Purchase of Certain Debt Securities by Business and Industrial Development Companies Relying on an Investment Company Act Exemption, 70117-70121 [2012-28456]

Download as PDF Federal Register / Vol. 77, No. 226 / Friday, November 23, 2012 / Rules and Regulations Dated: November 19, 2012. Elizabeth M. Murphy, Secretary. [FR Doc. 2012–28455 Filed 11–21–12; 8:45 am] BILLING CODE 8011–01–P SECURITIES AND EXCHANGE COMMISSION 17 CFR Part 270 [Release No. IC–30268; File No. S7–07–11] RIN 3235–AL02 Purchase of Certain Debt Securities by Business and Industrial Development Companies Relying on an Investment Company Act Exemption Securities and Exchange Commission. ACTION: Final rule. AGENCY: The Securities and Exchange Commission (‘‘Commission’’) is adopting a new rule under the Investment Company Act of 1940 (‘‘Investment Company Act’’) to establish a standard of credit-worthiness in place of a statutory reference to credit ratings that the Dodd-Frank Wall Street Reform and Consumer Protection Act (‘‘Dodd-Frank Act’’) removes. The rule will establish the standard of credit quality that must be met by certain debt securities purchased by entities relying on the Investment Company Act exemption for business and industrial development companies. DATES: Effective date: December 24, 2012. SUMMARY: Anu Dubey, Senior Counsel, or Penelope Saltzman, Assistant Director (202) 551– 6792, Office of Regulatory Policy, Division of Investment Management, Securities and Exchange Commission, 100 F Street NE., Washington, DC 20549–8549. SUPPLEMENTARY INFORMATION: The Commission is adopting new rule 6a–5 [17 CFR 270.6a–5] under the Investment Company Act.1 FOR FURTHER INFORMATION CONTACT: emcdonald on DSK7TPTVN1PROD with RULES Table of Contents I. Background II. Discussion III. Paperwork Reduction Act IV. Economic Analysis V. Final Regulatory Flexibility Analysis Statutory Authority Text of Rule 1 15 U.S.C. 80a–1. Unless otherwise noted, all references to statutory sections are to the Investment Company Act, and all references to rules under the Investment Company Act are to Title 17, Part 270 of the Code of Federal Regulations [17 CFR part 270]. VerDate Mar<15>2010 12:46 Nov 21, 2012 Jkt 229001 I. Background The Dodd-Frank Act was enacted on July 21, 2010.2 Section 939(c) of the Dodd-Frank Act removes a reference to credit ratings from section 6(a)(5) of the Investment Company Act and replaces it with a reference to ‘‘such standards of credit-worthiness as the Commission shall adopt.’’ 3 To implement this mandate, last year the Commission proposed new rule 6a–5 under the Investment Company Act that would establish a credit-worthiness standard to replace the credit rating reference in section 6(a)(5) of that Act that the DoddFrank Act eliminates.4 We received one comment letter regarding proposed rule 6a–5, which we discuss below.5 Today, we are adopting new rule 6a–5, which implements section 939(c) of the DoddFrank Act. II. Discussion Business and industrial development companies (‘‘BIDCOs’’) are companies 2 Public Law 111–203, 124 Stat. 1376 (2010). 939(c) of the Dodd-Frank Act (amending section 6(a)(5)(A)(iv)(I) of the Investment Company Act). This amendment to the Investment Company Act becomes effective on July 21, 2012. See section 939(g) of the Dodd-Frank Act. 4 See References to Credit Ratings in Certain Investment Company Act Rules and Forms, Investment Company Act Release No. 29592 (Mar. 3, 2011) [76 FR 12896 (Mar. 9, 2011)] (‘‘2011 Proposing Release’’). In that release, we also proposed amendments to replace references to credit ratings in rules 2a–7 and 5b–3 under the Investment Company Act and Forms N–1A, N–2, N–3 and N–MFP under the Investment Company Act and the Securities Act of 1933 (15 U.S.C. 77a). Those proposed amendments would implement section 939A of the Dodd-Frank Act, which requires the Commission to review its regulations for any references to or requirements regarding credit ratings that require the use of an assessment of the credit-worthiness of a security or money market instrument, remove these references or requirements, and substitute in those regulations other standards of credit-worthiness that we determine to be appropriate. We intend to address the proposed amendments to rule 2a–7, rule 5b–3 and Forms N–1A, N–2, N–3 and N–MFP separately. Rule 3a–7 under the Investment Company Act also contains a reference to ratings. In August 2011, in a concept release soliciting comment on the treatment of asset-backed issuers under the Investment Company Act, we sought comment on the role, if any, that credit ratings should continue to play in the context of rule 3a–7. See Treatment of Asset-Backed Issuers under the Investment Company Act, Investment Company Act Release No. 29779 (Aug. 31, 2011) [76 FR 55308 (Sept. 7, 2011)] at Section III.A.1. 5 The comment letters on the 2011 Proposing Release (File No. S7–07–11) are available at https://www.sec.gov/comments/s7-07-11/s70711. shtml. In addition, to facilitate public input on the Dodd-Frank Act, we provided a series of email links, organized by topic on our Web site at https:// www.sec.gov/spotlight/regreformcomments.shtml. The public comments we received in response to our solicitation for comment on Title IX of the Dodd-Frank Act (which includes sections 939 and 939A) are available on our Web site at https://www. sec.gov/comments/df-title-ix/credit-rating-agencies/ credit-rating-agencies.shtml. 3 Section PO 00000 Frm 00013 Fmt 4700 Sfmt 4700 70117 that operate under state statutes that provide direct investment and loan financing, as well as managerial assistance, to state and local enterprises.6 Because they invest in securities, BIDCOs frequently meet the definition of ‘‘investment company’’ under the Investment Company Act.7 In 1996, the Investment Company Act was amended to add section 6(a)(5) to exempt these companies from most provisions of the Act subject to certain conditions.8 The statutory exemption was premised on states having a strong interest in overseeing the structure and operations of these companies, thus rendering regulation under the Investment Company Act largely duplicative and unnecessary.9 BIDCOs that seek to rely on the exemption in section 6(a)(5) are limited with respect to the types of securities issued by investment companies and companies exempt from the definition of investment company under section 3(c)(1) or 3(c)(7) of the Investment Company Act (‘‘private funds’’) that they may purchase. Specifically, section 6(a)(5)(A)(iv) prohibits these BIDCOs from purchasing securities issued by investment companies and private funds other than debt securities that are rated investment grade by at least one NRSRO and securities issued by registered open-end investment companies that invest at least 65 percent of their assets in investment grade 6 See Report of the Senate Committee on Banking, Housing and Urban Affairs to Accompany S. 479, S. Rep. No. 103–166, at 11 (1993) (‘‘1993 Senate Report’’). 7 For purposes of the Investment Company Act, an ‘‘investment company’’ means any issuer that: (A) Is or holds itself out as being engaged primarily, or proposes to engage primarily, in the business of investing, reinvesting, or trading in securities; (B) is engaged or proposes to engage in the business of issuing face-amount certificates of the installment type, or has been engaged in such business and has any such certificate outstanding; or (C) is engaged or proposes to engage in the business of investing, reinvesting, owning, holding, or trading in securities, and owns or proposes to acquire investment securities having a value exceeding 40 per centum of the value of such issuer’s total assets (exclusive of government securities and cash items) on an unconsolidated basis. 15 U.S.C. 80a–3(a)(1). 8 15 U.S.C. 80a–6(a)(5); Public Law 104–290 § 501, 110 Stat. 3416, 3444 (1996). Section 6(a)(5)(B) provides that section 9 and, to the extent necessary to enforce section 9, sections 38 through 51, apply to a BIDCO as though the company were a registered investment company. Among other conditions to reliance on the exemption in section 6(a)(5), a BIDCO may not issue redeemable securities. 9 See 1993 Senate Report, supra note 6, at 19 (further stating that states are well positioned to monitor these companies and address the needs of resident investors). Prior to the addition of section 6(a)(5), the Commission had granted orders to exempt BIDCOs from regulation under the Act. See, e.g., The Idaho Company, Investment Company Release Nos. 18926 (Sept. 3, 1992) (notice) and 18985 (Sept. 30, 1992) (order). E:\FR\FM\23NOR1.SGM 23NOR1 70118 Federal Register / Vol. 77, No. 226 / Friday, November 23, 2012 / Rules and Regulations emcdonald on DSK7TPTVN1PROD with RULES securities or securities that the fund determines are comparable in quality.10 This provision was intended to provide limited flexibility to invest capital not immediately needed for the company’s long-term commitments.11 Although the legislative history of the provision does not specifically explain why Congress restricted BIDCOs to acquiring ‘‘investment grade’’ debt of investment companies and private funds, as we noted in the 2011 Proposing Release, it may have been designed to limit BIDCOs to investing in debt securities of sufficiently high credit quality that they are likely to maintain a fairly stable market value and that could be liquidated easily, as appropriate, for the BIDCO to support its investment and financing activities.12 As described above, section 939(c) of the Dodd-Frank Act eliminates the credit rating reference in section 6(a)(5)(A)(iv) of the Investment Company Act. Instead of limiting BIDCOs to purchasing debt securities issued by investment companies and private funds that are rated ‘‘investment grade,’’ the amendment requires such debt securities to meet ‘‘such standards of credit-worthiness as the Commission shall adopt.’’ We do not understand that the statutory amendment was intended to change the standard of credit quality represented by an investment grade rating. Accordingly, we are adopting rule 6a–5, as proposed, to establish a standard of credit-worthiness designed to achieve the same degree of risk limitation as the credit rating it replaces. Rule 6a–5 deems a BIDCO to have met the requirements for credit-worthiness of certain debt securities under section 6(a)(5)(A)(iv)(I) if the board of directors or members of the company (or its or 10 15 U.S.C. 80a–6(a)(5)(A), as in effect prior to July 21, 2012 (exempting any company that is not engaged in the business of issuing redeemable securities, the operations of which are subject to regulation by the State in which the company is organized under a statute governing entities that provide financial or managerial assistance to enterprises doing business, or proposing to do business in that state if, among other things, the company does not purchase any security issued by an investment company or by any company that would be an investment company except for the exclusions from the definition of the term ‘‘investment company’’ under sections 3(c)(1) or 3(c)(7), other than (I) any debt security that is rated investment grade by not less than 1 nationally recognized statistical rating organization; or (II) any security issued by a registered open-end fund that is required by its investment policies to invest not less than 65% of its total assets in securities described in subclause (I) or securities that are determined by such registered open-end fund to be comparable in quality to securities described in subclause (I)). 11 See 1993 Senate Report, supra note 6, at 20. 12 See 2011 Proposing Release, supra note 4, at Section II.D. VerDate Mar<15>2010 12:46 Nov 21, 2012 Jkt 229001 their delegate) determines, at the time of purchase, that the debt security is (i) subject to no greater than moderate credit risk and (ii) sufficiently liquid that the security can be sold at or near its carrying value within a reasonably short period of time.13 The board of directors or members of a BIDCO (or its or their delegate) would have to make this determination at the time of acquisition of the securities.14 As a result of rule 6a–5, section 6(a)(5) of the Investment Company Act will also limit a BIDCO’s investments in registered open-end funds to those funds that invest at least 65 percent of their assets in debt securities that meet our standard.15 The final rule does not, as one commenter suggested, include specific factors or tests that the board must apply in performing its credit analysis.16 We believe that the new credit quality standards (that the debt security be subject to no greater than moderate credit risk and be sufficiently liquid that it can be sold at or near its carrying value within a reasonably short period of time) are clear enough for a BIDCO’s board or members (or its or their delegate) to understand the risks acceptable under the rule. We note that the number and scope of factors that may be appropriate to making a credit quality determination with respect to a security may vary significantly depending on the particular security. We are concerned that prescribing a list of specific factors in a rule today might function as a limit to the credit quality analysis that boards or members would undertake and may not address information that would be relevant to credit quality determinations regarding 13 Rule 6a–5. The standard for credit-worthiness that we are adopting in rule 6a–5 is similar to the standard that we adopted in rule 10f–3 under the Investment Company Act. Rule 10f–3 defines eligible municipal securities as securities that are sufficiently liquid that they can be sold at or near their carrying value within a reasonably short period of time and either are subject to no greater than moderate credit risk or, if the issuer has been in operation for less than three years, the securities are subject to a minimal or low amount of credit risk. See rule 10f–3(a)(3). 14 Rule 6a–5. 15 Section 6(a)(5)(A)(iv)(II) (permitting a BIDCO to purchase any security issued by a registered openend fund that is required by its investment policies to invest not less than 65% of its total assets in securities described in subclause (I) (i.e., securities that meet the standards of credit-worthiness that the Commission adopts) or securities that are determined by such registered open-end fund to be comparable in quality to securities described in subclause (I)). 16 See Better Markets Comment Letter (Apr. 25, 2011) (‘‘Better Markets Comment Letter’’) (asserting that the proposed standard is vague and would undermine the reliability of a board’s credit risk determinations and the board’s accountability for such determinations). PO 00000 Frm 00014 Fmt 4700 Sfmt 4700 new types of debt securities that investment companies or private funds may issue and in which BIDCOs may invest in the future.17 The standard we are adopting is designed to limit BIDCOs to purchasing debt securities issued by investment companies or private funds of sufficiently high credit quality that they are likely to maintain a fairly stable market value and may be liquidated easily, as appropriate, for the BIDCO to support its investment and financing activities.18 Debt securities (or their issuers) subject to a moderate level of credit risk would demonstrate at least average credit-worthiness relative to other similar debt issues (or issuers of similar debt).19 Moderate credit risk would denote current low expectations of default risk associated with the security, with an adequate capacity for payment by the issuer of principal and interest.20 In making their credit quality determinations, a BIDCO’s board of directors or members (or its or their delegate) can also consider credit quality reports prepared by outside sources, including NRSRO ratings, that the BIDCO board or members conclude are credible and reliable for this purpose. III. Paperwork Reduction Act The Paperwork Reduction Act of 1995 (‘‘PRA’’) imposes certain requirements on federal agencies in connection with their conducting or sponsoring any collection of information as defined by the PRA. Rule 6a–5 does not create any new collections of information. IV. Economic Analysis As discussed above, we are adopting a new rule to implement section 939(c) of the Dodd-Frank Act to replace a statutory reference to a credit rating with an alternative credit-worthiness standard. We considered the economic effects, including costs and benefits, of our proposed new rule in the 2011 Proposing Release and we discuss below the comment received related to our analysis. The Commission has discretion in adopting the alternative standard of credit-worthiness, and we undertake 17 We also agree with this commenter, who acknowledged that a reliable and objective shorthand measure of credit risk that could be incorporated into Commission regulations is currently unavailable. See Better Markets Comment Letter. 18 See supra note 12 and accompanying text. 19 See References to Ratings of Nationally Recognized Statistical Rating Organizations, Investment Company Act Release No. 28939 (Oct. 5, 2009) [74 FR 52358 (Oct. 9, 2009)] at n.86 (release adopting amendments to rule 10f–3). 20 Id. E:\FR\FM\23NOR1.SGM 23NOR1 emcdonald on DSK7TPTVN1PROD with RULES Federal Register / Vol. 77, No. 226 / Friday, November 23, 2012 / Rules and Regulations below to discuss the economic effects of the new rule that are within our discretion under the Dodd-Frank Act, in addition to the economic effects of removing rating references from statutory provisions, as mandated by the Dodd-Frank Act itself. The two types of costs and benefits may not be entirely separable to the extent that our discretion is exercised to realize the benefits intended by the Dodd-Frank Act. In evaluating the economic effects of new rule 6a–5, we compare section 6(a)(5) of the Investment Company Act, as currently in effect (which includes a reference to a rating), with the new rule we are adopting. Rule 6a–5 establishes a creditworthiness standard under section 6(a)(5)(A)(iv)(I) of the Investment Company Act. BIDCOs that seek to rely on the exemption in section 6(a)(5) of the Act are limited to investing in debt securities issued by investment companies and private funds if, at the time of purchase, the board of directors or members of the BIDCO (or its or their delegate) determines that the debt security is (i) subject to no greater than moderate credit risk and (ii) sufficiently liquid that the security can be sold at or near its carrying value within a reasonably short period of time. We anticipate that the adoption of rule 6a–5 may result in certain benefits. First, we do not understand that by amending section 6(a)(5), Congress intended to change the credit quality of the debt securities that BIDCOs may purchase and our rule is designed to establish a similar credit quality standard in order to achieve the same limitation on risk as the credit rating it replaces. In particular, the amended standard is designed to limit BIDCOs to purchasing debt securities issued by investment companies or private funds of sufficiently high credit quality that they are likely to maintain a fairly stable market value and may be liquidated easily, as appropriate, for the BIDCO to support its investment and financing activities. Second, the subjective credit quality standard in amended rule 6a–5 may provide BIDCOs greater flexibility in determining the pool of eligible debt securities in which they may invest. Finally, the credit quality standard in new rule 6a–5 may further Congress’ stated purpose of reducing reliance on ratings in the context of a BIDCO’s purchase of certain debt securities.21 We also recognize that BIDCOs may incur some costs as a result of the