Proposed Amendments to Class Prohibited Transaction Exemptions To Remove Credit Ratings Pursuant to the Dodd-Frank Wall Street Reform and Consumer Protection Act, 37572-37583 [2013-14790]

Agencies

• Employee Benefits Security Administration
• DEPARTMENT OF LABOR

[Federal Register Volume 78, Number 120 (Friday, June 21, 2013)]
[Notices]
[Pages 37572-37583]
From the Federal Register Online via the Government Printing Office [www.gpo.gov]
[FR Doc No: 2013-14790]


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DEPARTMENT OF LABOR

Employee Benefits Security Administration

 RIN 1210-ZA18
[Application Number: D-11681]


Proposed Amendments to Class Prohibited Transaction Exemptions To 
Remove Credit Ratings Pursuant to the Dodd-Frank Wall Street Reform and 
Consumer Protection Act

AGENCY: Employee Benefits Security Administration, U.S. Department of 
Labor.

ACTION: Notice of Proposed Amendments to Certain Class Exemptions.

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SUMMARY: This document contains a notice of pendency before the 
Department of Labor (the Department) of Proposed Amendments to 
Prohibited Transaction Exemption (PTE) 75-1 (40 FR 50845, October 31, 
1975, as amended by 71 FR 5883, February 3, 2006); PTE 80-83 (45 FR 
73189, November 4, 1980); PTE 81-8 (46 FR 7511, January 23, 1981, as 
amended by 50 FR 14043, April 9, 1985); PTE 95-60 (60 FR 35925, July 
12, 1995); PTE 97-41 (62 FR 42830, August 8, 1997); and PTE 2006-16 (71 
FR 63786, October 31, 2006). The proposed amendments relate to the use 
of credit ratings as standards of credit-worthiness

[[Page 37573]]

in such class exemptions. Section 939A of the Dodd-Frank Wall Street 
Reform and Consumer Protection Act (Dodd-Frank) requires the Department 
to remove any references to or requirements of reliance on credit 
ratings from its class exemptions and to substitute such standards of 
credit-worthiness as the Department determines to be appropriate. If 
adopted, the proposed amendments would affect participants and 
beneficiaries of employee benefit plans, fiduciaries of such plans, and 
the financial institutions that engage in transactions with, or provide 
services or products to, the plans.

DATES: Written comments and requests for a public hearing should be 
received by the Department on or before August 20, 2013. If adopted, 
the amendments would be effective 60 days after the date of publication 
of the final amendments with respect to PTE 75-1; PTE 80-83; PTE 81-8; 
PTE 95-60; PTE 97-41; and PTE 2006-16.

ADDRESSES: All written comments and requests for a public hearing 
concerning the proposed amendments should be sent to the Office of 
Exemption Determinations via email to: e-OED@dol.gov, or via the 
Federal eRulemaking Portal: https://www.regulations.gov at Docket ID 
number: EBSA-2012-0013 (follow the instructions for submitting 
comments). Interested persons may also submit written comments and 
hearing requests by letter addressed to: Employee Benefits Security 
Administration, Room N-5700, (Attention: Application No. D-11681), U.S. 
Department of Labor, 200 Constitution Avenue NW., Washington, DC 20210, 
or by fax to (202) 219-0204. All comments and hearing requests must be 
received by the end of the comment period. The comments received will 
be available for public inspection in the Public Disclosure Room of the 
Employee Benefits Security Administration, Room N-1513, U.S. Department 
of Labor, 200 Constitution Avenue NW., Washington, DC 20210. Comments 
and hearing requests will also be available online at 
www.regulations.gov, at Docket ID number: EBSA-2012-0013 and 
www.dol.gov/ebsa, at no charge. All comments will be made available to 
the public.
    Warning: Do not include any personally identifiable information 
(such as name, address, or other contact information) or confidential 
business information that you do not want to be publicly disclosed. All 
comments may be posted on the Internet and can be retrieved by most 
Internet search engines.

FOR FURTHER INFORMATION CONTACT: Warren M. Blinder, Office of Exemption 
Determinations, Employee Benefits Security Administration, U.S. 
Department of Labor, Room N-5700, 200 Constitution Avenue NW., 
Washington, DC 20210, (202) 693-8553 (this is not a toll-free number).

SUPPLEMENTARY INFORMATION: Notice is hereby given of the pendency 
before the Department of proposed amendments to: PTE 75-1, Exemptions 
From Prohibitions Respecting Certain Classes of Transactions Involving 
Employee Benefit Plans and Certain Broker-Dealers, Reporting Dealers 
and Banks; PTE 80-83, Class Exemption for Certain Transactions 
Involving Purchases of Securities Where Issuer May Use Proceeds to 
Reduce or Retire Indebtedness to Parties in Interest; PTE 81-8, Class 
Exemption Covering Certain Short-term Investments; PTE 95-60, Class 
Exemption for Certain Transactions Involving Insurance Company General 
Accounts; PTE 97-41, Class Exemption for Collective Investment Fund 
Conversion Transactions; and PTE 2006-16, Class Exemption To Permit 
Certain Loans of Securities by Employee Benefit Plans (collectively, 
the Class Exemptions). The Class Exemptions provide relief from certain 
of the restrictions described in section 406 of the Employee Retirement 
Income Security Act of 1974 (ERISA), and the taxes imposed by sections 
4975(a) and (b) of the Code, by reason of a parallel provision 
described in section 4975(c)(1)(A) through (F) of the Code, provided 
that the conditions of the relevant exemption have been met. The 
Department is proposing to amend each of the Class Exemptions on its 
own motion, pursuant to section 408(a) of ERISA and section 4975(c)(2) 
of the Code and in accordance with the procedures set forth in 29 CFR 
part 2570, subpart B (55 FR 32836, August 10, 1990).\1\
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    \1\ Section 102 of the Reorganization Plan No. 4 of 1978, 5 
U.S.C. App. 1 (1996), generally transferred the authority of the 
Secretary of Treasury to issue administrative exemptions under 
section 4975(c)(2) of the Code to the Secretary of Labor. For 
purposes of this exemption, references to specific provisions of 
Title I of ERISA, unless otherwise specified, refer also to the 
corresponding provisions of the Code.
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A. Background

    Dodd-Frank,\2\ enacted in the wake of the financial crisis of 2008, 
was intended to, among other things, promote the financial stability of 
the United States by improving accountability and transparency in the 
financial system. Title IX, Subtitle C, of Dodd-Frank includes 
provisions regarding statutory and regulatory references to credit 
ratings in rules and regulations promulgated by Federal agencies, 
including the Department, which are designed ``[t]o reduce the reliance 
on ratings.'' \3\
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    \2\ See Public Law 111-203, 124 Stat. 1376 (2010).
    \3\ See Joint Explanatory Statement of the Committee of 
Conference, Conference Committee Report No. 111-517, to accompany 
H.R. 4173, 864-879, 870 (Jun. 29, 2010).
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    Congress recognized the ``systemic importance of credit ratings and 
the reliance placed on credit ratings by individual and institutional 
investors and financial regulators.'' \4\ Because credit rating 
agencies perform evaluative and analytical services on behalf of 
clients, much the same as auditors, securities analysts, and investment 
bankers do, Congress noted that ``the activities of credit rating 
agencies are fundamentally commercial in character and should be 
subject to the same standards of liability and oversight.'' \5\ 
Furthermore, Congress observed that, in the recent financial crisis 
precipitating Dodd-Frank, credit ratings of certain financial products 
proved to be inaccurate, which ``contributed significantly to the 
mismanagement of risks by financial institutions and investors, which 
in turn adversely impacted the health of the economy in the United 
States and around the world.'' \6\ As a result, Congress determined 
that ``[s]uch inaccuracy necessitates increased accountability on the 
part of credit rating agencies.'' \7\
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    \4\ Public Law 111-203, Section 931(1).
    \5\ Public Law 111-203, Section 931(3).
    \6\ Public Law 111-203, Section 931(5).
    \7\ Id.
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    Specifically, in section 939A of Dodd-Frank, Congress requires that 
the Department ``review any regulation issued by [the Department] that 
requires the use of an assessment of the credit-worthiness of a 
security or money market instrument and any references to or 
requirements in such regulations regarding credit ratings.'' \8\ Once 
the Department has completed that review, the statute provides that the 
Department ``remove any reference to or requirement of reliance on 
credit ratings, and to substitute in such regulations such standard of 
credit-worthiness'' as the Department determines to be appropriate.\9\
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    \8\ Public Law 111-203, Section 939A(a)(1)-(2).
    \9\ Public Law 111-203, Section 939A(b).
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    Based on the Department's consideration of section 939A of Dodd-
Frank, the Department believes that the Class Exemptions are 
``regulations'' for purposes of section 939A and, therefore,

