------------------------------------------------------

    \177\ See COVID-19 Market Monitoring Group, supra note 160 
(``Cost of debt capital is driven by a wide range of financial and 
non-financial factors and forces; ratings downgrades are generally 
lagging indicators of cost of debt capital.'').
---------------------------------------------------------------------------

    Due to the number of variations among Structural Credit Risk Models 
and their estimated inputs, the probability of default estimates may be 
subjective to some extent and not comparable across different issuers 
or for the same issuer across different issues if estimates are based 
on different models, or done by different researchers or vendors. The 
latter may affect market participants' ability to effectively rely on 
the estimates to make comparative assessments across multiple 
securities. However, this is also true of the credit ratings that often 
rely on similar models, which mitigates these costs of the proposed 
amendments relative to the market baseline.
    In addition, as discussed previously in reference to the selected 
threshold, the amendment may expand slightly the universe of firms that 
qualify for the exception and include firms that did not receive an 
investment grade credit rating, but have a structural credit model 
implied probability of default that falls below the threshold. The debt 
prices of these firms may be prone to manipulation if the price of 
their debt is relatively less sensitive to aggregate interest rate 
changes.
    Additionally, this amendment may create potential opportunities for 
new products offered by the vendors designed specifically for a given 
issue or issuer. A custom designed estimate paid for by the issuer may 
lead to potential conflicts of interest since the vendor is 
incentivized in this case to produce an estimate which would allow the 
issuer to rely on the exception. However, the existing major vendors 
supplying probability of default estimates have numerous clients 
currently using this information for business purposes other than the 
Rule 101 exception. Therefore, given the reputational concerns it is 
unlikely that these vendors would produce a slightly different product 
to cater specifically to the use of these estimates for purposes of 
relying on the Rule 101 exception. Additionally, the model input 
estimates or assumptions may be tweaked by the distribution 
participants in such a way as to produce the desired estimation result 
if the model is estimated internally and may result in market 
participants' adjusting the models so as to be able to rely on the 
exception.\178\ This may result in an additional cost of adding some 
manipulation risk to the relevant markets if manipulation prone issues 
are allowed to rely on the exception as a result.
---------------------------------------------------------------------------

    \178\ The definition of Structural Credit Risk Models for 
purposes of Rule 101(c)(2)(i) is limited to commercially or publicly 
available models, which would limit a distribution participant's 
ability to develop its own models to achieve favorable results.
---------------------------------------------------------------------------

    Finally, the proposed threshold of 0.055% for the exception is 
based on model assumptions and historical data. Future market evolution 
may result in this threshold becoming either too large or too small, 
allowing risky issues to rely on the exception or preventing safe 
issues from using it. This may vary by industry, with the threshold 
being more restrictive in some industries relative to the original 
NRSRO investment grade designation. Moreover, probabilities of default 
as implied by Structural Credit Risk Models tend to be counter-cyclical 
and can spike in periods of crisis due to decreases in market valuation 
and increases in equity volatility. Consequently, fewer investment 
grade firms would fall below the threshold. Credit rating by NRSROs are 
also countercyclical but tend to be slow moving, since credit rating 
changes often lag updates to firm conditions that would impact cost of 
capital.\179\
---------------------------------------------------------------------------

    \179\ COVID-19 Market Monitoring Group, supra note 160 (``Cost 
of debt capital is driven by a wide range of financial and non-
financial factors and forces; ratings downgrades are generally 
lagging indicators of cost of debt capital.'').

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

[[Page 18333]]

4. Costs Associated With Asset-Backed Securities' Amendments
    The proposed amendments may render some asset-backed securities 
ineligible to rely on the exception from the Regulation M. This may 
increase issuance costs for the distribution participants. For 
instance, broker-dealers may reduce an offering's size or increase fees 
if required to comply with Regulation M. Additionally, distribution 
participants may need to establish new business relationships due to 
Regulation M restrictions. Furthermore, some issuers may decide not to 
issue the affected securities if required to comply with Regulation M 
restrictions. As a result, some asset-backed securities' issues may not 
take place, which could affect issuers' ability to raise capital and 
could affect investors in the relevant markets by potentially reducing 
the selection of the available asset-backed securities.
5. Costs Associated With Amendments to Rule 102
    As discussed previously, the effect of eliminating the exception 
from Rule 102 is expected to be minimal since the exception is likely 
not useful from a practical standpoint, because the issuers and selling 
security holders who are subject to Rule 102 typically do not trade 
their own securities that are being issued. However, as was identified 
previously in a comment letter, an Investment Grade Exception from Rule 
102 could affect the ability of foreign sovereign issuers or their 
affiliates to purchase any of such issuer's securities.\180\ In the 
past the Commission has issued exemptive relief for some foreign 
sovereign issuers because they trade, as represented in incoming 
letters, based on a yield spread to US treasuries.\181\ This might mean 
that bonds of foreign sovereign issuers are less susceptible to 
manipulation risk since there is less uncertainty in regards to their 
valuation. Eliminating the exception from Rule 102 may increase 
issuance costs or deter market participants from issuing such 
securities with low manipulation risk.
---------------------------------------------------------------------------

