SEC’s Dodd-Frank credit ratings interpretation critiqued

Author: | Published: 9 Aug 2011
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The SEC did not interpret Dodd-Frank’s Section 939A requirement to remove credit ratings from short-form eligibility criteria to decrease the number of short-form issuers. New rules adopted on July 26 may do just the opposite according to US counsel.

In response to 48 comment letters from law firms, companies and others, the Securities and Exchange Commission (SEC) amended its new rules on short form registration requirements for non-convertible debt securities issuers (Form S-3 and Form F-3) to make them less restrictive.

The original proposal made in February featured only one alternative for the transaction requirement – an issuance of at least $1 billion in non-convertible securities for cash in registered offerings over the prior three years.

The enacted rule includes three other alternatives: possession of at least $750 million of outstanding non-convertible registered securities, other than common equity, issued in primary offerings for cash; being a wholly-owned subsidiary of a well-known seasoned issuer; or being a majority-owned operating partnership of a real estate investment trust that qualifies as a well known seasoned issuer.

The new rules are due to come into effect on September 2. They also include a three-year grandfather provision that allows issuers to remain eligible based on an NRSRO investment grade credit rating.

“They wanted to make sure there wasn’t such a jolt to the system in implementing the new rules,” said Sey-Hyo Lee, partner with Chadbourne & Parke.

“It would be sort of jarring for the issuers to be eligible today and then not be eligible tomorrow.”

“The new rules only affect those investment grade issuers who do not meet the public float test of having $75 million of common equity held by non-affiliated shareholders, which is a sliver of the population,” Lee says.

The Commission estimates a net increase of 12 short-form issuers under the new rules, with four companies losing short form eligibility and 16 companies becoming eligible for Forms S-3 and F-3.

While the rules won’t have a significant impact on the number, or quality, of short form issuers, they do end the Commission’s endorsement of credit ratings and credit rating agencies.

“It’s important that they disentangle themselves as they are required to under Dodd-Frank, and they no longer appear to give a seal of approval to ratings,” Gibson Dunn & Crutcher partner Andrew Fabens says.

“That’s not to say that ratings aren’t important, but there’s no reason to rely on them in this area,” he added.

While credit ratings have been removed from short-run registration criteria for non-convertible debt securities, the same cannot be said for asset-backed securities.

The Commission re-proposed a rule that would remove credit ratings from consideration of asset-backed securities seeking shelf eligibility. This proposal has not been approved, but should make a greater impact than the new rule for debt securities.

“That market has been at the centre of all the disruption over the last couple of years. There is still uncertainty as to what the regulations are looking like,” Fabens says. “Market participants, the SEC and other regulators are still considering how that market should be regulated.”

New rules on short form registration don’t have much of an effect on the market for non-convertible debt securities, but they do symbolise a greater trend. The Commission does not seek to legitimise credit ratings by using them as measuring sticks for regulatory purposes.