[[Page 37574]]

are subject to its requirement to remove references to credit ratings. 
The process for proposing and granting class exemptions is similar to 
the regulatory process, and class exemptions generally apply to broad 
classes of transactions and/or parties.
    Accordingly, the Department has conducted a review of its class 
exemptions as required by section 939A(a) of Dodd-Frank and identified 
the Class Exemptions as those including references to, or requiring 
reliance on, credit ratings. In this regard, in each of the Class 
Exemptions, the Department has conditioned relief on the financial 
instruments which are the subject of such exemptions, or an issuer of 
such a financial instrument, receiving a specified credit rating, 
issued by a credit rating agency. Credit ratings have been considered 
useful for fiduciaries of employee benefit plans in evaluating the 
credit quality of a particular financial instrument or issuer, as plan 
fiduciaries frequently do not possess the expertise or resources to 
engage in an analysis of the credit quality of a financial instrument 
or its issuer. This credit rating condition is one component of the 
safeguards established in each Class Exemption to protect the interests 
of plans, and their participants and beneficiaries, which enter into 
transactions covered by the Class Exemptions.
    The credit ratings requirements found in the Class Exemptions range 
from a rating in one of the highest four generic categories of credit 
ratings to a rating in one of the highest two categories of credit 
ratings, from a nationally recognized statistical rating organization 
(NRSRO). In this regard, PTE 75-1 and PTE 80-83 require credit ratings 
in one of the four highest rating categories for non-convertible debt 
securities. PTE 2006-16 requires a credit rating of ``investment 
grade'' \10\ or better for certain issuers of irrevocable letters of 
credit and a credit rating in one of the two highest rating categories 
for collateral which consists of foreign sovereign debt securities. PTE 
81-8 utilizes a credit rating in one of the three highest rating 
categories for commercial paper. PTE 95-60 and PTE 97-41 do not require 
specific credit ratings, but instead refer generally to the credit 
ratings of certain financial instruments. Pursuant to Dodd-Frank, the 
Department is proposing herein to amend the Class Exemptions listed 
above to remove such references to credit ratings, and where 
applicable, substitute in their place alternative methods for 
determining credit quality which take into account the purpose and 
characteristics of each such Class Exemption.
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    \10\ The Department understands that ``investment grade'' is the 
common term for a credit rating in the highest four rating 
categories issued by a credit rating agency.
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B. Securities and Exchange Commission (SEC) Alternatives to Credit 
Ratings

    In proposing these amendments to the Class Exemptions, the 
Department has considered alternatives to credit ratings set forth in 
three recent SEC releases (the SEC Releases). The first is a recent 
proposal (the Investment Company Proposal) released by the SEC in 
response to section 939A and section 939(c) of Dodd-Frank that relates 
to the use of credit ratings in rules and forms under the Investment 
Company Act of 1940 (the Investment Company Act).\11\ The second is the 
adoption of a new rule 6a-5 implementing section 939(c) of Dodd-
Frank.\12\ Rule 6a-5 was initially proposed in the Investment Company 
Proposal and relates to the use of credit ratings in rules under the 
Investment Company Act (the Investment Company Final Rule, and together 
with the Investment Company Proposal, the Investment Company Releases). 
The third is the adoption of rule amendments (the 2009 NRSRO Rule 
Adopting Release) released by the SEC in 2009 on its own initiative 
regarding references to credit ratings of nationally recognized 
statistical rating organizations in certain rules under the Securities 
Exchange Act of 1934 (the Exchange Act) and the Investment Company 
Act.\13\
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    \11\ See References to Credit Ratings in Certain Investment 
Company Act Rules and Forms, Release Nos. 33-9193, IC-29592; 76 FR 
12896 (March 9, 2011).
    \12\ See Purchase of Certain Debt Securities by Business and 
Industrial Development Companies Relying on an Investment Company 
Act Exemption, Release No. IC-30268; 77 FR 70117 (November 23, 
2012).
    \13\ See References to Ratings of Nationally Recognized 
Statistical Rating Organizations, Release Nos. 34-60789, IC-28939; 
74 FR 52358 (October 9, 2009).
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    In the Investment Company Proposal, the SEC proposed alternatives 
to credit ratings in amendments to rules 2a-7, 5b-3, and in the 
Investment Company Final Rule, the SEC adopted an alternative to credit 
ratings in new rule 6a-5, each such rule under the Investment Company 
Act. In the 2009 NRSRO Rule Adopting Release, the SEC adopted an 
alternative to credit ratings in amendments to rule 10f-3 under the 
Investment Company Act. Among other provisions, the Investment Company 
Act regulates conflicts of interest in investment companies, requiring 
disclosure of material details about an investment company, and placing 
restrictions on certain mutual fund activities. The Department believes 
that the alternatives described in the SEC Releases referenced above 
are instructive in developing appropriate alternatives for credit 
ratings referenced in the Class Exemptions, in part because of the 
similar manner in which the SEC's rules and the Class Exemptions make 
use of such ratings, and also because of the similar standards of 
credit quality currently required in the rules and the Class 
Exemptions, or in the case of new rule 6a-5 and final rule 10f-3, 
required prior to their adoption.
    In this regard, the Department considered new rule 6a-5 and final 
rule 10f-3 for purposes of proposing to amend PTE 75-1 and PTE 80-83, 
and considered new rule 6a-5 with respect to its proposed amendment of 
PTE 2006-16, in developing an alternative to a credit rating in one of 
the highest four rating categories, or ``investment grade.'' The 
Department also considered final rule 10f-3 and the proposed amendment 
to rule 2a-7 for purposes of proposing to amend PTE 81-8, in developing 
an alternative to a credit rating in one of the highest three rating 
categories. Finally, the Department also considered the proposed 
amendments to rules 2a-7 and 5b-3 for purposes of proposing to amend 
PTE 2006-16, in developing an alternative to a credit rating in one of 
the highest two rating categories.

1. New Rule 6a-5 and Final Rule 10f-3: Standard for Highest Four 
Ratings Categories or ``Investment Grade''; Standard for Highest Three 
Ratings Categories

    Section 6(a)(5) of the Investment Company Act provides an exemption 
from certain of its provisions for business and industrial development 
companies (BIDCOs).\14\ Under section 6(a)(5)(A)(iv) prior to its 
amendment by Dodd-Frank, BIDCOs seeking to rely on the exemption were 
limited in their purchases of securities issued by investment companies 
and private funds to:
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    \14\ See 15 U.S.C. 80a-6(a)(5)(A). BIDCOs are companies that 
operate under state statute that provide direct investment and loan 
financing, as well as managerial assistance to state and local 
enterprises. Because BIDCOs invest in securities, they frequently 
meet the definition of ``investment compan[ies]'' under the 
Investment Company Act and would otherwise be required to register 
and be regulated under the Act in the absence of an exemption.

    (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 investment company 
that is required by its investment policies to

[[Page 37575]]

invest not less than 65 percent of its total assets in securities 
described in subclause (I) or securities that are determined by such 
registered open-end investment company to be comparable in quality 
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to securities described in subclause (I).

The Department understands that an ``investment grade'' rating is a 
common term for a rating in one of the highest four rating categories 
by a credit rating agency.
    Section 939(c) of Dodd-Frank amended section 6(a)(5)(A)(iv) of the 
Investment Company Act, effective July 21, 2012, to eliminate the 
reference to ``investment grade.'' As amended, the section references 
debt securities that meet ``such standards of credit-worthiness as the 
Commission shall adopt.'' Rule 6a-5 sets forth a credit-worthiness 
standard to replace the credit rating reference to ``investment grade'' 
that Dodd-Frank eliminated from section 6(a)(5)(A)(iv).
    Under rule 6a-5, the requirements for creditworthiness under 
section 6(a)(5)(A)(iv)(I) would be satisfied if the board of directors 
or members of the BIDCO (or a delegate thereof) determines that the 
debt security is:

    (a) subject to no greater than moderate credit risk and (b) 
sufficiently liquid that the security can be sold at or near its 
carrying value within a reasonably short period of time.

The determination is made at the time of the purchase.\15\
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    \15\ For purposes of the amendments to the Class Exemptions, the 
Department has interpreted carrying value as equivalent to fair 
market value.
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    In the Investment Company Final Rule, the SEC stated that this 
standard is designed to limit purchases of securities to those of 
``sufficiently high credit quality that they are likely to maintain a 
fairly stable market value and may be liquidated easily . . ..'' The 
SEC provided the following explanation of moderate credit risk:

    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). 
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.

The SEC noted further that in making such 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.''
    In the Investment Company Final Rule, the SEC noted that the 
standard of credit-worthiness in rule 6a-5 is similar to that 
previously adopted for rule 10f-3 under the Investment Company Act, 
amended effective November 12, 2009, to remove references to NRSRO 
ratings. Section 10(f) of the Investment Company Act prohibits a 
registered investment company from knowingly purchasing or otherwise 
acquiring, during the existence of any underwriting or selling 
syndicate, any security for which a principal underwriter of the 
security has certain relationships with the registered investment 
company, such as an officer, director, or investment adviser. Rule 10f-
3 contains a definition of ``eligible municipal securities'' with 
respect to securities that may be purchased during an affiliated 
underwriting under certain conditions. Prior to the amendment of the 
rule, such eligible municipal securities were required to have:

an investment grade rating from at least one NRSRO; provided, that 
if the issuer of the municipal securities, or the entity supplying 
the revenues or other payments from which the issue is to be paid, 
has been in continuous operation for less than three years, 
including the operation of any predecessors, the securities shall 
have received one of the three highest ratings from an NRSRO.

