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The SEC has proposed rules that would remove references to credit ratings in several rules under the Exchange Act.  These proposals represent the next step in a series of actions taken under the Dodd-Frank Wall Street Reform and Consumer Protection Act to remove references to credit ratings within agency rules and, where appropriate, replace them with alternative criteria.  Under Dodd-Frank, federal agencies must review how their existing regulations rely on credit ratings as an assessment of creditworthiness. At the conclusion of this review, each agency is required to report to Congress on how the agency modified these references to replace them with alternative standards that the agency determined to be appropriate.

The proposal addresses the following topics:

  • Removing References to Credit Ratings in the SEC’s Net Capital Rule for Broker-Dealers
  • Removing References to Credit Ratings in the Definition of “Major Market Foreign Currency”
  • Removing References to Credit Ratings When Determining Net Capital Charges for Credit Risk
  • Removing References to Credit Ratings in Rule 15c3-3
  • Removing References to Credit Ratings in Rules 101 and 102 of Regulation M
  • Removing References to Credit Ratings in Rule 10b-10

The SEC is also is requesting comment on potential standards of creditworthiness for purposes of Exchange Act Sections 3(a)(41) and 3(a)(53), which define the terms “mortgage related security” and “small business related security,” respectively, as the SEC considers how to implement Section 939(e) of the Dodd-Frank Act.

In a statement at the meeting in which the rules were adopted, Commissioner Luis A. Aguilar said “In order to generate comments on today’s proposal, I will support the proposal, but I have serious concerns. As one example, I am troubled about the proposed amendments to Rule 15c3-1, the net capital rule, because it does not appear that we have been able to identify an appropriate substitute for credit ratings.”  He continued quoting a commentator on a previous proposed rule that “[T]here is an inherent conflict of interest involved in allowing broker-dealers to evaluate the credit risk of the securities they hold, and thereby determine how much capital they must hold against those securities. Such a system creates an incentive for broker-dealers to overestimate the creditworthiness of those securities so as to minimize the amount of required capital and thereby to minimize the broker-dealer’s costs.”

Check frequently for updates on the Dodd-Frank Act and other important securities law matters.

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