adoption of new rule 6a–5. These may 21 See Report of the House of Representatives Financial Services Committee to Accompany H.R. 4173, H. Rep. No. 111–517, at 871 (2010). VerDate Mar<15>2010 12:46 Nov 21, 2012 Jkt 229001 be internal costs or costs to consult outside legal counsel to evaluate whether changes to any policies and procedures the BIDCOs may have currently for acquiring debt securities issued by investment companies or private funds may be appropriate in light of the new rule. We expect that, although not required by the Investment Company Act, as a matter of good business practice, directors or members of most BIDCOs that do not currently have them may prepare policies and procedures to make the credit quality and liquidity determinations required by the new rule. Staff estimates that BIDCOs will incur the costs of preparing the procedures for making determinations of credit quality and liquidity under the rule once, and directors and members of BIDCOs (or their delegates) will be able to follow these procedures for purposes of making future determinations under the rule. Commission staff estimated in the 2011 Proposing Release that each BIDCO would incur, on average, an initial onetime cost of $1000 to prepare policies and procedures and an average of $1000 in annual costs for making credit determinations with respect to the acquisition of debt securities.22 We 22 See 2011 Proposing Release, supra note 4, at n.112. Staff does not have reliable data and is not aware of any databases that compile information regarding the number of existing BIDCOs. Moreover, we received no data from commenters. We note that some state regulators disclose the number of BIDCOs registered in the state on the regulators’ Web sites. Of those that do, the number of registered BIDCOs ranges from one to 10. See, e.g., Louisiana Office of Financial Institutions at https://www.ofi.state.la.us/ (listing 10 BIDCOs in a directory of active BIDCOs); California Department of Financial Institutions at https://www.dfi.ca.gov/ directory/bidco.asp (listing one BIDCO in a directory of BIDCOs). We estimate that each BIDCO would incur on average a one-time burden of 4 hours for a senior business analyst (under board or member delegation) to develop policies and procedures for evaluating credit and liquidity risk (4 hours × $237 per hour = $948). The staff estimates that the internal cost for time spent by a senior business analyst is $237 per hour. This estimate, as well as other internal time cost estimates made in this analysis, are derived from SIFMA’s Management and Professional Earnings in the Securities Industry 2011, modified by Commission staff to account for an 1800-hour work week and multiplied by 5.35 to account for bonuses, firm size, employee benefits and overhead. Commission staff believes that additional costs incurred by boards or members for review of procedures would be incorporated into BIDCOs’ overall board or member costs and would not add any particular costs. In addition, Commission staff estimates that a BIDCO board or member is likely to delegate the credit risk determinations, and that such determinations would take on average 1 hour of a senior business analyst’s time (at $237 per hour) to evaluate the credit quality for each of an average of four investment company or private fund debt securities that a BIDCO would purchase each year (4 hours × $237 per hour) for a total cost of $948 per year. Staff has calculated these estimates using an internal cost estimate for a business PO 00000 Frm 00015 Fmt 4700 Sfmt 4700 70119 received no comments on those estimates. We note however, that under rule 6a–5, in evaluating whether debt securities issued by investment companies and private funds present moderate credit risk, boards of directors and members of BIDCOs (or its or their delegates) can consider credit quality determinations prepared by outside sources, including NRSRO ratings, that they conclude are credible and reliable for purposes of making these determinations, and we anticipate that many BIDCOs that invest cash in these types of debt securities will continue to do so. We expect that the ability to consider outside assessments will help minimize the burden on BIDCOs and contribute to a BIDCO’s ability to make consistent and reliable credit quality determinations. Nevertheless, we recognize that some BIDCO boards or members may choose to hire consultants to assist in developing procedures and to make or oversee the determinations. Staff estimated in the 2011 Proposing Release that the cost to hire such consultants would be, on average, $8000 for each BIDCO.23 We received no comments on this estimate. Adopting a new credit quality standard in place of the ratings requirement in section 6(a)(5)(A)(iv) of the Investment Company Act may result in other costs for BIDCOs and their investors. The minimum rating requirement in section 6(a)(5)(A)(iv) of the Act, before it was amended by the Dodd-Frank Act, established an objective standard that is easy to apply and may have limited BIDCOs from investing in securities that posed greater credit risks. The new rule instead requires BIDCO boards or members to assess credit quality by applying a subjective standard. We acknowledge that a BIDCO could invest in lower quality debt securities that it determines meets the standard in new rule 6a–5, and that it may be difficult for the Commission to challenge the determination of a BIDCO’s directors or members (or their delegates). In addition, because credit quality assessments could differ across BIDCOs, the range of risk of investments may be broader than it is currently. We do not, analyst’s time that is updated from the one used in calculating the estimates in the 2011 Proposing Release. 23 See 2011 Proposing Release, supra note 4, at n.114 and accompanying text. Staff estimates that a BIDCO may need up to 16 hours of consulting advice to assist in developing procedures and to make or oversee the proposed determinations. Staff estimates that this advice would cost a BIDCO $500 per hour based on an understanding of the rates typically charged by outside consulting firms resulting in an average cost of $8000 for each BIDCO. E:\FR\FM\23NOR1.SGM 23NOR1 70120 Federal Register / Vol. 77, No. 226 / Friday, November 23, 2012 / Rules and Regulations however, believe that the new rule is likely to lead BIDCOs to invest in riskier securities because the standard we are adopting is very similar to the standard articulated by the rating agencies for investment grade securities.24 As part of our economic analysis, we considered alternatives to the standard that we are adopting in rule 6a–5. In particular, we considered including specific factors or tests that a fund board must apply in performing its credit analysis in the rule. As noted above, we believe that this alternative could function as a limit to a fund’s credit quality analysis 25 and thus might result in a less effective credit quality determination than a BIDCO would perform under the credit quality standard in the new rule, which could result in investments that expose the BIDCO to greater risk. V. Final Regulatory Flexibility Analysis The Commission has prepared the following Final Regulatory Flexibility Analysis (‘‘FRFA’’) in accordance with section 4(a) of the Regulatory Flexibility Act regarding new rule 6a–5, which we are adopting today to give effect to provisions of the Dodd-Frank Act.26 We prepared an Initial Regulatory Flexibility Analysis (‘‘IRFA’’) in conjunction with the 2011 Proposing Release in March 2011.27 A. Need for and Objectives of the Rule and Form Amendments and New Rule emcdonald on DSK7TPTVN1PROD with RULES As described more fully in Sections I and II of this Release, the Commission is adopting new rule 6a–5 to set forth a standard of credit-worthiness for purposes of section 6(a)(5)(A)(iv) of the Investment Company Act, as anticipated by section 939(c) the Dodd Frank Act, which eliminates the investment grade standard from section 6(a)(5) of the Investment Company Act. 24 See Moody’s Investor Service, Ratings Symbols and Definitions (June 2012), https://www.moodys. com/researchdocumentcontentpage.aspx?docid= PBC_79004, at 5 (‘‘Obligations rated Baa are judged to be medium-grade and subject to moderate credit risk and as such may possess certain speculative characteristics.’’); FitchRatings, Definitions of Ratings and Other Forms of Opinion (Apr. 2012), https://www.fitchratings.com/web_content/ratings/ fitch_ratings_definitions_and_scales.pdf, at 12 (‘‘‘BBB’ ratings indicate that expectations of credit risk are currently low. The capacity for payment of financial commitments is considered adequate but adverse business or economic conditions are more likely to impair this capacity.’’) The term ‘‘investment grade’’ is generally used to describe the categories ‘BBB’ (or comparable) or above. See id., at 6. 25 See supra paragraph accompanying note 17. 26 5 U.S.C. 604(a). 