As amended, the definition of eligible municipal securities in rule 
10f-3 requires that the securities:

are sufficiently liquid that they can be sold at or near their 
carrying value within a reasonably short period of time and either: 
i. Are subject to no greater than moderate credit risk; or ii. If 
the issuer of the municipal securities, or the entity supplying the 
revenues or other payments from which the issue is to be paid, has 
been in continuous operation for less than three years, including 
the operation of any predecessors, the securities are subject to a 
minimal or low amount of credit risk.

    In the 2009 NRSRO Rule Adopting Release, the SEC noted that 
securities with a minimal or low credit risk ``would be less 
susceptible to default risk (i.e., have a low risk of default) than 
those with moderate credit risk. These securities (or their issuers) 
also would demonstrate a strong capacity for principal and interest 
payments and present above average creditworthiness relative to other 
municipal or tax exempt issues (or issuers).''
    Thus, in both new rule 6a-5 and final rule 10f-3, the SEC set forth 
a standard to replace ``investment grade'' that requires that the 
security be:
     Sufficiently liquid that it can be sold at or near its 
carrying value within a reasonably short period of time, and
     subject to no greater than moderate credit risk.
    Additionally, with respect to a requirement that a security be 
rated in one of the three highest rating categories, the SEC in final 
rule 10f-3 created a standard of credit-worthiness that would require 
the security to be:
     Sufficiently liquid that it can be sold at or near its 
carrying value within a reasonably short period of time, and
     subject to a minimal or low amount of credit risk.
    The Department likewise proposes herein to adopt similar standards 
to replace references in the Class Exemptions to the highest four 
rating categories or ``investment grade,'' and the highest three rating 
categories.

2. Proposed Rule 2a-7: Standard for Highest Two Rating Categories

    Investment Company Act rule 2a-7, which governs the operation of 
money market funds, exempts money market funds from certain of its 
provisions regarding the calculation of current net asset value per 
share.\16\ A fund that relies on rule 2a-7 may use special valuation 
and pricing procedures that help the fund maintain a stable net asset 
value per share (typically $1.00). To facilitate maintaining a stable 
net asset value, among other conditions, rule 2a-7 limits money market 
funds to investing in debt obligations that are at the time of 
acquisition, ``eligible securities,'' meaning they have:

    \16\ 17 CFR 270.2a-7.
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received a rating from the Requisite NRSROs \17\ in one of the two 
highest short-term rating categories.\18\
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    \17\ ``Requisite NRSROs'' are defined as any two nationally 
recognized statistical rating organizations that have issued a 
rating with respect to a security or class of debt obligations of an 
issuer or, if only one such organization has issued a rating with 
respect to such security or class of debt obligations of an issuer 
at the time the investment company acquires the security, that 
nationally recognized statistical rating organization. A Requisite 
NRSRO must also be a ``Designated NRSRO,'' which is generally any 
one of at least four nationally recognized statistical rating 
organizations that a money market fund's board of directors has 
designated for use, and determines at least annually issues credit 
ratings that are sufficiently reliable for the fund to use in 
determining whether a security is an eligible security. After 
enactment of Dodd-Frank, money market funds received SEC staff 
assurances that the staff would not recommend enforcement action if 
a money market fund board did not designate NRSROs (and did not make 
certain related disclosures) before the SEC made any modifications 
to rule 2a-7 as mandated by section 939A of Dodd-Frank. See 
Investment Company Institute, SEC No-Action Letter (Aug. 19, 2010).
    \18\ Eligible securities also must have a remaining maturity of 
397 calendar days or less. Unrated securities of comparable credit 
quality can also meet the definition of ``eligible security.''

    Rule 2a-7 further requires that securities purchased by money 
market

[[Page 37576]]

funds are those ``that the fund's board of directors determines present 
minimal credit risks (which determination must be based on factors 
pertaining to credit quality in addition to any rating assigned to such 
securities by a Designated NRSRO).'' \19\
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    \19\ Under rule 2a-7(a), an eligible security is generally 
either a ``first tier security'' or a ``second tier security.'' 
First tier securities are defined as (a) securities possessing a 
short-term rating from the requisite NRSROs in the highest short-
term rating category for debt obligations, (b) comparable unrated 
securities, (c) securities issued by money market funds, or (d) 
government securities, as defined in the Investment Company Act. 
Second tier securities, in turn, are defined as any eligible 
securities that are not first tier securities. The Department has 
determined not to adopt the ``first tier'' and ``second tier'' 
labels utilized in Rule 2a-7 to describe securities rated in the 
highest and second highest rating categories, respectively, because 
such labels are unnecessary in the context of the Class Exemptions.
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    In order to implement Section 939A of Dodd-Frank, the SEC proposed 
to amend rule 2a-7 of the Investment Company Act to remove the 
references to credit ratings discussed above and replace them with 
alternative standards of credit worthiness that are designed to achieve 
the same degree of credit quality as the ratings requirement currently 
in use. Under the proposed amendment, the requirement of rule 2a-7 
regarding minimal credit risks would be moved into the definition of 
``eligible security.'' Thus, an eligible security would be a security 
that:

the fund's board of directors determines 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).

In the Investment Company Proposal, the SEC explained that an issuer 
that would satisfy the credit-worthiness requirement associated with an 
eligible security should have ``a very strong ability to repay its 
short-term debt obligations, and a very low vulnerability to default.''
    Furthermore, in the Investment Company Proposal, the SEC noted that 
money market fund boards of directors ``would still be able to consider 
quality determinations prepared by outside sources, including NRSRO 
ratings, that fund advisers conclude are credible and reliable, in 
making credit risk determinations.'' However, the SEC observed further 
that fund advisers would be expected ``to understand the method for 
determining the rating and make an independent judgment of credit 
risks, and to consider an outside source's record with respect to 
evaluating the types of securities in which the fund invests.''
    Thus, the SEC proposed to amend the requirement in rule 2a-7 that 
an ``eligible security'' has received a rating from certain NRSROs in 
one of the highest two rating categories with a standard of credit-
worthiness that would require that the security:
     Present minimal credit risks based on factors pertaining 
to credit quality and the issuer's ability to meet its short-term 
financial obligations.

The Department likewise proposes herein to adopt a similar standard in 
order to replace references in the Class Exemptions to credit ratings 
in one of the highest two rating categories.

3. Proposed Rule 5b-3: Standard for Highest Two Rating Categories

    Rule 5b-3 under the Investment Company Act permits funds to treat 
the acquisition of a repurchase agreement as an acquisition of 
securities collateralizing the repurchase agreement in determining 
whether the fund is in compliance with certain provisions of the 
Investment Company Act, if the obligation of the seller to repurchase 
the securities from the fund is ``collateralized fully.'' \20\ In order 
for a repurchase agreement to be collateralized fully under rule 5b-
3(c)(1), among other things, the collateral for the repurchase 
agreement must consist entirely of:
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    \20\ The SEC explains in the Investment Company Proposal that a 
repurchase agreement functions economically as ``a loan from the 
fund to the counterparty, in which the securities purchased by the 
fund serve as collateral for the loan and are placed in the 
possession or under the control of the fund's custodian during the 
term of the agreement.'' Accordingly, the SEC notes that ``a fund 
investing in a repurchase agreement looks to the value and liquidity 
of the securities collateralizing the repurchase agreement rather 
than the credit quality of the counterparty for satisfaction of the 
repurchase agreement.''

    (A) cash items; (B) government securities; (C) securities that 
at the time the repurchase agreement is entered into are rated in 
the highest rating category by the [r]equisite NRSROs; or (D) 
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certain comparable unrated securities.

    In response to section 939A of Dodd-Frank, the SEC has proposed to 
eliminate the credit ratings requirement in rule 5b-3(c)(1) and set 
forth a new standard of credit-worthiness applicable to collateral 
other than cash or government securities. Under the proposed amendment 
to rule 5b-3, the requirements for credit-worthiness under rule 5b-
3(c)(1) would be satisfied if the fund's board of directors (or its 
delegate) determines that the purchased securities are:

    (i) Issued by an issuer that has the highest capacity to meet 
its financial obligations; and
    (ii) sufficiently liquid that they can be sold at approximately 
their carrying value in the ordinary course of business within seven 
calendar days.

The determination is made at the time the repurchase agreement is 
entered into.
    In the Investment Company Proposal, the SEC stated that it designed 
``the proposed amendments to retain a degree of credit quality similar 
to that under the current rule.'' The SEC provided the following 
description of an issuer with the ``highest capacity'' to meet its 
financial obligations:

[an issuer with] an exceptionally strong capacity to repay its short 
or long-term debt obligations, as appropriate, the lowest 
expectation of default, and a capacity for repayment of its 
financial commitments that is the least susceptible to adverse 
effects of changes in circumstances.