    \180\ Arnold & Porter Letter at 3.
    \181\ See supra note 121.
---------------------------------------------------------------------------

6. Indirect and Other Costs of the Amendments
    Besides the direct effects on the distribution participants and 
affected securities discussed above the proposed amendment may also 
generate indirect effects on investors in these securities and NRSROs. 
For instance, if issuer participation in the relevant security issues 
becomes limited, some issues may not take place that otherwise would. 
Investors may face a more limited choice of investment instruments as a 
result, for example in the case of reopenings. This may further affect 
liquidity of their portfolios since reopenings can offer additional 
liquidity benefits as the securities offered in reopenings are 
interchangeable with the existing issues. However, as already 
discussed, these costs are expected to be minimal as reopenings are 
used infrequently.
    The proposed amendment does not rely on an NRSRO rating in order to 
determine if an issue can rely on the exception. This may diminish 
NRSROs' clientele to the extent NRSROs choose not to provide Structural 
Credit Risk Model-based estimates of the probability of default for 
their existing clients opting to rely on the exception. However, the 
amendment may increase the clientele of the vendors that supply 
relevant data and metrics to the distribution participants if such 
vendors already supply probability of default estimates or choose to 
offer this estimate as a part of their services. In addition, if firms 
do not solicit credit rating services from NRSROs beyond the estimate 
of a probability of default implied by a Structural Credit Risk Model, 
investors will not be able to benefit from the information provided by 
a credit rating report and ongoing coverage of the firm that otherwise 
would be provided through the distribution participant.

D. Efficiency, Competition, and Capital Formation

    As discussed previously, distribution participants will have 
flexibility to select the best Structural Credit Risk Model to access 
credit-worthiness as a measure of manipulation risk for their business. 
This may encourage market participation in affected security issues 
and, as a result, could improve competition between issuers for the 
investors as well as between other distribution participants. Further, 
widely available estimates of the probability of default as well as an 
option of internal model estimation could lead to a more competitive 
environment as the requirement to rely on proprietary credit risk 
models of a small number of NRSROs is removed. The improved 
competition, market participation and efficiency ultimately should lead 
to more efficient capital formation as the access to and functioning of 
the relevant fixed income markets improves. We note however that these 
effects are not expected to be significant because the exceptions in 
Rules 101 and 102 affect only a small portion of the relevant market as 
discussed previously.
    However, while unlikely, it is possible that a new business model 
could emerge in the relevant markets that leads to conflicts of 
interest and neutralizes the effects discussed above. For instance, 
distribution participants could contract with a vendor or a credit 
rating agency directly to create a custom estimate of the probability 
of default. This could result in a business model where an issuer pays 
for the supplied estimate and where vendors may be incentivized to 
produce an estimate designed to fit the desired estimation result. Thus 
issues that otherwise would not be able to rely on the exception could 
end up being excepted potentially increasing the manipulation risk in 
the relevant markets, which in turn could negatively affect competition 
and capital formation.
    Further, the positive effects discussed above could be offset by 
the fact that some issuers may face higher costs or no longer be able 
to use the exception, for example, due to imperfect model estimates as 
a result of market fluctuations or changing market. High costs of 
issuance or inability to rely on the exception may deter participants 
from issuing the affected securities, which could impact the 
competition and capital formation in the relevant markets. Further, 
potential negative effects of non-uniform estimates and subjectivity 
additionally reduce these benefits. Finally, potentially increased 
issuance costs due to some asset-backed securities being ineligible for 
the exception may also negatively affect market participation and 
competition of the relevant markets.

