The Securities and Exchange Commission has proposed rule changes to remove the use of credit ratings from rules and forms under the Investment Company Act of 1940. Release Nos. 33-9193, IC-29592 (Mar. 3, 2011). The rule changes are mandated by Section 939A of the Dodd-Frank Wall Street Reform and Consumer Protection Act, which requires all federal agencies to modify their rules to remove any reference to or requirement of reliance on credit ratings and to substitute such standard of credit-worthiness as they shall determine as appropriate. The most significant amendments proposed are those to Rule 2a-7, which governs money market funds.
Under the proposed amendments, a security would be an eligible security for investment by money market funds only if the board of directors (or its delegate) determines that it presents minimal credit risks, which determination must be based on factors pertaining to credit quality and the issuer's ability to meet its short-term financial obligations. An eligible security would be a first tier security (regardless of the ratings it has received from any credit rating agency) if the fund's board (or its delegate) determines that the issuer (or in the case of a security subject to a guarantee, the guarantor) has the highest capacity to meet its short-term financial obligations, meaning that it has an exceptionally strong ability to repay its short-term debt obligations and the lowest expectation of default. The credit risk associated with a second tier security, which would continue to be limited to 3% of total fund assets, would differ from that associated with first tier securities only to a small degree. The amendments are designed to retain a degree of risk limitation on money market funds similar to the current rule.
The proposed amendments would also require that, in the event the money market fund's adviser (or any person to whom the board has delegated portfolio management responsibilities) becomes aware of any credit information about a portfolio security or an issuer of a portfolio security that suggests that the security is no longer a first tier security or a second tier security, as the case may be, the board or its delegate would have to reassess promptly whether the portfolio security continues to present minimal credit risks. This requirement would replace the existing requirement that a board or its delegate must promptly reassess whether a security whose credit rating has been downgraded continues to present minimal credit risks. To satisfy the proposed standard, an investment adviser would be required to exercise reasonable diligence in keeping abreast of new information about a portfolio security that the adviser believes to be credible.
Comments on the rule proposal should be received on or before April 25, 2011. The proposal is available online at
For the SEC's press release announcing the rule proposal, including a fact sheet summarizing the changes, see
John M. Baker <JMB@...
Stradley Ronon Stevens & Young, LLP http://www.stradley.com
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