The SEC further noted that in making such determinations, ``fund boards 
(or their delegates) would still be able to consider analysis provided 
by outside sources, including credit agency ratings, that they conclude 
are credible and reliable, for purposes of making these credit quality 
evaluations.''
    The SEC observed in the Investment Company Proposal that, 
securities trading in a secondary market at the time of the acquisition 
of the repurchase agreement would satisfy the proposed liquidity 
standard.
    In the Investment Company Proposal, the SEC explained that the 
proposed amendments were designed:

to be clear enough to permit a fund board or fund investment adviser 
to make a determination regarding credit quality and liquidity that 
would achieve the same objectives that the credit rating requirement 
was designed to achieve, i.e., to limit collateral securities to 
those that are likely to retain a fairly stable market value and 
that, under ordinary circumstances, the fund would be able to 
liquidate quickly in the event of a counterparty default.

    Thus, in the proposed amendment to rule 5b-3, the SEC proposed a 
new standard of credit-worthiness to replace the reference to a credit 
rating in the highest rating category that would require a security to 
be:
     Issued by an issuer that has the highest capacity to meet 
its financial obligations, and
     sufficiently liquid that it can be sold at approximately 
its carrying value in the ordinary course of business within seven 
calendar days.
    The Department proposes herein to make use of certain portions of 
the standard set forth above, including that pertaining to the 
liquidity of the securities, to replace references in the

[[Page 37577]]

Class Exemption to a credit rating in the highest rating category.

C. Class Exemptions

    These proposed amendments to the Class Exemptions are designed to 
implement the mandate of section 939A(b) of Dodd-Frank to ``remove any 
reference to or requirement of reliance on credit ratings and to 
substitute in such regulations such standard of credit-worthiness as 
each respective agency shall determine as appropriate for such 
regulations.'' In this regard, the Department has designed the proposed 
amendments to retain the same degree of credit quality required under 
the Class Exemptions prior to the amendments, but without referencing 
or relying on credit ratings. The Department does not consider the 
changes proposed herein to be substantive in nature. Thus, for example, 
although the proposed amendment to PTE 75-1, Part III and Part IV, no 
longer refers to securities rated in one of the four highest rating 
categories, it is meant to capture securities that should generally 
qualify for that designation without relying on third-party credit 
ratings.
    The Department recognizes that, where a fiduciary has neither the 
expertise nor the time to make an informed determination of credit 
quality, it may be appropriate as a matter of prudence for such 
fiduciary to seek out the advice and counsel of third parties. 
Furthermore, it should be noted that, while credit ratings may no 
longer serve as a basis, or threshold, of credit quality, section 939A 
of Dodd-Frank does not prohibit a fiduciary from using credit ratings 
as an element, or data point, in that analysis.
    The Department notes that, in conducting an analysis of the credit 
quality of a particular financial instrument or person, a fiduciary 
should consider a variety of factors that may be applicable in making 
such determination. The following factors, derived from a recent SEC 
release regarding proposed changes to certain rules under the 
Securities Exchange Act of 1934 (the Exchange Act Proposal), may be 
considered relevant in assessing credit risk: \21\
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    \21\ The factors listed below were published in the SEC's 
proposing release entitled, Removal of Certain References to Credit 
Ratings Under the Securities Exchange Act of 1934, Release No. 34-
64352; 76 FR 26550, at 26552-26553 (May 6, 2011). While such factors 
derive from the SEC's proposed amendment to Rule 15c3-1, which 
requires a broker-dealer to determine whether a security satisfies a 
``minimal amount of credit risk,'' the Department believes that they 
may, where appropriate, be helpful in connection with a fiduciary's 
determination of credit quality under the amendments proposed 
herein.
---------------------------------------------------------------------------

     Credit spreads (i.e., the amount of credit risk a position 
in commercial paper and/or nonconvertible debt is subject to, based on 
the spread between the security's yield and the yield of Treasury or 
other securities, or based on credit default swap spreads that 
reference the security);
     Securities-related research (i.e., to what extent 
providers of securities-related research believe the issuer of the 
security will be able to meet its financial commitments, generally, or 
specifically, with respect to securities held);
     Internal or external credit risk assessments (i.e., 
whether credit assessments developed internally by a broker-dealer or 
externally by a credit rating agency, express a view as to the credit 
risk associated with a particular security);
     Default statistics (i.e., whether providers of credit 
information relating to securities express a view that specific 
securities have a probability of default consistent with other 
securities with a determined amount of credit risk);
     Inclusion on an index (i.e., whether a security, or issuer 
of the security, is included as a component of a recognized index of 
instruments that are subject to a determined amount of credit risk);
     Priorities and enhancements (i.e., the extent to which a 
security is covered by credit enhancements, such as 
overcollateralization and reserve accounts, or has priority under 
applicable bankruptcy or creditors' rights provisions);
     Price, yield and/or volume (i.e., whether the price and 
yield of a security or a credit default swap that references the 
security are consistent with other securities that the broker-dealer 
has determined are subject to a certain amount of credit risk and 
whether the price resulted from active trading); and
     Asset class-specific factors (e.g., in the case of 
structured finance products, the quality of the underlying assets).
    The Department observes that the SEC's list above was not meant to 
be exhaustive or mutually exclusive, and that the range and type of 
specific factors considered would vary depending on the particular 
securities that are reviewed.
    The Department notes further that in making a determination of the 
relative credit quality of a particular financial instrument or entity, 
as well as in assigning a relative value to a third party's advice or a 
credit rating, a plan fiduciary would continue to be subject to section 
404 of ERISA. Moreover, such fiduciary would remain subject to the 
other conditions of relief as set forth in the Class Exemptions, 
including, but not limited to, any requirements regarding the 
maintenance of records which are necessary to enable the persons 
described therein to determine whether the conditions of such Class 
Exemption have been met.

1. PTE 75-1

    PTE 75-1, granted soon after the enactment of ERISA, provides 
relief for certain transactions that were customary at the time between 
plans and broker-dealers or banks, including a plan's acquisition of 
securities from a member of an underwriting syndicate of which a plan 
fiduciary or its affiliate is a member, and an employee benefit plan's 
purchase or sale of securities for which the plan's fiduciary is a 
``market maker,'' to or from such fiduciary or its affiliate.
    Specifically, PTE 75-1, Part III, provides relief from the 
restrictions of section 406 of ERISA and the taxes imposed by section 
4975(a) and (b) of the Code, by reason of section 4975(c)(1) of the 
Code, for an employee benefit plan's acquisition of securities during 
the existence of an underwriting syndicate, from a person other than a 
fiduciary with respect to the plan, where a fiduciary of such employee 
benefit plan is a member of the underwriting syndicate. Section III(a) 
provides further that no fiduciary who is involved in any way in 
causing the plan to make such purchase may be a manager of such 
underwriting or selling syndicate. In this regard, section (a) defines 
a manager as any member of an underwriting or selling syndicate who, 
either alone or together with other members of the syndicate, is 
authorized to act on behalf of the members of the syndicate in 
connection with the sale and distribution of the securities being 
offered or who receives compensation from the members of the syndicate 
for its services as a manager of the syndicate.
    Part IV of PTE 75-1 provides relief from the restrictions of 
section 406 of ERISA and the taxes imposed by section 4975(a) and (b) 
of the Code, by reason of section 4975(c)(1) of the Code, for a plan's 
purchase or sale of securities from or to a ``market maker'' with 
respect to such security who is also a fiduciary with respect to the 
plan or an affiliate of such fiduciary. Part IV provides further that 
at least one person other than the fiduciary must be a market-maker in 
such securities, and the transaction must be executed at a net price to 
the plan for the number of shares or other units to be purchased or