27 See 2011 Proposing Release, supra note 4, at Section VIII. VerDate Mar<15>2010 12:46 Nov 21, 2012 Jkt 229001 B. Significant Issues Raised by Public Comment In the Proposing Release, we requested comment on the IRFA. In particular, we sought comment on how many small entities would be subject to the proposed new rule and whether the effect of the proposed new rule on small entities subject to it would be economically significant. None of the comment letters we received specifically addressed the IRFA. None of the comment letters specifically addressed the effect of the new rule on small BIDCOs. C. Small Entities Subject to the Rule and Form Amendments and New Rule New rule 6a–5 under the Investment Company Act would affect BIDCOs, including entities that are considered to be a small business or small organization (collectively, ‘‘small entity’’) for purposes of the Regulatory Flexibility Act. Under the standards adopted by the Small Business Administration, small entities in the financial investment industry include entities with $7 million or less in annual receipts.28 We do not have any data and are not aware of any databases that compile information regarding how many BIDCOs would be small entities under this definition. We also did not receive any comments from BIDCOs. D. Projected Reporting, Recordkeeping, and Other Compliance Requirements Rule 6a–5 imposes no reporting, recordkeeping or other compliance requirements. E. Agency Action To Minimize Effect on Small Entities The Regulatory Flexibility Act directs us to consider significant alternatives that would accomplish our stated objectives, while minimizing any significant adverse effect on small entities. In connection with the new rule, the Commission considered the following alternatives: (i) Establishing different compliance standards or timetables that take into account the resources available to small entities; (ii) clarifying, consolidating, or simplifying compliance and reporting requirements under the rule for small entities; (iii) use of performance rather than design standards; and (iv) exempting small entities from all or part of the requirements. We believe that special compliance or reporting requirements for small entities, or an exemption from coverage for small entities, is not appropriate or consistent with investor protection or 28 13 PO 00000 CFR 121.201. Frm 00016 Fmt 4700 Sfmt 4700 section 939(c) of the Dodd-Frank Act, which rule 6a–5 implements. With respect to rule 6a–5, we believe that special compliance requirements or timetables for small entities, or an exemption from coverage for small entities, may create a risk that those BIDCOs could acquire debt securities that are not of sufficiently high credit quality that they would be likely to maintain a fairly stable market value or be liquidated easily, as we believe may have been intended for the BIDCO to support its long-term commitments. Further consolidation or simplification of rule 6a–5 for BIDCOs that are small entities is inconsistent with the Commission’s goals of fostering investor protection. Finally, rule 6a–5 uses performance rather than design standards for determining the credit quality of specific debt securities. Statutory Authority The Commission is adopting new rule 6a–5 under the authority set forth in section 38(a) of the Investment Company Act [15 U.S.C. 80a–37(a)] and section 939 of the Dodd-Frank Act, to be codified at section 6(a)(5)(A)(iv)(I) of the Investment Company Act [15 U.S.C. 80a–6(a)(5)(A)(iv)(I)]. List of Subjects in 17 CFR Part 270 Investment companies, Reporting and recordkeeping requirements, Securities. Text of Rule PART 270—RULES AND REGULATIONS, INVESTMENT COMPANY ACT OF 1940 1. The authority citation for part 270 is amended by adding a sub-authority in numerical order to read as follows: ■ Authority: 15 U.S.C. 80a–1 et seq., 80a– 34(d), 80a–37, and 80a–39, unless otherwise noted. * * * * * Section 270.6a–5 is also issued under 15 U.S.C. 80a–6(a)(5)(A)(iv)(I). * * * * * 2. Section 270.6a–5 is added to read as follows: ■ § 270.6a–5 Purchase of certain debt securities by companies relying on section 6(a)(5) of the Act. For purposes of reliance on the exemption for certain companies under section 6(a)(5)(A) of the Act (15 U.S.C. 80a–6(a)(5)(A)), a company shall be deemed to have met the requirement for credit-worthiness of certain debt securities under section 6(a)(5)(A)(iv)(I) of the Investment Company Act (15 U.S.C. 80a–6(a)(5)(A)(iv)(I)) if, at the time of purchase, the board of directors E:\FR\FM\23NOR1.SGM 23NOR1 Federal Register / Vol. 77, No. 226 / Friday, November 23, 2012 / Rules and Regulations (or its delegate) determines or members of the company (or their delegate) determine that the debt security is: (a) Subject to no greater than moderate credit risk; and (b) Sufficiently liquid that it can be sold at or near its carrying value within a reasonably short period of time. By the Commission. Dated: November 19, 2012. Elizabeth M. Murphy, Secretary. [FR Doc. 2012–28456 Filed 11–21–12; 8:45 am] BILLING CODE 8011–01–P DEPARTMENT OF HOMELAND SECURITY Coast Guard 33 CFR Part 100 [Docket No. USCG–2012–0954] Special Local Regulation; Annual Marine Events on the Colorado River Between Davis Dam (Bullhead City, AZ) and Headgate Dam (Parker, AZ) Within the San Diego Captain of the Port Zone Coast Guard, DHS. Notice of enforcement of regulation. AGENCY: ACTION: The Coast Guard will enforce special local regulations during the Lake Havasu City Boat Parade of Lights on December 01, 2012 from 5 p.m. to 9 p.m. This event occurs on Lake Havasu on the Bridgwater Channel. These special local regulations are necessary to provide for the safety of the participants, crew, spectators, sponsor vessels of the regatta, and general users of the waterway. During the enforcement period, persons and vessels are prohibited from entering into, transiting through, or anchoring within this safety zone unless authorized by the Captain of the Port, or his designated representative. SUMMARY: The regulations in 33 CFR 100.1102 will be enforced on December 1, 2012 from 5 p.m. until 9 p.m. FOR FURTHER INFORMATION CONTACT: If you have questions on this notice, call or email Petty Officer Bryan Gollogly, Waterways Management, U.S. Coast Guard Sector San Diego, CA; telephone (619) 278–7656, email D11-PFMarineEventsSanDiego@uscg.mil. emcdonald on DSK7TPTVN1PROD with RULES DATES: The Coast Guard will enforce the special local regulations in 33 CFR 100.1102 in SUPPLEMENTARY INFORMATION: VerDate Mar<15>2010 12:46 Nov 21, 2012 Jkt 229001 support of the Lake Havasu City Boat Parade of Lights (Item 10 on Table 1 of 33 CFR 100.1102). The Coast Guard will enforce the special local regulations between Thompson Bay and Windsor State Beach on December 01, 2012 from 5 p.m. to 9 p.m. The event will include approximately fifty powerboats and sailboats participating in a follow-theleader style parade. The vessels will be decorated in Christmas lights according to a predetermined theme. The route will begin in Thompson Bay, proceed through the channel, make a large circle in Windsor bay, and return to Thompson Bay along the same route. Under the provisions of 33 CFR 100.1102, persons and vessels are prohibited from entering into, transiting through, or anchoring within this safety zone unless authorized by the Captain of the Port, or his designated representative. The Coast Guard may be assisted by other Federal, State, or local law enforcement agencies in enforcing this regulation. This notice is issued under authority of 33 CFR 100.1102 and 5 U.S.C. 552(a). In addition to this notice in the Federal Register, the Coast Guard will provide the maritime community with extensive advance notification of this enforcement period via the Local Notice to Mariners, state, or local agencies. Dated: November 5, 2012. S.M. Mahoney, Captain of the Port San Diego, United States Coast Guard. [FR Doc. 2012–28395 Filed 11–21–12; 8:45 am] BILLING CODE 9110–04–P ENVIRONMENTAL PROTECTION AGENCY 40 CFR Part 52 [EPA–R05–OAR–2007–1102; EPA–R05– OAR–2008–0782; FRL–9753–7] Approval and Promulgation of Air Quality Implementation Plans; Ohio; PBR and PTIO Environmental Protection Agency (EPA). ACTION: Withdrawal of direct final rule. AGENCY: Due to the approval of certain terms that were not meant to be approved, EPA is withdrawing the October 1, 2012 direct final rule approving a revision to the Ohio State Implementation Plan (SIP). EPA will address the revision in a subsequent final action based upon the proposed rulemaking action, which was also SUMMARY: PO 00000 Frm 00017 Fmt 4700 Sfmt 4700 70121 published on October 1, 2012. EPA does not expect to institute a second comment period on this action. DATES: The direct final rule published at 77 FR 59751 on October 1, 2012, is withdrawn as of November 23, 2012. FOR FURTHER INFORMATION CONTACT: Kaushal Gupta, Environmental Engineer, Air Permits Section, Air Programs Branch (AR–18J), Environmental Protection Agency, Region 5, 77 West Jackson Boulevard, Chicago, Illinois 60604, (312) 886–6803, gupta.kaushal@epa.gov. SUPPLEMENTARY INFORMATION: EPA is withdrawing the October 1, 2012 direct final rule (77 FR 59751) approving six Permit-by-Rule (PBR) provisions, a Permit to Install and Operate (PTIO) program, two permanent exemptions from the Permit to Install (PTI) requirement and a general permit program as additions to Ohio’s SIP. After publication of the direct final rule, it came to EPA’s attention that the following had been inadvertently included in the rulemaking action: • The SIP revision classified municipal incinerators capable of charging more than 250 tons of refuse per day as having a major stationary source emission threshold of 100 tons per year or more. Ohio Administrative Code (OAC) 3745–31–01(LLL)(2)(ix). • The SIP revision allowed Director’s discretion for complying with the public participation notification requirements for Federal Land Managers. OAC 3745– 31–06(H)(2)(d). • The SIP revision allowed Director’s discretion and specific exemptions with regard to preconstruction activities. OAC 3745–31–33. EPA did not intend to act on the above provisions when approving the PBR and PTIO rules and is therefore withdrawing the direct final rule. EPA will publish a subsequent final action based upon the proposed rulemaking action, also published on October 1, 2012 (77 FR 59879), that excludes the above provisions. EPA does not expect to institute a second comment period on this action. List of Subjects in 40 CFR Part 52 Environmental protection, Air pollution control, Incorporation by reference, Intergovernmental relations, Reporting and recordkeeping requirements. Authority: 42 U.S.C. 7401 et seq. Dated: November 8, 2012. Susan Hedman, Regional Administrator, Region 5. E:\FR\FM\23NOR1.SGM 23NOR1