E. Reasonable Alternatives

    Alternative 1 discussed below deals with the proposed threshold, 2-
4 propose alternative approaches to using Structural Credit Risk Models 
as a standard of credit-worthiness to measure manipulation risk. 
Alternative 5 discusses elimination of the exception, alternative 6 
deals with asset-backed securities, while alternative 7 discusses Rule 
102 options.
1. Alternative Threshold for Probability of Default
    The proposed threshold of 0.055% was chosen so as to capture most 
of the investment grade securities while at the same time capturing the 
fewest of the non-investment grade securities. However, a different 
threshold could be used in the proposed exception, which would capture 
different proportions of investment and non-investment grade 
securities. For example, a higher

[[Page 18334]]

threshold of 0.5% is estimated to capture about 98.6% of investment 
grade securities (2673 out of 2710 investment grade issues), overall 
resulting in 2883 issues that can rely on the exception under the 
proposed standard.\182\ A lower threshold of 0.01% is estimated to 
capture about 65% of investment grade securities (1760 out of 2710 
investment grade issues) and overall results in 1811 issues that can 
rely on the exception under the proposed standard.\183\ The advantage 
of a higher threshold is that it captures a larger set of investment 
grade securities, but at the expense of also capturing a small set of 
non-investment grade securities, which could be more prone to 
manipulation risk. As alternatives, the Commission could increase the 
threshold, which would allow more investment grade securities to rely 
on the exception at expense of potentially a higher manipulation risk; 
or decrease the threshold, which would limit the ability of some of the 
investment grade securities to use the exception, but would potentially 
also limit the number of non-investment grade securities allowed to 
rely on the exception and, as a result, also limit manipulation risk.
---------------------------------------------------------------------------

    \182\ 2883 issues captured by the new proposed standard (with 
probability of default below 0.5%) consist of 2673 investment grade 
issues and 210 non-investment grade rated issues.
    \183\ 1811 issues captured by the new proposed standard (with 
probability of default below 0.01%) consist of 1760 investment grade 
issues and 51 non-investment grade rated issues.
---------------------------------------------------------------------------

    As an alternative to providing a specific number as a threshold, 
the Commission could specify a method for distribution participants to 
use in calculating such a threshold. For example, such method could 
involve calculating probability of default for a sample of 
nonconvertible securities similar to the distribution participant's 
securities issued over a specified time interval and comparing it to 
investment grade status or another specified standard of credit-
worthiness. A longer time interval would capture more issues and 
improve statistical accuracy at expense of having market conditions 
potentially changing and generating incorrect estimates. A shorter time 
interval ensures the market conditions have not changed but includes 
fewer issues resulting in a smaller sample and lower statistical 
accuracy.
    The main advantage of specifying a method as opposed to a number 
for the threshold is its flexibility with respect to changing market 
conditions. The main disadvantage of this alternative is subjectivity 
of the analysis involved, which may lead to non-uniform application of 
the Regulation M exception across issues or issuers; or lead to market 
participants adjusting the estimation to be able to rely on the 
exception.
2. Exception Based on Security Characteristics
    As an alternative replacement for the reference to investment grade 
securities, the Commission has considered analysis that could be based 
on security characteristics, such as (1) total amount of issue 
outstanding (public float); (2) yield to maturity of the security 
during a past trading period; or (3) empirical duration.\184\ Other 
relevant security characteristics that could be used are outlined in 
the 2011 Proposal.\185\ Such analysis could be performed internally or 
externally and could be additionally verified by a third party. Below 
we discuss public float, yield to maturity and empirical duration 
criteria in more detail.
---------------------------------------------------------------------------

    \184\ Empirical duration is bond duration calculated based on 
historical data rather than a formula. Typically, it is estimated 
using a regression analysis of the relationship between market bond 
prices and Treasury yields.
    \185\ 2011 Proposing Release, 76 FR 26557-64.
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     Exception Based on the Total Amount of Issue Outstanding 
(Public Float).
    To the extent that it is more difficult to manipulate price of a 
larger issue, public float could be used as an alternative criterion to 
reflect manipulation risk. This criterion has the advantage of being 
straightforward and easy to evaluate. Due to its simplicity it lacks 
the estimation issues associated with other measures such as the 
probability of default. However, determination of a threshold for 
public float to select securities for the exception is complicated due 
to its considerable variation across issuers or industries. A specific 
threshold selection could potentially disadvantage smaller issuers--
especially during periods of market downturns when valuations are 
low.\186\
---------------------------------------------------------------------------

    \186\ See also a related discussion in supra note 70.
---------------------------------------------------------------------------