[[Page 37578]]

sold in the transaction which is more favorable to the plan than that 
which such fiduciary, acting in good faith, reasonably believes to be 
available at the time of such transaction from all other market makers 
in such securities.
    The relief afforded in Part III and Part IV of PTE 75-1 is also 
conditioned upon, among other things, the issuer of the securities 
having been in continuous operation for not less than three years, 
including the operations of any predecessors. However, several 
exceptions to this condition exist with respect to each exemption, 
including an exception for securities that are ``non-convertible debt 
securities rated in one of the four highest rating categories by at 
least one nationally recognized statistical rating organization.''
    The condition requiring the issuer of securities in an underwriting 
to have been in continuous operation for at least three years bolsters 
the quality of the underwritten securities, by ensuring that the issuer 
is an established entity that has been operating as a business for a 
continuous period of time. Securities issued by such an issuer should 
be more predictable in terms of price and trading volume stability than 
securities issued by unproven entities with shorter operating 
histories. Ostensibly, debt securities rated as investment grade or 
higher, by an unrelated third party in the business of evaluating 
credit quality, possess attributes of credit quality that provide more 
predictability in terms of price, volatility, and ultimate payment of 
principal. Thus, the Department is cognizant that any substitute for 
credit ratings must provide the same level of protection for plans 
entering into the transactions.
    The Department is proposing to replace the references to credit 
ratings in Part III and Part IV of PTE 75-1 with the requirement that, 
``[a]t the time of acquisition, such securities are non-convertible 
debt securities (i) subject to no greater than moderate credit risk and 
(ii) sufficiently liquid that such securities can be sold at or near 
their fair market value within a reasonably short period of time.'' 
Thus, as amended, condition (c)(1) of Part III and condition (a)(1) of 
Part IV, of PTE 75-1, would require securities to be issued by a person 
that has been in continuous operation for not less than three years, 
including the operations of any predecessors, unless, among other 
exceptions, the fiduciary directing the plan in such transaction has 
made a determination that, at the time they are acquired, such 
securities satisfy the new standard described above.
    For purposes of this amendment, debt securities subject to a 
moderate level of credit risk should possess at least average credit-
worthiness relative to other similar debt issues. Moderate credit risk 
would denote current low expectations of default risk, with an adequate 
capacity for payment of principal and interest.
    The Department views the new proposed standard as reflecting the 
same level of credit quality as required prior to this amendment. The 
alternative standard described above is modeled on the SEC's new rule 
6a-5 and final rule 10f-3 of the Investment Company Act. New rule 6a-5 
and one element of the final amendments to rule 10f-3 each set forth a 
standard that replaced a reference to an ``investment grade'' rating, 
which the Department understands is the same as a reference to one of 
the four highest rating categories issued by at least one nationally 
recognized statistical rating organization. Furthermore, because PTE 
75-1, Part III, and final rule 10f-3 involve the acquisition of 
securities in an underwriting where there is a relationship between the 
acquiring fund or entity and a member of the underwriting syndicate, it 
is relevant that the standard of credit quality required under each 
rule is similar.
    The proposed standard is also appropriate for PTE 75-1, because it 
addresses concerns that an acquirer of securities might be harmed by a 
purchase of illiquid securities. In this regard, the proposed standard 
preserves the purpose of the original condition in paragraphs (c)(1) of 
Part III and (a)(1) of Part IV of PTE 75-1, by restricting fiduciaries' 
acquisitions to purchases of securities of sufficiently high credit 
quality. As stated above, in making these determinations, a fiduciary 
would not be precluded from considering credit quality reports prepared 
by outside sources, including credit ratings prepared by credit rating 
agencies, that they conclude are credible and reliable for this 
purpose.

2. PTE 80-83

    PTE 80-83 generally provides relief for the purchase or acquisition 
in a public offering of securities by a fiduciary, on behalf of an 
employee benefit plan, solely because the proceeds from the sale may be 
used by the issuer of the securities to retire or reduce indebtedness 
owed to a party in interest with respect to the plan. Part C of the 
exemption provides relief from the restrictions of sections 
406(a)(1)(A) through (D) and 406(b)(1) and (2) of ERISA and the taxes 
imposed by reason of section 4975(c)(1)(A) through (E) of the Code, for 
the purchase or acquisition in a public offering of securities, by a 
fiduciary which is a bank or affiliate thereof, on behalf of a plan 
solely because the proceeds of the sale may be used by the issuer of 
the securities to retire or reduce indebtedness owed to such fiduciary 
or an affiliate thereof. In the event that such fiduciary of the plan 
``knows'' that the proceeds of the issue will be used in whole or in 
part by the issuer of the securities to reduce or retire indebtedness 
owed to such fiduciary or affiliate thereof, the relief in Part C is 
conditioned upon, among other things, the issuer of such securities 
having been in continuous operation for not less than three years, 
including the operations of any predecessors, unless such securities 
are non-convertible debt securities rated in one of the four highest 
rating categories by at least one nationally recognized statistical 
rating organization.
    As in PTE 75-1, Part III and Part IV, the three years continuous 
operation condition bolsters the quality of the underwritten securities 
by ensuring that the issuer is an established entity that has been 
operating as a business for a continuous period of time. In crafting an 
alternative to credit ratings to be used as an exception to the three 
years continuous operation condition, the Department has likewise 
employed an alternative that provides similar protection for plans 
entering into the transactions.
    The Department is proposing to amend condition 3 of Part C of PTE 
80-83 to replace the reference to credit ratings with a requirement 
that, ``at the time of acquisition, such securities are non-convertible 
debt securities (i) subject to no greater than moderate credit risk and 
(ii) sufficiently liquid that such securities can be sold at or near 
their fair market value within a reasonably short period of time.'' For 
purposes of this amendment, debt securities subject to a moderate level 
of credit risk should possess at least average credit-worthiness 
relative to other similar debt issues. Moderate credit risk would 
denote current low expectations of default risk, with an adequate 
capacity for payment of principal and interest.
    The Department views the new proposed standard as reflecting the 
same level of credit quality as required prior to this amendment. It is 
appropriate that the proposed alternative is modeled on the SEC's new 
rule 6a-5 and final rule 10f-3 of the Investment Company Act. New rule 
6a-5 and one element of the final amendments to rule 10f-3 each 
supplied a standard that replaced the reference to an ``investment 
grade'' rating, which the Department

[[Page 37579]]

understands is the same as a reference to a rating in one of the four 
highest rating categories by at least one nationally recognized 
statistical rating organization. The alternative standard in the 
proposed amendment to PTE 80-83 also addresses concerns that an 
acquirer of securities might be harmed by such person's purchase of 
illiquid securities. The alternative preserves the level of protection 
afforded by the original standard, by requiring a fiduciary to make a 
prudent determination that a security acquired in an underwriting is of 
a sufficiently high credit quality. In making the proposed 
determination of credit quality, a fiduciary may consider information 
provided by third parties, including credit ratings issued by credit 
rating agencies.

3. PTE 81-8

    PTE 81-8 provides exemptive relief from the restrictions of section 
406(a)(1)(A), (B), and (D) of ERISA and the taxes imposed by reason of 
section 4975(c)(1)(A), (B), and (D) of the Code, for the investment of 
employee benefit plan assets which involve the purchase or other 
acquisition, holding, sale, exchange or redemption by or on behalf of 
an employee benefit plan of certain short-term investments issued by a 
party in interest, including commercial paper. As a condition of 
exemptive relief, paragraph II(D) requires that, with respect to an 
acquisition or holding of commercial paper, at the time it is acquired, 
such commercial paper must be ranked in one of the three highest rating 
categories by at least one nationally recognized statistical rating 
service. The original condition was incorporated into PTE 81-8 to allow 
fiduciaries who make investment decisions regarding the short-term 
investments of a plan to choose from a broad range of issues of 
commercial paper while assuring that the quality of the issue had been 
assessed by an independent third party.
    The Department proposes to amend paragraph II(D) to delete the 
reference to the credit rating of commercial paper and replace it with 
the requirement that, ``at the time of acquisition, the commercial 
paper is (i) subject to a minimal or low amount of credit risk based on 
factors pertaining to credit quality and the issuer's ability to meet 
its short-term financial obligations, and (ii) sufficiently liquid that 
such securities can be sold at or near their fair market value within a 
reasonably short period of time.'' Commercial paper subject to a 
minimal or low credit risk would be less susceptible to default risk 
(i.e., have a low risk of default) than those with moderate credit 
risk. These instruments also would demonstrate a strong capacity for 
principal and interest payments and present above-average credit-
worthiness relative to other issues of commercial paper.
    The Department views the new proposed standard as reflecting the 
same level of credit quality required prior to this amendment. The 
``minimal or low amount of credit risk'' standard in the proposed 
alternative is modeled on one element of the SEC's final rule 10f-3 of 
the Investment Company Act, described above, which was developed as an 
alternative to a credit rating in one of the highest three rating 
categories. In developing the alternative standard for PTE 81-8, as 
amended, the Department found it relevant that final rule 10f-3 
provides an alternative to the same credit rating category that is 
currently in PTE 81-8.
    In addition, the Department considered the language ``based on 
factors pertaining to credit quality and the issuer's ability to meet 
its short-term financial obligations'' from the SEC's proposed 
amendment to rule 2a-7. The Department understands rule 2a-7 to apply 
to mutual funds (more specifically, money market funds) that invest in 
high quality, short-term debt instruments. As commercial paper is a 
short-term debt instrument as well, the Department determined that it 
would be appropriate to include such language in its alternative credit 
standard to reflect an increased focus on the issuer's ability to meet 
its short-term obligations.
    The Department notes that the preamble to PTE 81-8 (46 FR 7511 at 
7512, January 23, 1981) states that, based on the record, the 
Department was unable to conclude that unrated issues of commercial 
paper sold in a private offering ``have such protective characteristics 
that affected plans would not need the independent safeguards that the 
rating condition is intended to provide,'' which may suggest that a 
credit rating by an independent third party is an important condition 
of the relief provided. Under section 939A of Dodd-Frank, the 
Department cannot continue to mandate that commercial paper acquired by 
a plan pursuant to PTE 81-8 must receive a specified credit rating. 
However, the Department also noted in PTE 81-8, that a determination 
whether an investment in commercial paper is appropriate for a plan 
should be determined ``by the responsible plan fiduciaries, taking into 
account all the relevant facts and circumstances.'' For purposes of 
this amendment, the Department believes that a fiduciary's 
determination of the credit quality of commercial paper according to 
the proposed standard should, as a matter of prudence, include the 
reports or advice of independent third parties, including where 
appropriate, such commercial paper's credit rating.