Agencies

SECURITIES AND EXCHANGE COMMISSION

[Federal Register Volume 77, Number 226 (Friday, November 23, 2012)]
[Rules and Regulations]
[Pages 70117-70121]
From the Federal Register Online via the Government Printing Office [www.gpo.gov]
[FR Doc No: 2012-28456]

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SECURITIES AND EXCHANGE COMMISSION

17 CFR Part 270

[Release No. IC-30268; File No. S7-07-11]
RIN 3235-AL02

Purchase of Certain Debt Securities by Business and Industrial
Development Companies Relying on an Investment Company Act Exemption

AGENCY: Securities and Exchange Commission.

ACTION: Final rule.

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SUMMARY: The Securities and Exchange Commission (``Commission'') is
adopting a new rule under the Investment Company Act of 1940
(``Investment Company Act'') to establish a standard of credit-
worthiness in place of a statutory reference to credit ratings that the
Dodd-Frank Wall Street Reform and Consumer Protection Act (``Dodd-Frank
Act'') removes. The rule will establish the standard of credit quality
that must be met by certain debt securities purchased by entities
relying on the Investment Company Act exemption for business and
industrial development companies.

DATES: Effective date: December 24, 2012.

FOR FURTHER INFORMATION CONTACT: Anu Dubey, Senior Counsel, or Penelope
Saltzman, Assistant Director (202) 551-6792, Office of Regulatory
Policy, Division of Investment Management, Securities and Exchange
Commission, 100 F Street NE., Washington, DC 20549-8549.

SUPPLEMENTARY INFORMATION: The Commission is adopting new rule 6a-5 [17
CFR 270.6a-5] under the Investment Company Act.\1\
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\1\ 15 U.S.C. 80a-1. Unless otherwise noted, all references to
statutory sections are to the Investment Company Act, and all
references to rules under the Investment Company Act are to Title
17, Part 270 of the Code of Federal Regulations [17 CFR part 270].
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Table of Contents

I. Background
II. Discussion
III. Paperwork Reduction Act
IV. Economic Analysis
V. Final Regulatory Flexibility Analysis
Statutory Authority
Text of Rule

I. Background

The Dodd-Frank Act was enacted on July 21, 2010.\2\ Section 939(c)
of the Dodd-Frank Act removes a reference to credit ratings from
section 6(a)(5) of the Investment Company Act and replaces it with a
reference to ``such standards of credit-worthiness as the Commission
shall adopt.'' \3\ To implement this mandate, last year the Commission
proposed new rule 6a-5 under the Investment Company Act that would
establish a credit-worthiness standard to replace the credit rating
reference in section 6(a)(5) of that Act that the Dodd-Frank Act
eliminates.\4\ We received one comment letter regarding proposed rule
6a-5, which we discuss below.\5\ Today, we are adopting new rule 6a-5,
which implements section 939(c) of the Dodd-Frank Act.
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\2\ Public Law 111-203, 124 Stat. 1376 (2010).
\3\ Section 939(c) of the Dodd-Frank Act (amending section
6(a)(5)(A)(iv)(I) of the Investment Company Act). This amendment to
the Investment Company Act becomes effective on July 21, 2012. See
section 939(g) of the Dodd-Frank Act.
\4\ See References to Credit Ratings in Certain Investment
Company Act Rules and Forms, Investment Company Act Release No.
29592 (Mar. 3, 2011) [76 FR 12896 (Mar. 9, 2011)] (``2011 Proposing
Release''). In that release, we also proposed amendments to replace
references to credit ratings in rules 2a-7 and 5b-3 under the
Investment Company Act and Forms N-1A, N-2, N-3 and N-MFP under the
Investment Company Act and the Securities Act of 1933 (15 U.S.C.
77a). Those proposed amendments would implement section 939A of the
Dodd-Frank Act, which requires the Commission to review its
regulations for any references to or requirements regarding credit
ratings that require the use of an assessment of the credit-
worthiness of a security or money market instrument, remove these
references or requirements, and substitute in those regulations
other standards of credit-worthiness that we determine to be
appropriate. We intend to address the proposed amendments to rule
2a-7, rule 5b-3 and Forms N-1A, N-2, N-3 and N-MFP separately. Rule
3a-7 under the Investment Company Act also contains a reference to
ratings. In August 2011, in a concept release soliciting comment on
the treatment of asset-backed issuers under the Investment Company
Act, we sought comment on the role, if any, that credit ratings
should continue to play in the context of rule 3a-7. See Treatment
of Asset-Backed Issuers under the Investment Company Act, Investment
Company Act Release No. 29779 (Aug. 31, 2011) [76 FR 55308 (Sept. 7,
2011)] at Section III.A.1.
\5\ The comment letters on the 2011 Proposing Release (File No.
S7-07-11) are available at https://www.sec.gov/comments/s7-07-11/s70711.shtml. In addition, to facilitate public input on the Dodd-
Frank Act, we provided a series of email links, organized by topic
on our Web site at https://www.sec.gov/spotlight/regreformcomments.shtml. The public comments we received in response
to our solicitation for comment on Title IX of the Dodd-Frank Act
(which includes sections 939 and 939A) are available on our Web site
at https://www.sec.gov/comments/df-title-ix/credit-rating-agencies/credit-rating-agencies.shtml.
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II. Discussion