     Exception Based on Yield to Maturity.
    Securities that are traded primarily on yield and maturity have low 
manipulation risk, as discussed before, since their pricing does not 
reflect issuer specific risks. Yield to maturity, therefore, can be 
used as an alternative criterion to evaluate manipulation risk. 
However, using yield to maturity as a criterion for securities eligible 
for the exception is also problematic. Even though this criterion is 
similarly easy to obtain and lacks any major estimation issues, 
selecting a threshold is not straightforward. For instance, yield to 
maturity differs considerably by industry. Selecting a fixed threshold 
may result in some industries being under-represented and others over-
represented in the pool of eligible issues. Moreover, yield to maturity 
often moves with risk-free rates; thus fewer firms would be excepted 
during periods of high interest rates.
     Exception Based on Empirical Duration.
    Empirical duration is another alternative proxy that can be used to 
evaluate Nonconvertible Securities for an exception from Regulation M. 
Negative empirical duration might be an indication that a 
Nonconvertible Security or its issuer is of low credit-worthiness. A 
Nonconvertible Security with negative empirical duration is less 
impacted by changes in interest rates than Nonconvertible Securities of 
credit-worthy issuers and trades similar to equity securities. Although 
negative empirical duration may demonstrate that a particular issuer or 
security is not credit-worthy, it has some limitations that impact the 
viability of negative empirical duration as a substitute for the 
Investment Grade Exception. In particular, this measure relies heavily 
on statistical analysis, requires the Nonconvertible Security to be 
traded, and may lack intuitive interpretation, which renders empirical 
duration a poor proxy for the type of manipulation that Regulation M is 
designed to prevent.
3. Exception Based on Issuer Characteristics
    The Commission has also considered an exception based on issuer 
characteristics, for example, the interest coverage ratio, the WKSI 
standard, as suggested in the 2008 Proposal,\187\ or a criterion based 
on a reduced-form credit risk model, as an alternative to the 
Structural Credit Risk Models. We discuss these alternatives below.
---------------------------------------------------------------------------

    \187\ 2008 Proposing Release, 73 FR 40095-97.
---------------------------------------------------------------------------

     Exception Based on the WKSI Standard.
    The Commission could adopt the WKSI standard as a criterion to 
determine eligibility for the exception. The issuers that fall under 
the WKSI definition are large and established firms that typically have 
sound credit-worthiness. The advantage of this characteristic is its 
simplicity and straightforward calculations. However, the WKSI standard 
as discussed in the 2008 Proposal was heavily criticized, for instance 
for allowing risky high-yield issues to be eligible for the exception 
and preventing issues by smaller but

[[Page 18335]]

otherwise credit-worthy issuers from relying on the exception.\188\
---------------------------------------------------------------------------

    \188\ ABA Letter at 15-17 and SIFMA Letter 1 at 13.
---------------------------------------------------------------------------

     Exception Based on the Interest Coverage Ratio.
    Another possible issuer-based criterion for exception eligibility 
is the interest coverage ratio. A high interest coverage ratio 
typically indicates the issuer's ability to repay debt and can be used 
as a criterion to reflect credit-worthiness. It has the advantage of 
being a simple and easy to calculate value. However, the interest 
coverage ratio is an accounting measure that can result in inconsistent 
outcomes as it is based on the reported earnings rather than cash 
flows. Reported earnings may differ based on accounting practices of 
the firm. The proposed Structural Credit Risk Models have an advantage 
over interest coverage ratio since they are not dependent on reported 
earnings, which are heavily influenced by accounting practices.
     Exception Based on Reduced-Form Credit Risk Model.
    An alternative to using Structural Credit Risk Models is reduced-
form credit risk models.\189\ The latter models could be a good measure 
of credit-worthiness and of manipulation risk to the extent that 
credit-worthiness is a good proxy for manipulation risk. Unlike 
structural models, reduced-form models do not assume default occurs 
when firm value falls below a threshold. The default is instead assumed 
to follow an unobserved process and the default model can be fitted to 
the market data. The advantage of these models is they do away with 
some of the unrealistic requirements of Structural Credit Risk Models, 
for example when the firm value, its volatility or other required 
parameters are unobserved. Even though such models can be considered 
more flexible and may provide better fit for the observed default 
events, their ability to predict future defaults may not necessarily 
exceed that of the structural models. In addition, unlike structural 
models, they suffer from a lack of theoretical background of the 
assumed relationships, or the intuitive interpretation of the model 
dependencies and why the defaults occur. Unrestricted use of these 
models might also provide more opportunity to choose a reduced-form 
model specification which enables use of the exception.
---------------------------------------------------------------------------

    \189\ The reduced-form credit risk models are discussed, for 
example, in Robert Litterman & Thomas Iben, Corporate Bond Valuation 
and the Term Structure of Credit Spreads, 17 (3) Fin. Analysts J. 
52, 52-64 (1991); Robert A. Jarrow & Stuart M. Turnbull, Pricing 
Derivatives on Financial Securities Subject to Default Risk, 50 J. 
Fin. 53, 53-86 (1995); Robert A. Jarrow, David Lando, & Stuart M. 
Turnbull, A Markov Model for the Term Structure of Credit Risk 
Spreads, 10 Rev. Fin. Stud. 481, 481-523 (1997); Darrell Duffie & 
Kenneth J. Singleton, Modeling the Term Structures of Defaultable 
Bonds, 12 Rev. Fin. Stud. 687, 687-720 (1999).
---------------------------------------------------------------------------