4. PTE 95-60

    PTE 95-60 was granted in response to the Supreme Court's decision 
in John Hancock Mutual Life Insurance Co. v. Harris Trust & Savings 
Bank (Harris Trust),\22\ holding that those funds allocated to an 
insurer's general account pursuant to a contract with a plan that vary 
with the investment experience of the insurance company are ``plan 
assets'' under ERISA. Harris Trust created uncertainty with respect to 
a number of exemptions previously granted by the Department in 
connection with the operation of asset pool investment trusts that 
issue asset-backed, pass-through certificates to plans. Specifically, 
the Department had previously granted PTE 83-1 (48 FR 895, January 7, 
1983) \23\ and the ``Underwriter Exemptions,'' \24\ which were 
conditioned, among other things, upon the certificates that were 
purchased by plans not being subordinated to other classes of 
certificates issued by the same trust. Because, in a typical asset pool 
investment trust, one or more classes of subordinated certificates are 
often purchased by life insurance companies, in holding that insurance 
company general accounts may be considered ``plan assets,'' Harris 
Trust raised the potential for servicers and trustees of pools to be 
engaging in prohibited transactions for the same acts involving the 
operation of trusts which would be exempt if the certificates were not 
subordinated.
---------------------------------------------------------------------------

    \22\ 510 US 86 (1993).
    \23\ PTE 83-1 provides relief for the operation of certain 
mortgage pool investment trusts and the acquisition and holding by 
plans of certain mortgage-backed pass-through certificates 
evidencing interests therein.
    \24\ The Underwriter Exemptions are comprised of a number of 
individual exemptions in which credit ratings have been used 
extensively (e.g., PTE 2009-31 (74 FR 59003, November 16, 2009)), 
which provide relief for the operation of certain asset pool 
investment trusts and the acquisition and holding by plans of 
certain asset-based pass-through certificates representing interests 
in those trusts.
---------------------------------------------------------------------------

    PTE 95-60 provides exemptive relief for certain transactions 
engaged in by insurance company general accounts in which an employee 
benefit plan has an interest, if certain specified conditions are met. 
Under Section III, additional relief is provided from the restrictions 
of sections 406(a), 406(b) and 407(a) of ERISA and the taxes imposed by 
section 4975(a) and (b) of the Code by reason of section 4975(c) of the 
Code for certain

[[Page 37580]]

transactions entered into in connection with the servicing, management, 
and operation of a trust (a Trust), described in PTE 83-1 or in one of 
the Underwriter Exemptions, in which an insurance company general 
account has an interest as a result of its acquisition of certificates 
issued by the Trust.
    Section III(a)(2) of PTE 95-60 requires that the conditions of 
either PTE 83-1 or an applicable Underwriter Exemption be met other 
than the requirements that the certificates acquired by the general 
account (A) not be subordinated to the rights and interests evidenced 
by other certificates of the same trust and (B) receive a rating that 
is in one of the three highest generic rating categories from an 
independent rating agency. Because PTE 83-1 only requires non-
subordination with respect to the acquired certificates, and does not 
have a credit rating reference or requirement, the exception from the 
ratings requirement applies only to the Underwriter Exemptions.
    The Department proposes to delete the reference in Section 
III(a)(2)(B) pertaining to the credit ratings of certificates acquired 
by a general account and replace it with a general reference to the 
credit quality of such certificates. Thus, Section III(a)(2) of PTE 95-
60, as amended, would provide that ``[t]he conditions of either PTE 83-
1 or the relevant Underwriter Exemption are met, except for the 
requirements that: (A) The rights and interests evidenced by the 
certificates acquired by the general account are not subordinated to 
the rights and interests evidenced by other certificates of the same 
Trust, and (B) the certificates acquired by the general account have 
the credit quality required under the relevant Underwriter Exemption at 
the time of such acquisition.''
    The Department believes that this modification will bring PTE 95-60 
into compliance with the mandate in section 939A of Dodd-Frank that any 
reference to or requirement of reliance on credit ratings be removed 
from the Department's rules and regulations. Because the Department has 
not proposed to amend the Underwriter Exemptions, this proposed 
amendment cannot refer to a specific alternative to credit ratings in 
such exemptions. Nevertheless, because Section III(a)(2), as amended, 
would state that the certificates are not required to meet the standard 
of credit quality referred to in the conditions of the Underwriter 
Exemptions, the Department believes that the amended requirement would 
be consistent with section 939A(b) of Dodd-Frank. Additionally, in the 
Department's view, there should not be any substantive distinction 
between a person's compliance with the condition in paragraph 
III(a)(2)(B) prior to or after this amendment takes effect.

5. PTE 97-41

    Section II of PTE 97-41 provides relief from sections 406(a) and 
406(b)(1) and (2) of ERISA and the taxes imposed by section 4975 of the 
Code, by reason of section 4975(c)(1)(A) through (E) of the Code, for 
the purchase, by an employee benefit plan, of shares of one or more 
mutual funds in exchange for the assets of the plan, transferred in-
kind to the mutual fund from a collective investment fund (CIF) 
maintained by a bank or plan adviser where such bank or plan adviser is 
the investment adviser to the mutual fund and also a fiduciary of the 
plan, in connection with a complete withdrawal of the plan's assets 
from the CIF. Exemptive relief is conditioned upon, inter alia, Section 
II(c), the ``pro rata division rule,'' which provides that the 
transferred assets must constitute the plan's pro rata portion of the 
assets that were held by the CIF immediately prior to the transfer. 
However, Section II(c) provides further that, notwithstanding the 
foregoing, the allocation of fixed income securities held by a CIF 
among plans on the basis of each plan's pro rata share of the aggregate 
value of such securities will not fail to meet the requirements of the 
pro rata division rule if (1) the aggregate value of such securities 
does not exceed one percent of the total value of the assets held by 
the CIF immediately prior to the transfer, and (2) such securities have 
the same coupon rate and maturity, and at the time of transfer, the 
same credit ratings from nationally recognized statistical rating 
organizations.
    The exception to the general pro rata division rule in Section 
II(c) ensures that plans can avoid the transaction costs involved in 
liquidating small positions in fixed-income securities that are not 
divisible, or that can be divided only at substantial cost, prior to 
their maturity. In these situations, equivalent, small investments of 
fixed-income securities are treated as fungible for allocation purposes 
if such securities have the same coupon rates, maturities and credit 
ratings at the time of the transaction. This requirement ensures that 
all plans receive securities that have equivalent terms and features 
and that such fixed-income securities will be allocated among the plans 
in a manner such that each plan receives its pro rata share of the 
value of such securities.
    The Department is proposing to amend the exception found in Section 
II(c) by deleting the requirement found in subsection (2) that the 
securities transferred in-kind from a CIF to the mutual fund have the 
same credit ratings and replacing it with a requirement that such 
securities are of the same credit quality. Section II(c)(1) and (2), as 
amended, would provide that the allocation of fixed-income securities 
held by a CIF among the plans on the basis of each plan's pro rata 
share of the aggregate value of such securities will not fail to meet 
the requirements of Section II(c) if ``(1) the aggregate value of such 
securities does not exceed one percent of the total value of the assets 
held by the CIF immediately prior to the transfer, and (2) such 
securities have the same coupon rate and maturity, and at the time of 
transfer, the same credit quality.''
    In making the determination as to the credit quality of fixed 
income securities for purposes of this condition, the Department notes 
that a fiduciary should, to the extent possible, engage in credit 
quality comparisons of securities using the same standards (e.g., 
employing the same metrics) for each set of securities. The Department 
believes that an ``apples to apples'' comparison of the credit quality 
of each security taking into account the same variables would comply 
with the proposed amendment to the condition set forth in Section 
II(c)(2). Furthermore, the Department notes that a fiduciary may rely 
on reports and advice given by independent third parties, including 
ratings issued by rating agencies.