Business and industrial development companies (``BIDCOs'') are
companies that operate under state statutes that provide direct
investment and loan financing, as well as managerial assistance, to
state and local enterprises.\6\ Because they invest in securities,
BIDCOs frequently meet the definition of ``investment company'' under
the Investment Company Act.\7\ In 1996, the Investment Company Act was
amended to add section 6(a)(5) to exempt these companies from most
provisions of the Act subject to certain conditions.\8\ The statutory
exemption was premised on states having a strong interest in overseeing
the structure and operations of these companies, thus rendering
regulation under the Investment Company Act largely duplicative and
unnecessary.\9\
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\6\ See Report of the Senate Committee on Banking, Housing and
Urban Affairs to Accompany S. 479, S. Rep. No. 103-166, at 11 (1993)
(``1993 Senate Report'').
\7\ For purposes of the Investment Company Act, an ``investment
company'' means any issuer that: (A) Is or holds itself out as being
engaged primarily, or proposes to engage primarily, in the business
of investing, reinvesting, or trading in securities; (B) is engaged
or proposes to engage in the business of issuing face-amount
certificates of the installment type, or has been engaged in such
business and has any such certificate outstanding; or (C) is engaged
or proposes to engage in the business of investing, reinvesting,
owning, holding, or trading in securities, and owns or proposes to
acquire investment securities having a value exceeding 40 per centum
of the value of such issuer's total assets (exclusive of government
securities and cash items) on an unconsolidated basis. 15 U.S.C.
80a-3(a)(1).
\8\ 15 U.S.C. 80a-6(a)(5); Public Law 104-290 Sec. 501, 110
Stat. 3416, 3444 (1996). Section 6(a)(5)(B) provides that section 9
and, to the extent necessary to enforce section 9, sections 38
through 51, apply to a BIDCO as though the company were a registered
investment company. Among other conditions to reliance on the
exemption in section 6(a)(5), a BIDCO may not issue redeemable
securities.
\9\ See 1993 Senate Report, supra note 6, at 19 (further stating
that states are well positioned to monitor these companies and
address the needs of resident investors). Prior to the addition of
section 6(a)(5), the Commission had granted orders to exempt BIDCOs
from regulation under the Act. See, e.g., The Idaho Company,
Investment Company Release Nos. 18926 (Sept. 3, 1992) (notice) and
18985 (Sept. 30, 1992) (order).
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BIDCOs that seek to rely on the exemption in section 6(a)(5) are
limited with respect to the types of securities issued by investment
companies and companies exempt from the definition of investment
company under section 3(c)(1) or 3(c)(7) of the Investment Company Act
(``private funds'') that they may purchase. Specifically, section
6(a)(5)(A)(iv) prohibits these BIDCOs from purchasing securities issued
by investment companies and private funds other than debt securities
that are rated investment grade by at least one NRSRO and securities
issued by registered open-end investment companies that invest at least
65 percent of their assets in investment grade

[[Page 70118]]

securities or securities that the fund determines are comparable in
quality.\10\ This provision was intended to provide limited flexibility
to invest capital not immediately needed for the company's long-term
commitments.\11\ Although the legislative history of the provision does
not specifically explain why Congress restricted BIDCOs to acquiring
``investment grade'' debt of investment companies and private funds, as
we noted in the 2011 Proposing Release, it may have been designed to
limit BIDCOs to investing in debt securities of sufficiently high
credit quality that they are likely to maintain a fairly stable market
value and that could be liquidated easily, as appropriate, for the
BIDCO to support its investment and financing activities.\12\
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\10\ 15 U.S.C. 80a-6(a)(5)(A), as in effect prior to July 21,
2012 (exempting any company that is not engaged in the business of
issuing redeemable securities, the operations of which are subject
to regulation by the State in which the company is organized under a
statute governing entities that provide financial or managerial
assistance to enterprises doing business, or proposing to do
business in that state if, among other things, the company does not
purchase any security issued by an investment company or by any
company that would be an investment company except for the
exclusions from the definition of the term ``investment company''
under sections 3(c)(1) or 3(c)(7), other than (I) any debt security
that is rated investment grade by not less than 1 nationally
recognized statistical rating organization; or (II) any security
issued by a registered open-end fund that is required by its
investment policies to invest not less than 65% of its total assets
in securities described in subclause (I) or securities that are
determined by such registered open-end fund to be comparable in
quality to securities described in subclause (I)).
\11\ See 1993 Senate Report, supra note 6, at 20.
\12\ See 2011 Proposing Release, supra note 4, at Section II.D.
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As described above, section 939(c) of the Dodd-Frank Act eliminates
the credit rating reference in section 6(a)(5)(A)(iv) of the Investment
Company Act. Instead of limiting BIDCOs to purchasing debt securities
issued by investment companies and private funds that are rated
``investment grade,'' the amendment requires such debt securities to
meet ``such standards of credit-worthiness as the Commission shall
adopt.''
We do not understand that the statutory amendment was intended to
change the standard of credit quality represented by an investment
grade rating. Accordingly, we are adopting rule 6a-5, as proposed, to
establish a standard of credit-worthiness designed to achieve the same
degree of risk limitation as the credit rating it replaces. Rule 6a-5
deems a BIDCO to have met the requirements for credit-worthiness of
certain debt securities under section 6(a)(5)(A)(iv)(I) if the board of
directors or members of the company (or its or their delegate)
determines, at the time of purchase, that the debt security is (i)
subject to no greater than moderate credit risk and (ii) sufficiently
liquid that the security can be sold at or near its carrying value
within a reasonably short period of time.\13\ The board of directors or
members of a BIDCO (or its or their delegate) would have to make this
determination at the time of acquisition of the securities.\14\ As a
result of rule 6a-5, section 6(a)(5) of the Investment Company Act will
also limit a BIDCO's investments in registered open-end funds to those
funds that invest at least 65 percent of their assets in debt
securities that meet our standard.\15\
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\13\ Rule 6a-5. The standard for credit-worthiness that we are
adopting in rule 6a-5 is similar to the standard that we adopted in
rule 10f-3 under the Investment Company Act. Rule 10f-3 defines
eligible municipal securities as securities that are sufficiently
liquid that they can be sold at or near their carrying value within
a reasonably short period of time and either are subject to no
greater than moderate credit risk or, if the issuer has been in
operation for less than three years, the securities are subject to a
minimal or low amount of credit risk. See rule 10f-3(a)(3).
\14\ Rule 6a-5.
\15\ Section 6(a)(5)(A)(iv)(II) (permitting a BIDCO to purchase
any security issued by a registered open-end fund that is required
by its investment policies to invest not less than 65% of its total
assets in securities described in subclause (I) (i.e., securities
that meet the standards of credit-worthiness that the Commission
adopts) or securities that are determined by such registered open-
end fund to be comparable in quality to securities described in
subclause (I)).
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The final rule does not, as one commenter suggested, include
specific factors or tests that the board must apply in performing its
credit analysis.\16\ We believe that the new credit quality standards
(that the debt security be subject to no greater than moderate credit
risk and be sufficiently liquid that it can be sold at or near its
carrying value within a reasonably short period of time) are clear
enough for a BIDCO's board or members (or its or their delegate) to
understand the risks acceptable under the rule. We note that the number
and scope of factors that may be appropriate to making a credit quality
determination with respect to a security may vary significantly
depending on the particular security. We are concerned that prescribing
a list of specific factors in a rule today might function as a limit to
the credit quality analysis that boards or members would undertake and
may not address information that would be relevant to credit quality
determinations regarding new types of debt securities that investment
companies or private funds may issue and in which BIDCOs may invest in
the future.\17\
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\16\ See Better Markets Comment Letter (Apr. 25, 2011) (``Better
Markets Comment Letter'') (asserting that the proposed standard is
vague and would undermine the reliability of a board's credit risk
determinations and the board's accountability for such
determinations).
\17\ We also agree with this commenter, who acknowledged that a
reliable and objective shorthand measure of credit risk that could
be incorporated into Commission regulations is currently
unavailable. See Better Markets Comment Letter.
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The standard we are adopting is designed to limit BIDCOs to
purchasing debt securities issued by investment companies or private
funds of sufficiently high credit quality that they are likely to
maintain a fairly stable market value and may be liquidated easily, as
appropriate, for the BIDCO to support its investment and financing
activities.\18\ Debt securities (or their issuers) subject to a
moderate level of credit risk would demonstrate at least average
credit-worthiness relative to other similar debt issues (or issuers of
similar debt).\19\ Moderate credit risk would denote current low
expectations of default risk associated with the security, with an
adequate capacity for payment by the issuer of principal and
interest.\20\ In making their credit quality determinations, a BIDCO's
board of directors or members (or its or their delegate) can also
consider credit quality reports prepared by outside sources, including
NRSRO ratings, that the BIDCO board or members conclude are credible
and reliable for this purpose.
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\18\ See supra note 12 and accompanying text.
\19\ See References to Ratings of Nationally Recognized
Statistical Rating Organizations, Investment Company Act Release No.
28939 (Oct. 5, 2009) [74 FR 52358 (Oct. 9, 2009)] at n.86 (release
adopting amendments to rule 10f-3).
\20\ Id.
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III. Paperwork Reduction Act

