August 16, 2011

More on Credit Rating Removal: Rule 134

Another aspect of the credit rating removal rulemaking that I blogged about yesterday is the amendment of Securities Act Rule 134 to remove paragraph (a)(17), which permitted the disclosure of a security rating assigned, or reasonably expected to be assigned, by a nationally recognized statistical rating organization (NRSRO) in a Rule 134 notice (or “tombstone” as some like to call it). Rule 134, of course, provides that a communication published after a registration statement with a Section 10(a) prospectus is on file and limited to the Rule 134 content will not be considered a prospectus or free writing prospectus for the purposes of the SEC’s rules.

Rule 134(a)(17) appears to be arguably an innocent bystander in the quest to remove credit ratings from SEC rules and forms prompted by Section 939A of the Dodd-Frank Act, which required the SEC to “review any regulation … that requires the use of an assessment of the credit-worthiness of a security or money market instrument and any reference to or requirements in such regulations regarding credit ratings.” Nonetheless, the SEC believed that the presence of the reference in Rule 134 represented reliance on credit ratings, and ultimately determined that the change would not have a material impact on the information available to investors “because issuers will (as is common now) be able to disclose a credit rating in a free writing prospectus.” In fact, the free writing prospectus is now pretty much the only place where a credit rating can be disclosed in a securities offering, because Dodd-Frank’s repeal of Rule 436(g), as a practical matter, prevents the disclosure of credit ratings in a prospectus (or report incorporated by reference into a prospectus) for the purpose of offering the security.

The SEC did note that the removal of the safe harbor for the credit rating reference did not necessarily result in a communication that included rating information being deemed to be a prospectus or a free writing prospectus, rather the issuer would have to make the determination now based on all of the facts and circumstances. While that statement is helpful, I am not sure if it provides too much comfort in the Rule 134 context, so that by and large I expect that we will say goodbye to ratings in Rule 134 notices come September 2. (Note that the SEC did not rescind or otherwise amend Item 10(c) of Regulation S-K as part of the quest to remove credit ratings, which governs how disclosure of credit ratings should be provided when an issuer elects to include disclosure of credit ratings in an SEC filing)

Testing the Bounds of the Disqualification Waiver

A few weeks back, the SEC denied Xerox Corporation’s request for a waiver of the disqualification provisions of forward looking statement safe harbors found in Securities Act Section 27A and Exchange Act Section 21E, which arose because Xerox acquiree Affiliated Computer Services, Inc. had settled a civil action with the SEC, which subjected Affiliated Computer Services to an order prohibiting future violations of the antifraud provisions of the federal securities laws.

The SEC decided to deny the waiver request on the grounds that the disqualification provisions in the forward looking statement safe harbors did not apply to Xerox, because Xerox acquired Affiliated Computer Services after the violations alleged in the SEC’s action were committed and Xerox did not otherwise become subject to the SEC’s order. This appears to be the first time that the SEC has addressed this issue.

Large Trader Reporting Rules Adopted

With all of the volatility in the markets over the past few weeks, it reminds us that much of the concern coming out of the financial crisis focused on identifying and evaluating systemic risk. A few weeks back, the SEC moved a bit closer to having enhanced insight into market movements with the adoption of the large trader reporting rules. As this Alston & Bird memorandum notes:

The large trader reporting requirements are intended to provide the Commission with data to support its investigative and enforcement activities, as well as to facilitate its ability to assess the impact of large trader activity on the securities markets, to reconstruct trading activity following periods of unusual market volatility, and to analyze significant market events for regulatory purposes. The Commission has had the authority to adopt a large trader regime for 20 years. In response to the market crash of 1987 (and the less severe break of 1989), Congress passed the Market Reform Act of 1990, which, in part, added Section 13(h) to the Exchange Act.3 Section 13(h) specifically authorized the Commission to establish large trader reporting and was intended to provide the SEC with the ability to identify causes of market disruption. The Commission proposed a large trader registration and reporting regime for the third time shortly before the flash crash of May 6, 2010, in which the Dow Jones Industrial Average fell about 900 points and then recovered those losses within minutes. The flash crash and the recent financial crisis prodded the Commission to finally and unanimously adopt these new requirements.

The rule’s effective date is October 2, 2011. Those entities identified as “Large Traders” must comply with the self-identification requirements of Rule 13h-1(b) by December 1, 2011. Broker-dealers must comply with the recordkeeping, reporting and monitoring requirements by April 30, 2012.

– Dave Lynn