4. Exception Based on Issuer and Issue Characteristics
    The Commission considered, as another alternative, an analysis 
based on both security and issuer characteristics; for example, 
characteristics outlined in Exchange Act Rule 15c3-1. Rule 15c3-1 
specifies a set of factors to determine a minimum amount of credit risk 
broker-dealers can use to determine if a security can qualify for lower 
haircuts: (1) Credit spreads; (2) securities-related research; (3) 
internal or external credit assessments; (4) default statistics; (5) 
inclusion in an index; (6) enhancements and priorities; (7) price, 
yield and/or volume; or (8) asset-class specific factors.\190\ Some of 
these factors, such as default statistics or credit assessments, 
measure issuer credit-worthiness, while others, such as price, yield, 
or volume, measure the manipulation risk present in each specific 
issue, providing a good overall assessment of manipulation risk.
---------------------------------------------------------------------------

    \190\ See Removal of Certain References to Credit Ratings Under 
the Securities Exchange Act of 1934, Release No. 34-71194 (Dec. 27, 
2013) [79 FR 1522, 1527-28 (Jan. 8, 2014)].
---------------------------------------------------------------------------

    The advantage of this alternative is that it would align the 
exception with already existing standards that broker-dealers might 
apply to determine whether a security has a minimal amount of credit 
risk. The standard in Rule 15c3-1 was adopted in 2013 as a replacement 
for a reference to investment grade securities pursuant to Section 939A 
of the Dodd-Frank Act. Such test could have minimum additional costs 
for broker-dealers who already have all the necessary procedures in 
place for its application.
    However, the scope and objectives of the 15c3-1 standard and the 
exception in Rules 101 and 102 of Regulation M are different: The 15c3-
1 standard applies only to broker-dealers, which already have the 
necessary arrangements in place to apply 15c3-1 standard, whereas the 
Regulation M exceptions affect a broader range of market participants. 
For example, banks involved in the relevant security issues will also 
be affected. Depending on these other participants' systems and 
regulatory obligations, it may be costly for them to replace the 
investment grade standard with the minimal credit risk standard. This 
could result in a situation where different distribution participants 
are facing different costs,\191\ possibly deterring some market 
participants.
---------------------------------------------------------------------------

    \191\ This is unlike the Structural Credit Risk Model based 
probability of default that would imply the same costs for all the 
participants who obtain the estimated values.
---------------------------------------------------------------------------

5. Elimination of the Exception
    The Commission also considered eliminating the exception for fixed-
income securities. The advantage of this alternative is a more uniform 
application of Regulation M, which eliminates the situations when 
manipulation-prone securities fall under the exception due to 
limitations of proxies used to select the securities to be excepted. 
For instance, as discussed above, there are various limitations of the 
Structural Credit Risk Models' applications, which may limit the 
ability of certain issuers to rely on the exception or allow issuers 
with a higher risk of having their securities manipulated to avoid 
Regulation M. If the exception is eliminated, any limitations of such a 
proxy for manipulation risk are eliminated as well.
    In addition, this approach could ultimately relieve broker-dealers 
from the need to spend time or costs to implement, understand, and 
calibrate any proposed standard such as a Structural Credit Risk Model. 
The Commission preliminarily believes that most broker-dealers already 
have the capability to undertake those calculations themselves or 
procure them from a data vendor and would benefit from the continued 
availability of an exception despite the costs.
    However, this approach raises a number of concerns. Specifically, 
eliminating the exception could make some offerings in the excepted 
securities considerably more costly. For example, with respect to 
reopenings, broker-dealers who might otherwise elect to reopen a bond 
offering may determine not to do so to avoid restrictions of Regulation 
M that could arise during such a reopening if it becomes a sticky 
offering. This could increase the cost of the issue that has to rely on 
the next-best alternative structure. Further, an alternative 
transaction structure, if selected, may decrease the liquidity of the 
securities being issued because they would not be fungible with the 
previously issued securities. This may also result in some distribution 
participants, such as broker-dealers, deciding not to participate. This 
could limit the number of available participants, potentially 
increasing fees faced by the issuers. Further, if certain