The Paperwork Reduction Act of 1995 (``PRA'') imposes certain
requirements on federal agencies in connection with their conducting or
sponsoring any collection of information as defined by the PRA. Rule
6a-5 does not create any new collections of information.

IV. Economic Analysis

As discussed above, we are adopting a new rule to implement section
939(c) of the Dodd-Frank Act to replace a statutory reference to a
credit rating with an alternative credit-worthiness standard. We
considered the economic effects, including costs and benefits, of our
proposed new rule in the 2011 Proposing Release and we discuss below
the comment received related to our analysis.
The Commission has discretion in adopting the alternative standard
of credit-worthiness, and we undertake

[[Page 70119]]

below to discuss the economic effects of the new rule that are within
our discretion under the Dodd-Frank Act, in addition to the economic
effects of removing rating references from statutory provisions, as
mandated by the Dodd-Frank Act itself. The two types of costs and
benefits may not be entirely separable to the extent that our
discretion is exercised to realize the benefits intended by the Dodd-
Frank Act. In evaluating the economic effects of new rule 6a-5, we
compare section 6(a)(5) of the Investment Company Act, as currently in
effect (which includes a reference to a rating), with the new rule we
are adopting.
Rule 6a-5 establishes a credit-worthiness standard under section
6(a)(5)(A)(iv)(I) of the Investment Company Act. BIDCOs that seek to
rely on the exemption in section 6(a)(5) of the Act are limited to
investing in debt securities issued by investment companies and private
funds if, at the time of purchase, the board of directors or members of
the BIDCO (or its or their delegate) determines that the debt security
is (i) subject to no greater than moderate credit risk and (ii)
sufficiently liquid that the security can be sold at or near its
carrying value within a reasonably short period of time.
We anticipate that the adoption of rule 6a-5 may result in certain
benefits. First, we do not understand that by amending section 6(a)(5),
Congress intended to change the credit quality of the debt securities
that BIDCOs may purchase and our rule is designed to establish a
similar credit quality standard in order to achieve the same limitation
on risk as the credit rating it replaces. In particular, the amended
standard is designed to limit BIDCOs to purchasing debt securities
issued by investment companies or private funds of sufficiently high
credit quality that they are likely to maintain a fairly stable market
value and may be liquidated easily, as appropriate, for the BIDCO to
support its investment and financing activities. Second, the subjective
credit quality standard in amended rule 6a-5 may provide BIDCOs greater
flexibility in determining the pool of eligible debt securities in
which they may invest. Finally, the credit quality standard in new rule
6a-5 may further Congress' stated purpose of reducing reliance on
ratings in the context of a BIDCO's purchase of certain debt
securities.\21\
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\21\ See Report of the House of Representatives Financial
Services Committee to Accompany H.R. 4173, H. Rep. No. 111-517, at
871 (2010).
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We also recognize that BIDCOs may incur some costs as a result of
the adoption of new rule 6a-5. These may be internal costs or costs to
consult outside legal counsel to evaluate whether changes to any
policies and procedures the BIDCOs may have currently for acquiring
debt securities issued by investment companies or private funds may be
appropriate in light of the new rule. We expect that, although not
required by the Investment Company Act, as a matter of good business
practice, directors or members of most BIDCOs that do not currently
have them may prepare policies and procedures to make the credit
quality and liquidity determinations required by the new rule. Staff
estimates that BIDCOs will incur the costs of preparing the procedures
for making determinations of credit quality and liquidity under the
rule once, and directors and members of BIDCOs (or their delegates)
will be able to follow these procedures for purposes of making future
determinations under the rule. Commission staff estimated in the 2011
Proposing Release that each BIDCO would incur, on average, an initial
one-time cost of $1000 to prepare policies and procedures and an
average of $1000 in annual costs for making credit determinations with
respect to the acquisition of debt securities.\22\ We received no
comments on those estimates. We note however, that under rule 6a-5, in
evaluating whether debt securities issued by investment companies and
private funds present moderate credit risk, boards of directors and
members of BIDCOs (or its or their delegates) can consider credit
quality determinations prepared by outside sources, including NRSRO
ratings, that they conclude are credible and reliable for purposes of
making these determinations, and we anticipate that many BIDCOs that
invest cash in these types of debt securities will continue to do so.
We expect that the ability to consider outside assessments will help
minimize the burden on BIDCOs and contribute to a BIDCO's ability to
make consistent and reliable credit quality determinations.
Nevertheless, we recognize that some BIDCO boards or members may choose
to hire consultants to assist in developing procedures and to make or
oversee the determinations. Staff estimated in the 2011 Proposing
Release that the cost to hire such consultants would be, on average,
$8000 for each BIDCO.\23\ We received no comments on this estimate.
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\22\ See 2011 Proposing Release, supra note 4, at n.112. Staff
does not have reliable data and is not aware of any databases that
compile information regarding the number of existing BIDCOs.
Moreover, we received no data from commenters. We note that some
state regulators disclose the number of BIDCOs registered in the
state on the regulators' Web sites. Of those that do, the number of
registered BIDCOs ranges from one to 10. See, e.g., Louisiana Office
of Financial Institutions at https://www.ofi.state.la.us/ (listing 10
BIDCOs in a directory of active BIDCOs); California Department of
Financial Institutions at https://www.dfi.ca.gov/directory/bidco.asp
(listing one BIDCO in a directory of BIDCOs). We estimate that each
BIDCO would incur on average a one-time burden of 4 hours for a
senior business analyst (under board or member delegation) to
develop policies and procedures for evaluating credit and liquidity
risk (4 hours x $237 per hour = $948). The staff estimates that the
internal cost for time spent by a senior business analyst is $237
per hour. This estimate, as well as other internal time cost
estimates made in this analysis, are derived from SIFMA's Management
and Professional Earnings in the Securities Industry 2011, modified
by Commission staff to account for an 1800-hour work week and
multiplied by 5.35 to account for bonuses, firm size, employee
benefits and overhead. Commission staff believes that additional
costs incurred by boards or members for review of procedures would
be incorporated into BIDCOs' overall board or member costs and would
not add any particular costs. In addition, Commission staff
estimates that a BIDCO board or member is likely to delegate the
credit risk determinations, and that such determinations would take
on average 1 hour of a senior business analyst's time (at $237 per
hour) to evaluate the credit quality for each of an average of four
investment company or private fund debt securities that a BIDCO
would purchase each year (4 hours x $237 per hour) for a total cost
of $948 per year. Staff has calculated these estimates using an
internal cost estimate for a business analyst's time that is updated
from the one used in calculating the estimates in the 2011 Proposing
Release.
\23\ See 2011 Proposing Release, supra note 4, at n.114 and
accompanying text. Staff estimates that a BIDCO may need up to 16
hours of consulting advice to assist in developing procedures and to
make or oversee the proposed determinations. Staff estimates that
this advice would cost a BIDCO $500 per hour based on an
understanding of the rates typically charged by outside consulting
firms resulting in an average cost of $8000 for each BIDCO.
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Adopting a new credit quality standard in place of the ratings
requirement in section 6(a)(5)(A)(iv) of the Investment Company Act may
result in other costs for BIDCOs and their investors. The minimum
rating requirement in section 6(a)(5)(A)(iv) of the Act, before it was
amended by the Dodd-Frank Act, established an objective standard that
is easy to apply and may have limited BIDCOs from investing in
securities that posed greater credit risks. The new rule instead
requires BIDCO boards or members to assess credit quality by applying a
subjective standard. We acknowledge that a BIDCO could invest in lower
quality debt securities that it determines meets the standard in new
rule 6a-5, and that it may be difficult for the Commission to challenge
the determination of a BIDCO's directors or members (or their
delegates). In addition, because credit quality assessments could
differ across BIDCOs, the range of risk of investments may be broader
than it is currently. We do not,

