Removal of Credit Ratings As ‘Short Form’ Eligibility Requirement Pushed

Jack Humphrey, Regulatory journalist
July 26, 2011 /

The Securities and Exchange Commission has adopted new rules to remove credit ratings as eligibility criteria for companies seeking to use “short form” registration when registering securities for public sale.

Last May, the SEC proposed new rules and amendments to increase transparency and improve the integrity of credit ratings following a controversy in September 2010 involving the Moody’s Investors Service (MIS), which was accused of maintaining dubious ratings conduct.

An investigation found that an error in computer coding was detected by an analyst at MIS in 2007, meaning the credit ratings issued were not correct and higher ratings were being given to debt obligation notes.

Under existing federal securities laws, a company offering securities must register the offer and sale of those securities with the SEC unless the sale is otherwise exempt.

The short-form registration forms include Form S-3 for domestic companies and Form F-3 for foreign private issuers, which are used by eligible issuers to register securities offerings under the Securities Act. Companies that qualify for these short forms can offer securities “off the shelf” or on an expedited basis.

At present, companies qualify to use these forms only if the offering that they are registering is non-convertible securities, such as debt securities, that have received an investment grade rating by at least one nationally recognized statistical rating organization (NRSRO).

The new rules remove the condition for an NRSRO investment grade rating that is included in current short forms.

Instead of the ratings criteria, the final rules allow for the use of Form S-3 or Form F-3 if the issuer satisfies one of four tests.

First, the issuer has issued at least $1 billion in non-convertible securities other than common equity, in primary offerings for cash, not exchange, registered under the Securities Act, over the previous three years. Possession of the non-convertible securities must be within 60 days prior to the filing of the registration statement.

Second, the issuer has outstanding (as of a date within 60 days prior to the filing of the registration statement) at least $750 million of non-convertible securities other than common equity, issued in primary offerings for cash, not exchange, registered under the Securities Act.

Third, the issuer is a wholly-owned subsidiary of a well-known seasoned issuer as defined under the Securities Act.

Finally, the issuer is a majority-owned operating partnership of a real estate investment trust that qualifies as a well-known seasoned issuer.

The final rules also include a temporary grandfather provision that allows an issuer to use Form S-3 or Form F-3 for a period of three years from the effective date of the amendments if it would have been eligible to register the securities offerings under the old provision.

“This action is part of our effort to reduce reliance on credit ratings, as the Dodd-Frank Act requires all financial regulators to do,” said SEC Chairman Mary Schapiro.

“The new rules provide an appropriate and workable alternative to credit ratings for determining whether an issuer should be able to use short form registration and have access to the shelf offering process.”

The SEC’s rules generally allow a non-asset-backed security issuer to use “short-form” registration if that company meets two criteria.

The first criterion related to issuers requires among other things that the company has been yilding to the SEC’s reporting provisions and filing its periodic reports on time for at least one year.

The second criterion containing a list of transaction requirements provides leverage for a company having at least $75 million in common equity held by unaffiliated shareholders. Another provision, which would allow an issuer to use short-form registration for an offering of non-convertible securities such as debt securities, provides that those securities be rated investment grade by at least one credit rating agency that is a nationally recognized statistical rating organization (NRSRO).

“If a company qualifies for short-form registration, it is allowed to rely on its quarterly, annual and other reports filed with the SEC to provide historical and future information about itself, rather than repeating the information in the prospectus or amending the prospectus as future reports are filed,” the SEC said.

The prospectus disclosure in these offerings describes the particular securities being offered and focuses on other offering-specific information.

According to the SEC, the ability to “incorporate by reference” historic and future SEC reports for the company information can provide significant cost and time savings for companies.

Companies that are “short-form eligible” also are allowed to register securities “on the shelf.” This means that the companies can file registrations for future offerings and can do one or multiple offerings from the single registration in the future without needing any new SEC staff clearance.

On the other hand, shelf registration provides companies with flexibility to issue the securities at their disposal.

“Often times, companies use this process when they are planning to offer securities on multiple occasions. Companies that are not short-form and shelf eligible are required to file a new registration for each public securities offering and have the SEC staff take action before completing the offering,” the SEC noted.

The final rules also annulled Form F-9, which is the form certain Canadian registrants use to register non-convertible investment grade debt.

Using Form F-9 over the only other available form (Form F-10) does not require reconciliation to U.S. generally accepted accounting principles.

“Changes to Canadian regulations to require Canadian issuers to use International Financial Reporting Standards instead of GAAP will mean that reconciliation also will not be required on Form F-10. As a result, F-9 and F-10 will have the same requirements, so Form F-9 will be rescinded effective Dec. 31, 2012,” the SEC said.

Additionally, the final rules revise Form 40-F, the annual report form used by certain Canadian registrants, to ease the transition for issuers who previously filed registration statements on Form F-9.

The new rules on credit ratings take effect 30 days after publication in the Federal Register, except the rescission of Form F-9 and amendments to remove references to Form F-9 in other rules and forms will be effective December 31, 2012.


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