The SEC Begins to Part Ways with Credit Ratings Pursuant to Dodd-Frank Stricture

February 15, 2011

On February 9, 2011, the Securities and Exchange Commission ("SEC") proposed to amend the SEC’s rules to eliminate credit rating as one of the "transaction requirement" criteria by which an issuer can qualify for the short-form registration process, most notably under Forms S-3 and F-3.  Originally proposed in 2008, similar amendments were the subject of extensive, largely negative, comments and were not adopted at that time.  Section 939A of the Dodd-Frank Act now requires the SEC to replace any reference to or reliance upon credit ratings with an appropriate alternative standard of credit-worthiness, and the 2008 proposals have thus been resurrected.  We expect the proposed amendments, if adopted, will have a relatively limited impact on most companies that are frequent issuers.  The proposals will likely affect those issuers with no publicly held common equity that historically have relied upon their investment-grade credit rating to qualify for short-form registration.

As discussed below, the SEC’s proposed amendments would affect some issuers’ ability to use SEC Forms S-3, F-3, S-4, F-4 and F-9.  The proposed amendments also modify the Rule 134 "safe harbor," eliminating any protection for an issuer’s disclosure of its credit rating in a limited content press release during an offering.  In addition, the proposed amendments would alter the circumstances under which a broker/dealer could rely on Rules 138 and 139, and a foreign-private issuer on Rule 168.

Short-Form Registration

The current SEC rules require an issuer to meet two main criteria to benefit from short-form registration:

First, the SEC’s "issuer requirement," which is satisfied when the issuer has been subject to the SEC’s reporting requirements for at least one year prior to filing its registration statement and has filed all required reports in a timely manner; and

Second, the "transaction requirement," which is satisfied for most primary offerings in one of two ways — either the issuer has at least $75 million of publicly held common equity, or the issuer is proposing to offer non-convertible debt rated investment grade by at least one nationally recognized statistical rating organization ("NRSRO").

The short-form registration process currently allows an issuer to rely on previously filed quarterly, annual and other reports by incorporating by reference the information that would otherwise be required to appear directly in a registration statement.  Of course, the issuer’s prospectus must still include specific information about the offered securities.

Shelf Registration

Issuers that are short-form eligible can take advantage of the SEC’s shelf registration process, using Form S-3 or F-3 to facilitate offerings on a delayed basis.  During the shelf registration’s three-year effective period, an issuer can perform multiple offerings under a single registration statement.  Among other hurdles, an issuer that is not short-form eligible typically must seek an SEC declaration of effectiveness prior to each securities offering, which can hinder an issuer’s ability to access the capital markets on a rapid basis when offering conditions are ideal.

The SEC’s Proposed Amendments to Eliminate Credit Rating as a Means to Satisfy the Transaction Requirement

Under the proposed amendments, an issuer that does not have a public float of at least $75 million in equity must, over the past three years (as measured from a date within 60 days of the issuer’s registration statement filing), have issued at least $1 billion of non-convertible debt securities for cash in registered primary offerings to satisfy the transaction requirement for typical offerings.  An issuer would no longer be able to satisfy the short-form registration’s transaction requirement by issuing investment grade debt.

The SEC’s proposed new debt issuance criteria mirror the current requirement for well-known seasoned issuers (or WKSIs) that do not meet the WKSI public float test.  WKSIs are required to have a public float of at least $700 million in equity or to have issued at least $1 billion of non-convertible debt securities for cash in registered primary offerings over the past three years.  In effect, the proposed amendments would require all short-form issuers that do not satisfy the $75 million of public equity transaction requirement to step up to the WKSI debt issuance threshold.

Based on a review conducted from January 1, 2006 to August 15, 2008, the SEC expects its proposed amendments would cause approximately 45 issuers to lose access to short-form registration.  The SEC also notes that a very small number of high-yield issuers (with less than $75 million of public equity) that previously did not qualify for short-form registration would now qualify if such issuers can satisfy the existing short-form issuer requirements and the new proposed transaction requirement.

The SEC’s Proposed Amendments to Rule 134’s Limited Content Press Release

Securities Act Rule 134 provides a safe harbor for an issuer’s public statements that could otherwise be deemed a "prospectus" if made during the securities offering process.  Currently, Rule 134 exempts certain limited, factual statements about an issuer’s business or the securities to be offered, including disclosure of the securities’ rating assigned by an NRSRO.  The SEC proposal would eliminate disclosure of a security’s NRSRO rating from the Rule 134 safe harbor.

Many issuers historically have not included a security’s rating in Rule 134 press releases or similar communications, so this change should not have a significant impact on market practice.

The SEC’s Proposed Amendments to Rules 138, 139 and 168

Rules 138 and 139 of the Securities Act provide a safe harbor for broker/dealer communications that could otherwise be deemed a prospectus if made during the securities offering process.  Rules 138 and 139 currently provide a safe harbor for certain regularly published research reports in cases where the broker/dealer distributing the report is participating in an offering by the subject company (for Rule 138) or an offering of the subject security (for Rule 139).  Similarly, Rule 168 allows a foreign-private issuer to continue to provide certain factual business information or forward-looking statements during an offering process without requiring such information to be incorporated into the foreign-private issuer’s prospectus.  Currently, the safe harbor contained in Rules 138, 139 and 168 can be relied upon if an issuer satisfies the existing short-form eligibility requirements discussed above.

The proposed amendments to Rules 138, 139 and 168 would alter the rules to follow the revised short-form registration transaction requirement.  If the amendments are adopted, the Rule 138, 139 and 168 safe harbors will be limited to situations where the broker/dealer or foreign-private issuer’s statements relate to a registration that satisfies the existing short-form issuer requirement and the new proposed transaction requirement.

The SEC will be accepting public comments on the above-mentioned proposed amendments through March 28, 2011.

Gibson, Dunn & Crutcher LLP  

Gibson, Dunn & Crutcher lawyers are available to assist in addressing any questions you may have regarding the issues discussed above.  Please contact the Gibson Dunn lawyer with whom you work, any member of the Capital Markets Practice Group, or any of the following:

Stewart L. McDowell – Practice Co-Chair, San Francisco (415-393-8322, smcdowell@gibsondunn.com)
Anne Lee Benedict – Washington, D.C. (202-955-8654, abenedict@gibsondunn.com)
Andrew L. Fabens – New York (212-351-4034, afabens@gibsondunn.com)
Brian J. Lane – Washington, D.C. (202-887-3646, blane@gibsondunn.com)
David C. Lee – Orange County (949-451-4069, dlee@gibsondunn.com)
James J. Moloney – Orange County (949-451-4343, jmoloney@gibsondunn.com
Glenn Pollner – New York (212-351-2333, gpollner@gibsondunn.com)
Peter W. Wardle – Los Angeles (213-229-7242, pwardle@gibsondunn.com)
Robyn E. Zolman – Denver (303-298-5740, rzolman@gibsondunn.com

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