6. PTE 2006-16

    Sections I(a) and (b) of PTE 2006-16 provide exemptive relief from 
section 406(a)(1)(A) through (D) of ERISA and the taxes imposed by 
section 4975(a) and (b) of the Code by reason of section 4975(c)(1)(A) 
through (D) of the Code for the lending of securities that are assets 
of an employee benefit plan to certain banks and broker-dealers that 
are parties in interest with respect to the plan. Section I(c) of PTE 
2006-16 provides exemptive relief from section 406(b)(1) of ERISA and 
the taxes imposed by section 4975(a) and (b) of the Code by reason of 
section 4975(c)(1)(E) of the Code for the payment to a fiduciary of 
compensation for services rendered in connection with loans of plan 
assets that are securities.
    Section II(b) of PTE 2006-16 conditions the relief provided under 
Sections I(a) and (b) upon the plans' receipt from the borrower, by the 
close of the lending fiduciary's business on the day in which the 
securities lent are delivered to the borrower, of either ``U.S. 
Collateral,'' or ``Foreign Collateral,'' as such terms are defined in

[[Page 37581]]

Section V of the exemption. Section V(f)(2) defines ``Foreign 
Collateral'' to include ``foreign sovereign debt securities provided 
that at least one nationally recognized statistical rating organization 
has rated in one of its two highest categories either the issue, the 
issuer or guarantor.'' Section V(f)(4) defines ``Foreign Collateral'' 
to include ``irrevocable letters of credit issued by a [f]oreign 
[b]ank, other than the borrower or an affiliate thereof, which has a 
counterparty rating of investment grade or better as determined by a 
nationally recognized statistical rating organization.''
    The Department is proposing to amend Section V(f)(2) to delete the 
reference to credit ratings and provide that ``Foreign Collateral'' 
will include ``foreign sovereign debt securities that are (i) subject 
to a minimal amount of credit risk, and (ii) sufficiently liquid that 
such securities can be sold at or near their fair market value in the 
ordinary course of business within seven calendar days.''
    The credit risk associated with securities that present ``minimal 
credit risks'' would differ from that of the highest credit quality 
securities only to a small degree. Thus, an issuer that would satisfy 
the credit-worthiness requirement associated with foreign sovereign 
debt securities should have a very strong ability to repay its debt 
obligations, and a very low vulnerability to default. In addition, the 
SEC has indicated its expectation that securities that trade in a 
secondary market at the time of their acquisition would satisfy the 
``seven calendar day'' liquidity standard.\25\
---------------------------------------------------------------------------

    \25\ See Investment Company Proposal, supra note 11, at text 
following n.54.
---------------------------------------------------------------------------

    The Department views the new standard as reflecting the same level 
of credit quality required prior to this amendment. The alternative 
standard of credit quality proposed for Section V(f)(2) of PTE 2006-16 
takes a similar approach to the SEC's proposed amendments to rule 2a-7, 
which governs the securities that certain money market funds may hold 
as investments, and proposed amendments to rule 5b-3, which relates to 
funds entering into repurchase agreements that are collateralized with 
certain high credit-quality securities, as described above.
    The Department believes that the ``minimal'' credit risk standard 
in the proposed alternative to credit ratings in rule 2a-7 is an 
appropriate model for the alternative standard of credit quality 
proposed in Section V(f)(2) of PTE 2006-16, as the current level of 
credit worthiness required under both provisions reflects credit 
ratings in one of the two highest rating categories. However, the 
Department understands that, whereas rule 2a-7 currently utilizes a 
short-term rating, foreign sovereign debt securities described in 
Section V(f)(2) could comprise either long-term or short-term 
securities. Therefore, in formulating the proposed alternative standard 
of credit quality in Section V(f)(2), the Department did not include in 
its proposed standard the language ``based on factors pertaining to 
credit quality and the issuer's ability to meet its short-term 
financial obligations.'' However, in the case of a short-term foreign 
sovereign debt security used as collateral, fiduciaries may wish to 
include the issuer's ability to meet its short term obligations as a 
factor in its evaluation of the security's credit quality.
    In addition to the ``minimal'' credit risk standard of the proposed 
amendment, the Department believes that the liquidity requirement 
proposed in rule 5b-3 (``sufficiently liquid that such securities can 
be sold at or near their fair market value in the ordinary course of 
business within seven calendar days'') is appropriate for inclusion in 
the alternative standard of credit quality proposed in Section V(f)(2) 
of PTE 2006-16, because the economic considerations and regulatory 
framework underpinning securities repurchase agreements is similar to 
that supporting securities lending transactions.
    The Department is also proposing to amend Section V(f)(4) to delete 
the reference to credit ratings and provide that ``Foreign Collateral'' 
will include ``irrevocable letters of credit issued by a Foreign Bank, 
other than the borrower or an affiliate thereof, provided that, at the 
time the letters of credit are issued, the Foreign Bank's ability to 
honor its commitments thereunder is subject to no greater than moderate 
credit risk.'' The Department notes that, where a Foreign Bank's 
ability to honor its commitment under a letter of credit is subject to 
a moderate level of credit risk, such bank would demonstrate at least 
average credit-worthiness relative to other issuers of similar debt. 
Moderate credit risk would denote current low expectations of default 
risk, with an adequate capacity for payment of principal and interest.
    The Department views the new standard as reflecting the same level 
of credit quality required prior to this amendment. The proposed 
alternative described for Section V(f)(4) is modeled after the SEC's 
new rule 6a-5 of the Investment Company Act, described above, which 
adopts an alternative to a credit rating of investment grade, or a 
credit rating in one the four highest rating categories.\26\ In 
particular, the Department has modeled the new standard of credit 
quality for PTE 2006-16 on the credit quality element of the standard 
in rule 6a-5; as such, the proposed amendment focuses on the issuing 
bank's ability to honor its commitment under the letter of credit. 
Furthermore, in developing the alternative standard for Section V(f)(4) 
of PTE 2006-16, as amended, the Department found it relevant that the 
standards adopted in new rule 6a-5 and proposed in amendments to 
Section V(f)(4) of PTE 2006-16 are designed to reflect the same level 
of credit quality as the credit ratings they replaced in section 
6(a)(5)(A)(iv) of the Investment Company Act and would replace in 
Section V(f)(4), respectively.
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    \26\ As noted above, the SEC adopted rule 6a-5 under the 
Investment Company Act as directed by section 939(c) of Dodd-Frank, 
which eliminates a statutory condition requiring that certain 
securities have received a credit rating of investment grade, and 
instead requires that the securities ``meet such standards of 
creditworthiness as the Commission shall adopt.''
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    Finally, Lending Fiduciaries making determinations of credit 
quality under Sections V(f)(2) and V(f)(4) of PTE 2006-16 would still 
be able to consider credit quality determinations prepared by outside 
sources, including credit ratings issued by rating organizations, that 
such fiduciaries conclude are credible and reliable, in making 
determinations of credit worthiness.

7. Request for Comment Regarding Modifications to Class Exemptions

    The Department is requesting comments regarding all aspects of 
these proposed amendments. In this regard, the Department specifically 
requests comments regarding whether the alternatives for credit ratings 
described herein represent adequate substitutes for credit ratings by 
rating organizations, taking into account the different Class 
Exemptions making use of such ratings, and the costs to comply with the 
alternatives, and invites comments on additional or alternative credit 
standards for consideration by the Department. As stated above, any 
suggested alternative to a credit rating should retain as close as 
possible the original intent of the standard in its related Class 
Exemption. Furthermore, the Department will consider the SEC's 
treatment of comments received in response to its proposals modifying 
the use of credit ratings as part of its compliance with section 939A 
and 939(c) of Dodd-Frank.

[[Page 37582]]

    In addition to the comments requested above, the Department 
requests comments on guidance provided in connection with the term 
``moderate credit risk'' as used in the proposed amendments to PTEs 75-
1, 80-83, and 2006-16. Specifically, the Department solicits input on 
whether average credit-worthiness relative to other similar issues or 
issuers is an appropriate point of reference to associate with a 
moderate level of credit risk, as used in the Class Exemptions. The 
Department also requests comments regarding the inclusion of a 
liquidity requirement as part of its standard of credit-worthiness 
proposed for use in the Class Exemptions. In this regard, the 
Department is interested in commenters' views as to whether a liquidity 
requirement contributes to the protective characteristics of the 
relevant standard of credit-worthiness proposed for use in the 
applicable Class Exemptions, and invites comments on alternative 
liquidity requirements for consideration by the Department or whether 
the absence of such a requirement is more appropriate. Any comment 
received in this regard should explain in detail the commenter's 
rationale, including how the presence or absence of a liquidity 
requirement would be protective of plans, participants and their 
beneficiaries.
    Finally, the Department requests comments regarding its use of 
``fair market value'' for purposes of establishing a liquidity 
requirement in the proposed alternatives to credit ratings. 
Specifically, the Department requests comments concerning whether a 
different measure of value, such as ``carrying value'' or ``fair 
value,'' \27\ would be more appropriate for the proposed alternatives 
to credit ratings and offer greater protections for employee benefit 
plans and their participants and beneficiaries engaging in the covered 
transactions. Any comment received in this regard should explain in 
detail the suggested measure of value, including how it is determined 
and why it is appropriate for use in a Class Exemption.
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    \27\ As stated in FASB Accounting Standards Codification Topic 
820, Fair Value Measurements and Disclosures (ASC Topic 820).
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8. Underwriter Exemptions