[[Page 70120]]

however, believe that the new rule is likely to lead BIDCOs to invest
in riskier securities because the standard we are adopting is very
similar to the standard articulated by the rating agencies for
investment grade securities.\24\
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\24\ See Moody's Investor Service, Ratings Symbols and
Definitions (June 2012), https://www.moodys.com/researchdocumentcontentpage.aspx?docid=PBC_79004, at 5
(``Obligations rated Baa are judged to be medium-grade and subject
to moderate credit risk and as such may possess certain speculative
characteristics.''); FitchRatings, Definitions of Ratings and Other
Forms of Opinion (Apr. 2012), https://www.fitchratings.com/web_content/ratings/fitch_ratings_definitions_and_scales.pdf, at 12
(```BBB' ratings indicate that expectations of credit risk are
currently low. The capacity for payment of financial commitments is
considered adequate but adverse business or economic conditions are
more likely to impair this capacity.'') The term ``investment
grade'' is generally used to describe the categories `BBB' (or
comparable) or above. See id., at 6.
---------------------------------------------------------------------------

As part of our economic analysis, we considered alternatives to the
standard that we are adopting in rule 6a-5. In particular, we
considered including specific factors or tests that a fund board must
apply in performing its credit analysis in the rule. As noted above, we
believe that this alternative could function as a limit to a fund's
credit quality analysis \25\ and thus might result in a less effective
credit quality determination than a BIDCO would perform under the
credit quality standard in the new rule, which could result in
investments that expose the BIDCO to greater risk.
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\25\ See supra paragraph accompanying note 17.
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V. Final Regulatory Flexibility Analysis

The Commission has prepared the following Final Regulatory
Flexibility Analysis (``FRFA'') in accordance with section 4(a) of the
Regulatory Flexibility Act regarding new rule 6a-5, which we are
adopting today to give effect to provisions of the Dodd-Frank Act.\26\
We prepared an Initial Regulatory Flexibility Analysis (``IRFA'') in
conjunction with the 2011 Proposing Release in March 2011.\27\
---------------------------------------------------------------------------

\26\ 5 U.S.C. 604(a).
\27\ See 2011 Proposing Release, supra note 4, at Section VIII.
---------------------------------------------------------------------------

A. Need for and Objectives of the Rule and Form Amendments and New Rule

As described more fully in Sections I and II of this Release, the
Commission is adopting new rule 6a-5 to set forth a standard of credit-
worthiness for purposes of section 6(a)(5)(A)(iv) of the Investment
Company Act, as anticipated by section 939(c) the Dodd Frank Act, which
eliminates the investment grade standard from section 6(a)(5) of the
Investment Company Act.

B. Significant Issues Raised by Public Comment

In the Proposing Release, we requested comment on the IRFA. In
particular, we sought comment on how many small entities would be
subject to the proposed new rule and whether the effect of the proposed
new rule on small entities subject to it would be economically
significant. None of the comment letters we received specifically
addressed the IRFA. None of the comment letters specifically addressed
the effect of the new rule on small BIDCOs.

C. Small Entities Subject to the Rule and Form Amendments and New Rule

New rule 6a-5 under the Investment Company Act would affect BIDCOs,
including entities that are considered to be a small business or small
organization (collectively, ``small entity'') for purposes of the
Regulatory Flexibility Act. Under the standards adopted by the Small
Business Administration, small entities in the financial investment
industry include entities with $7 million or less in annual
receipts.\28\ We do not have any data and are not aware of any
databases that compile information regarding how many BIDCOs would be
small entities under this definition. We also did not receive any
comments from BIDCOs.
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\28\ 13 CFR 121.201.
---------------------------------------------------------------------------

D. Projected Reporting, Recordkeeping, and Other Compliance
Requirements

Rule 6a-5 imposes no reporting, recordkeeping or other compliance
requirements.

E. Agency Action To Minimize Effect on Small Entities

The Regulatory Flexibility Act directs us to consider significant
alternatives that would accomplish our stated objectives, while
minimizing any significant adverse effect on small entities. In
connection with the new rule, the Commission considered the following
alternatives: (i) Establishing different compliance standards or
timetables that take into account the resources available to small
entities; (ii) clarifying, consolidating, or simplifying compliance and
reporting requirements under the rule for small entities; (iii) use of
performance rather than design standards; and (iv) exempting small
entities from all or part of the requirements.
We believe that special compliance or reporting requirements for
small entities, or an exemption from coverage for small entities, is
not appropriate or consistent with investor protection or section
939(c) of the Dodd-Frank Act, which rule 6a-5 implements. With respect
to rule 6a-5, we believe that special compliance requirements or
timetables for small entities, or an exemption from coverage for small
entities, may create a risk that those BIDCOs could acquire debt
securities that are not of sufficiently high credit quality that they
would be likely to maintain a fairly stable market value or be
liquidated easily, as we believe may have been intended for the BIDCO
to support its long-term commitments. Further consolidation or
simplification of rule 6a-5 for BIDCOs that are small entities is
inconsistent with the Commission's goals of fostering investor
protection. Finally, rule 6a-5 uses performance rather than design
standards for determining the credit quality of specific debt
securities.

Statutory Authority

The Commission is adopting new rule 6a-5 under the authority set
forth in section 38(a) of the Investment Company Act [15 U.S.C. 80a-
37(a)] and section 939 of the Dodd-Frank Act, to be codified at section
6(a)(5)(A)(iv)(I) of the Investment Company Act [15 U.S.C. 80a-
6(a)(5)(A)(iv)(I)].

List of Subjects in 17 CFR Part 270

Investment companies, Reporting and recordkeeping requirements,
Securities.

Text of Rule

PART 270--RULES AND REGULATIONS, INVESTMENT COMPANY ACT OF 1940

0
1. The authority citation for part 270 is amended by adding a sub-
authority in numerical order to read as follows:

Authority: 15 U.S.C. 80a-1 et seq., 80a-34(d), 80a-37, and 80a-
39, unless otherwise noted.
* * * * *

Section 270.6a-5 is also issued under 15 U.S.C. 80a-
6(a)(5)(A)(iv)(I).

* * * * *

0
2. Section 270.6a-5 is added to read as follows:

Sec. 270.6a-5 Purchase of certain debt securities by companies
relying on section 6(a)(5) of the Act.

For purposes of reliance on the exemption for certain companies
under section 6(a)(5)(A) of the Act (15 U.S.C. 80a-6(a)(5)(A)), a
company shall be deemed to have met the requirement for credit-
worthiness of certain debt securities under section 6(a)(5)(A)(iv)(I)
of the Investment Company Act (15 U.S.C. 80a-6(a)(5)(A)(iv)(I)) if, at
the time of purchase, the board of directors

[[Page 70121]]

(or its delegate) determines or members of the company (or their
delegate) determine that the debt security is:
(a) Subject to no greater than moderate credit risk; and
(b) Sufficiently liquid that it can be sold at or near its carrying
value within a reasonably short period of time.

By the Commission.

Dated: November 19, 2012.
Elizabeth M. Murphy,
Secretary.
[FR Doc. 2012-28456 Filed 11-21-12; 8:45 am]
BILLING CODE 8011-01-P

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