[[Page 18336]]

issues do not take place under the proposed amendments, it could reduce 
the selection of available securities for the investors in the relevant 
markets and may limit issuers' ability to raise capital.
    However, these costs might be mitigated because a party subject to 
the prohibitions of Rules 101 or 102 could structure its buying 
activity before or after the applicable restricted period so as not to 
incur any costs associated with relying on the exceptions.
    The above arguments apply to all currently excepted investment 
grade securities because any such issue can become a sticky offering 
and the distribution participants have to account and adjust for this 
possibility ex-ante. In a scenario where an underwriter is unable to 
sell its allotted securities to the public on or promptly after the 
pricing date, there is no exception on which to rely, the underwriter/
broker-dealer would likely ex-ante adjust the cost of issuance to 
reflect this added risk. Broker-dealers could be more cautious in 
structuring potentially sticky offerings if they know they will be 
required to comply with Regulation M (and have no exceptions 
available), by reducing an offering's size or increasing fees as a risk 
premium. This could potentially raise the cost of investment grade 
offerings. However, this could also decrease the probability of an 
offering to become sticky, potentially reducing manipulation risk in 
the relevant markets.
    The removal of the exception could also affect the liquidity of the 
fixed-income issues if reopenings of issues already in circulation are 
more costly, potentially reducing issuers' reliance on this financing 
structure, which negatively impacts the investors in the relevant 
markets.
    This alternative could also disrupt some established business 
relationships. In certain circumstances new relationships may need to 
be established. For example, if an offering becomes sticky, the issuer 
may need to seek a different broker-dealer to comply with the 
Regulation M requirements. This would increase costs of the affected 
security offerings, including the new broker dealer fees or the search 
costs, especially when the market has a limited number of available 
broker-dealers.
6. Alternative for Asset-Backed Securities
    As an alternative for asset-backed securities the Commission could 
use a standard based on the value at risk. Value at risk measures the 
percentage loss of the security in the worst case scenarios over a 
specified time period. It can be estimated by performing a simulation 
over the underlying securities' pool and determining the cash flows 
available to the asset-backed security in each scenario. A number of 
commercially available options can be used to perform this analysis. 
Value at risk can be a good indicator of manipulation risk since low 
value at risk indicates that the majority of the cash flows are 
sufficiently assured. The price of the asset-backed security in this 
case is more certain and is less subject to manipulation risk.
    However, value at risk is by construction estimated for a specified 
time period and thus only accounts for the potential losses during such 
period, while losses may also occur after this time period. In this 
case the price of the asset-backed security may depend on issue-
specific factors and be prone to manipulation despite the estimated 
value at risk over the specified time period being low. This may allow 
securities with high manipulation risk to rely on the exception.
7. Alternatives for Rule 102 Exception
    The Commission considered exempting all bonds issued by a foreign 
government or political subdivision thereof from Rule 102 of Regulation 
M. This would allow such issuers to avoid compliance costs associated 
with Regulation M requirements as discussed above. However, this 
alternative implies excepting non-investment grade foreign sovereign 
securities along with investment grade foreign sovereign securities. 
This may introduce considerable risk that some foreign sovereign 
issuers with low credit-worthiness and which are subject to a 
considerable geopolitical risk are allowed to rely on Regulation M 
exception. This could potentially result in a high pricing uncertainty 
and a high manipulation risk introduced into the relevant markets.
    The Commission also considered excepting asset-backed securities 
from Rule 102 that are offered pursuant to an effective shelf 
registration statement filed on Form SF-3. However, this alternative 
might introduce risk regarding issuers, selling shareholders, or their 
affiliated purchasers engaging in activity to favorably affect the 
distribution based on their interest in an offering's outcome, without 
any benefit to facilitating orderly distributions or to limiting 
potential disruptions in the trading market.\192\ These market 
participants, unlike distribution participants, may have an interest in 
the specific pricing of the issue and could benefit from engaging in 
activity that impacts the market. Thus, excepting such asset-backed 
securities from requirements of Regulation M could introduce 
manipulation risk in the relevant markets.
---------------------------------------------------------------------------

    \192\ See supra note 120.
---------------------------------------------------------------------------

F. 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.
    47. Are commenters aware of any additional examples of situations 
when Structural Credit Risk Models cannot be applied or are difficult 
to apply? Please explain why these situations occur.
    48. Are there any assumptions or inputs of Structural Credit Risk 
Models that may be relevant to the estimation of the probability of 
default and may require additional clarification?
    49. Do commenters agree with the Commission's assessment of the 
availability and associated costs of the estimates for probability of 
default based on Structural Credit Risk Models? Similarly, do 
commenters agree with the Commission's assessment of availability and 
associated costs of the necessary software or other resources necessary 
to obtain the estimates internally? Are there any factors that the 
Commission failed to consider?
    50. Do commenters agree with the Commission's assessment of the 
proposed method of threshold measurements? Would a different method of 
threshold have greater benefits or fewer costs than the proposed method 
of threshold measurements? It is difficult to select a threshold that 
would capture all of the investment grade securities and none of the 
non-investment grade securities due to the imperfect correlation of 
credit ratings and probability of default. Should the current method 
used to calculating the threshold aim at capturing a larger set of 
investments grade securities, such as a set above 90%, or aimed at 
capturing a smaller set of non-investment grade securities, such as 
fewer than 125 issues? Should a different date other than October 22, 
2021, for the analysis be selected? Should the Commission propose a 
method for calculating the threshold instead of proposing a number? 
Should the Commission provide guidance on the sample of securities, 
time interval, standard of credit-worthiness as a basis for comparison, 
or other specifications that should be used in this method?