    The Underwriter Exemptions are comprised of a number of individual 
exemptions in which credit ratings have been used extensively (e.g., 
PTE 2009-31 (74 FR 59003, November 16, 2009)), which provide relief for 
the operation of certain asset pool investment trusts and the 
acquisition and holding by plans of certain asset-based pass-through 
certificates representing interests in those trusts. It is the 
Department's view that the Underwriter Exemptions, as individual 
prohibited transaction exemptions, are not federal regulations, and 
therefore section 939A of Dodd-Frank does not require their review and 
modification.
    Accordingly, notwithstanding the deadline for compliance with 
section 939A, the Underwriter Exemptions will remain in force with no 
modifications to their credit rating requirements.\28\ The Department 
is cognizant, however, of the Congressional intent to reduce reliance 
on credit ratings and is considering alternative standards for use 
instead of, or in addition to, existing requirements for credit ratings 
in granted individual prohibited transaction exemptions. Thus, the 
Department is requesting comments regarding such alternatives in 
addition to any comments regarding the Class Exemptions.
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    \28\ The Department notes that it recently proposed an amendment 
to the Underwriter Exemptions (the Underwriter Proposal) that 
modified the definition of ``Rating Agency'' to eliminate specific 
references to named credit rating agencies. Pursuant to the 
Underwriter Proposal, the term ``Rating Agency'' would be defined 
using a general framework of self-executing criteria based on both 
(i) SEC rules applicable to NRSROs and (ii) the Department's own 
``seasoning'' requirement for credit rating agencies. The 
Underwriter Proposal makes no modifications to the use of credit 
ratings in the Underwriter Exemptions, including the requirement 
that securities available for purchase by Plans generally must be 
rated in one of the three highest rating categories (or four in the 
case of certain ``Designated Transactions''). See Notice of Proposed 
Amendment to Prohibited Transaction Exemption 2007-05, 72 FR 13130 
(March 20, 2007), Involving Prudential Securities Incorporated, et 
al., To Amend the Definition of ``Rating Agency,'' 77 FR 76773 
(December 28, 2012).
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9. Executive Order 12866 Statement

    Under Executive Order 12866 (the Executive Order), the Department 
must determine whether a regulatory action is ``significant'' and 
therefore subject to the requirements of the Executive Order and 
subject to review by the Office of Management and Budget (OMB). Under 
section 3(f) of the Executive Order, a ``significant regulatory 
action'' is an action that is likely to result in a rule (1) having an 
effect on the economy of $100 million or more in any one year, or 
adversely and materially affecting a sector of the economy, 
productivity, competition, jobs, the environment, public health or 
safety, or State, local or tribal governments or communities (also 
referred to as ``economically significant''); (2) creating serious 
inconsistency or otherwise interfering with an action taken or planned 
by another agency; (3) materially altering the budgetary impacts of 
entitlement grants, user fees, or loan programs or the rights and 
obligations of recipients thereof; or (4) raising novel legal or policy 
issues arising out of legal mandates, the President's priorities, or 
the principles set forth in the Executive Order. OMB has determined 
that this action is significant within the meaning of section 3(f)(4) 
of the Executive Order, and accordingly, OMB has reviewed these 
proposed amendments to PTE 75-1, PTE 80-83, PTE 81-8, PTE 95-60, PTE 
97-41, and PTE 2006-16 pursuant to the Executive Order.

10. Paperwork Reduction Act

    According to the Paperwork Reduction Act of 1995 (Pub. L. 104-13) 
(the PRA), no persons are required to respond to a collection of 
information unless such collection displays a valid OMB control number. 
The Department notes that a Federal agency cannot conduct or sponsor a 
collection of information unless it is approved by OMB under the PRA, 
and displays a currently valid OMB control number, and the public is 
not required to respond to a collection of information unless it 
displays a currently valid OMB control number. See 44 U.S.C. 3507. 
Also, notwithstanding any other provisions of law, no person shall be 
subject to penalty for failing to comply with a collection of 
information if the collection of information does not display a 
currently valid OMB control number. See 44 U.S.C. 3512.
    The Department has not made a submission to OMB at this time, 
because the proposed amendments do not revise the information 
collection requests contained in the following PTEs: PTE 75-1, which is 
approved by OMB under OMB Control Number 1210-0092; PTE 80-83, which is 
approved by OMB under OMB Control Number 1210-0064; PTE 81-8, which is 
approved by OMB under OMB Control Number 1210-0061; PTE 95-60, which is 
approved by OMB under OMB Control Number 1210-0114; PTE 97-41, which is 
approved by OMB under OMB Control Number 1210-0104; and PTE 2006-16, 
which is approved by OMB under OMB Control Number 1210-0065.
GENERAL INFORMATION
    The attention of interested persons is directed to the following:
    (1) Before an exemption may be granted under section 408(a) of 
ERISA and section 4975(c)(2) of the Code, the Department must find that 
the exemption is administratively feasible, in the interests of the 
plan and of its participants and beneficiaries and

[[Page 37583]]

protective of the rights of participants and beneficiaries of such 
plan;
    (2) The proposed amendments, if granted, will be supplemental to, 
and not in derogation of, any other provisions of ERISA and the Code 
including statutory or administrative exemptions and transitional 
rules. Furthermore, the fact that a transaction is subject to an 
administrative or statutory exemption is not dispositive of whether the 
transaction is in fact a prohibited transaction; and
    (3) If granted, the proposed amendments will be applicable to a 
particular transaction only if the conditions specified in the class 
exemption are met.
WRITTEN COMMENTS
    All interested persons are invited to submit written comments or 
requests for a hearing on the proposed exemption to the address and 
within the time period set forth above. All comments and requests for a 
hearing will be made a part of the record. Comments and requests for a 
hearing should state the reasons for the writer's interest in the 
proposed exemption. Comments received will be available for public 
inspection at the address set forth above.
PROPOSED AMENDMENT
    Under the authority of section 408(a) of ERISA and section 
4975(c)(2) of the Code, and in accordance with the procedures set forth 
in 29 CFR 2570, subpart B (55 FR 32836, August 10, 1990), the 
Department proposes to amend the following class exemptions as set 
forth below:
    1. PTE 75-1 is amended by making the following modifications:
    (a) Part III, Paragraph (c)(1) is deleted in its entirety and 
replaced with the following: ``(1) At the time of acquisition, such 
securities are non-convertible debt securities (i) subject to no 
greater than moderate credit risk and (ii) sufficiently liquid that 
such securities can be sold at or near their fair market value within a 
reasonably short period of time.''
    (b) Part IV, Paragraph (a)(1), is deleted in its entirety and 
replaced with the following: ``(1) At the time of acquisition, such 
securities are non-convertible debt securities (i) subject to no 
greater than moderate credit risk and (ii) sufficiently liquid that 
such securities can be sold at or near their fair market value within a 
reasonably short period of time.''
    2. PTE 80-83 is amended by deleting Paragraph I(C)(3) in its 
entirety and replacing it with the following: ``(3) The issuer of such 
securities has been in continuous operation for not less than three 
years, including the operations of any predecessors, unless at the time 
of acquisition, such securities are non-convertible debt securities (i) 
subject to no greater than moderate credit risk and (ii) sufficiently 
liquid that such securities can be sold at or near their fair market 
value within a reasonably short period of time.''
    3. PTE 81-8 is amended by deleting Paragraph II(D) in its entirety 
and replacing it with the following: ``(D) With respect to an 
acquisition or holding of commercial paper (including an acquisition by 
exchange) occurring on or after the effective date of this amendment, 
at the time of acquisition, the commercial paper is (i) subject to a 
minimal or low amount of credit risk based on factors pertaining to 
credit quality and the issuer's ability to meet its short-term 
financial obligations and (ii) sufficiently liquid that such securities 
can be sold at or near their fair market value within a reasonably 
short period of time.''
    4. PTE 95-60 is amended by deleting Paragraph III(a)(2)(B) in its 
entirety and replacing it with the following: ``(B) the certificates 
acquired by the general account have the credit quality required under 
the relevant Underwriter Exemption at the time of such acquisition.''
    5. PTE 97-41 is amended by deleting Paragraph (II)(c)(2) in its 
entirety and replacing it with the following: ``(2) such securities 
have the same coupon rate and maturity, and at the time of transfer, 
the same credit quality.''
    6. PTE 2006-16 is amended by making the following modifications to 
the definition of ``Foreign Collateral'' in Section V(f):
    (a) Paragraph V(f)(2) is deleted in its entirety and replaced with 
the following: ``(2) foreign sovereign debt securities that are (i) 
subject to a minimal amount of credit risk, and (ii) sufficiently 
liquid that such securities can be sold at or near their fair market 
value in the ordinary course of business within seven calendar days;'' 
and
    (b) Paragraph V(f)(4) is deleted in its entirety and replaced with 
the following: ``(4) irrevocable letters of credit issued by a Foreign 
Bank, other than the borrower or an affiliate thereof, provided that, 
at the time the letters of credit are issued, the Foreign Bank's 
ability to honor its commitments thereunder is subject to no greater 
than moderate credit risk.''

Lyssa Hall,
Director of Exemption Determinations, Employee Benefits Security 
Administration, U.S. Department of Labor.
[FR Doc. 2013-14790 Filed 6-20-13; 8:45 am]
BILLING CODE P