[[Page 18337]]

    51. Are commenters aware of any available data that may help 
identify how many issuances of asset-backed securities with investment 
grade rating might be excluded under the proposed standard?
    52. Are commenters aware of cases when incorrect estimates of 
Structural Credit Risk Models' parameters result in inaccurate 
probability of default estimates? For example, cases when the estimated 
probability of default is high for an issuer with sound credit-
worthiness and vice versa. Please provide the supporting data and 
calculations if available.
    53. Are there cases where probability of default is not a 
reasonable proxy for credit-worthiness and therefore manipulation risk? 
If so, why is it a poor proxy in those cases?
    54. What concerns, if any, do commenters have regarding the counter 
cyclicality of probabilities of default implied by Structural Credit 
Risk Models?

IX. Regulatory Flexibility Act Certification

    Section 3(a) of the Regulatory Flexibility Act of 1980 \193\ 
(``RFA'') requires the Commission to undertake an initial regulatory 
flexibility analysis of the proposed rule on small entities unless the 
Commission certifies that the rule, if adopted, would not have a 
significant economic impact on a substantial number of small 
entities.\194\ Pursuant to Section 605(b) of the RFA, the Commission 
hereby certifies that the proposed amendments to the rule, would not, 
if adopted, have a significant economic impact on a substantial number 
of small entities. For purposes of Commission rulemaking in connection 
with the RFA, small entities include broker-dealers with total capital 
(net worth plus subordinated liabilities) of less than $500,000 on the 
date in the prior fiscal year as of which its audited financial 
statements were prepared pursuant to Rule 17a-5(d) under the Exchange 
Act,\195\ or, if not required to file such statements, a broker or 
dealer that had total capital (net worth plus subordinated liabilities) 
of less than $500,000 on the last day of the preceding fiscal year (or 
in the time that it has been in business, if shorter); and is not 
affiliated with any person (other than a natural person) that is not a 
small business or small organization.\196\
---------------------------------------------------------------------------

    \193\ 5 U.S.C. 603(a).
    \194\ 5 U.S.C. 605(b).
    \195\ See 17 CFR 240.17a-5(d).
    \196\ See 17 CFR 240.0-10(c).
---------------------------------------------------------------------------

    With respect to the amendments to Rules 101 and 102, it is unlikely 
that any broker-dealer who is defined as a ``small business'' or 
``small organization'' as defined in Rule 0-10 \197\ could be an 
underwriter or other distribution participant as it would not have 
sufficient capital to participate in underwriting activities. Small 
business or small organization for purposes of ``issuers'' or 
``person'' other than an investment company is defined as a person who, 
on the last day of its most recent fiscal year, had total assets of $5 
million or less.\198\ We believe that none of the various persons that 
would be affected by this proposal would qualify as a small entity 
under this definition as it is unlikely that any issuer of that size 
had investment grade securities that could rely on the existing 
exception. Therefore, we believe that these amendments would not impose 
a significant economic impact on a substantial number of small 
entities.
---------------------------------------------------------------------------

    \197\ 17 CFR 240.0-10.
    \198\ 17 CFR 240.0-10(a).
---------------------------------------------------------------------------

    We encourage written comments regarding this certification. The 
Commission solicits comment as to whether the proposed amendments to 
Rules 101 and 102, and Rule 17a-4 could have an effect on small 
entities that has not been considered. We request that commenters 
describe the nature of any impact on small entities and provide 
empirical data to support the extent of such impact.

X. Consideration of Impact on the Economy

    For purposes of the Small Business Regulatory Enforcement Fairness 
Act of 1996,\199\ the Commission is also requesting information 
regarding the potential impact of the proposed amendments on the 
economy on an annual basis. In particular, comments should address 
whether the proposed changes, if adopted, would have a $100,000,000 
annual effect on the economy, cause a major increase in costs or 
prices, or have a significant adverse effect on competition, 
investment, or innovations. Commenters are requested to provide 
empirical data and other factual support for their views to the extent 
possible.
---------------------------------------------------------------------------

    \199\ Public Law 104-121, Title II, 110 Stat. 857 (1996).
---------------------------------------------------------------------------

Statutory Basis and Text of Proposed Amendments

    Pursuant to the Exchange Act, 15 U.S.C. 78a et seq., and 
particularly Sections 3(b), 15, 23(a), and 36 (15 U.S.C. 78c(b), 78o, 
78w(a), and 78mm) thereof, and Sections 939 and 939A of the Dodd-Frank 
Act, the Commission is proposing to amend Exchange Act Rules 101 and 
102.

List of Subjects in 17 CFR Part 240 and 242

    Broker-dealers, Fraud, Issuers, Reporting and recordkeeping 
requirements, Securities.

Text of Rule Amendments

    For the reasons in the preamble, title 17, chapter II of the Code 
of Federal Regulations is proposed to be amended as follows:

PART 240--GENERAL RULES AND REGULATIONS, SECURITIES EXCHANGE ACT OF 
1934

0
1. The authority citation for part 240 continues to read, in part, as 
follows:

    Authority:  15 U.S.C. 77c, 77d, 77g, 77j, 77s, 77z-2, 77z-3, 
77eee, 77ggg, 77nnn, 77sss, 77ttt, 78c, 78c-3, 78c-5, 78d, 78e, 78f, 
78g, 78i, 78j, 78j-1, 78k, 78k-1, 78l, 78m, 78n, 78n-1, 78o, 78o-4, 
78o-10, 78p, 78q, 78q-1, 78s, 78u-5, 78w, 78x, 78dd, 78ll, 78mm, 
80a-20, 80a-23, 80a-29, 80a-37, 80b-3, 80b-4, 80b-11, and 7201 et 
seq., and 8302; 7 U.S.C. 2(c)(2)(E); 12 U.S.C. 5221(e)(3); 18 U.S.C. 
1350; Pub. L. 111-203, 939A, 124 Stat. 1376 (2010); and Pub. L. 112-
106, sec. 503 and 602, 126 Stat. 326 (2012), unless otherwise noted.
* * * * *
    Section 240.17a-4 also issued under secs. 2, 17, 23(a), 48 Stat. 
897, as amended; 15 U.S.C. 78a, 78d-1, 78d-2; sec. 14, Pub. L. 94-
29, 89 Stat. 137 (15 U.S.C. 78a); sec. 18, Pub. L. 94-29, 89 Stat. 
155 (15 U.S.C. 78w);
* * * * *
0
2. Amend Sec.  240.17a-4 by adding paragraph (b)(17) to read as 
follows:


Sec.  240.17a-4   Records to be preserved by certain exchange members, 
brokers and dealers.

* * * * *
    (b) * * *
    (17) The written probability of default determination pursuant to 
Sec.  242.101(c)(2)(i) of this chapter (Rule 101 of Regulation M).
* * * * *

PART 242--REGULATIONS M, SHO, ATS, AC, NMS, AND SBSR AND CUSTOMER 
MARGIN REQUIREMENTS FOR SECURITY FUTURES

0
3. The authority citation for part 242 continues to read as follows:

    Authority:  15 U.S.C. 77g, 77q(a), 77s(a), 78b, 78c, 78g(c)(2), 
78i(a), 78j, 78k-1(c), 78l, 78m, 78n, 78o(b), 78o(c), 78o(g), 
78q(a), 78q(b), 78q(h), 78w(a), 78dd-1, 78mm, 80a-23, 80a-29, and 
80a-37.

0
4. Amend Sec.  242.101 by revising paragraph (c)(2) to read as follows:

[[Page 18338]]

Sec.  242.101   Activities by distribution participants.

* * * * *
    (c) * * *
    (2) Certain nonconvertible and asset-backed securities. (i) The 
nonconvertible debt securities and nonconvertible preferred securities 
of issuers for which the probability of default, estimated as of the 
day of the determination of the offering pricing and over the horizon 
of 12 calendar months from such day, is less than 0.055%, as determined 
and documented in writing by the distribution participant using a 
structural credit risk model; provided, however, that, for purposes of 
this paragraph, the term ``structural credit risk model'' shall mean 
any commercially or publicly available model that calculates the 
probability that the value of the issuer may fall below a threshold 
based on an issuer's balance sheet; or
    (ii) Asset-backed securities that are offered pursuant to an 
effective shelf registration statement filed on Form SF-3 (17 CFR 
239.45).
* * * * *


Sec.  242.102   [Amended]

0
5. Amend Sec.  242.102 by removing and reserving paragraph (d)(2).

    By the Commission.

    Dated: March 23, 2022.
Vanessa A. Countryman,
Secretary.
[FR Doc. 2022-06583 Filed 3-29-22; 8:45 am]
BILLING CODE 8011-01-P