SEC Alert! he Securities and Exchange Commission today voted to propose changes that would remove the references to credit rating agencies from existing exceptions provided in Rule 101 and Rule 102 of Regulation M

Proposed Rule (95 pages)


The Commission proposes to replace the credit-rating requirement included in Rule 101โ€™s exception, which is available to distribution participants and their affiliated purchasers, with requirements that the nonconvertible debt securities and nonconvertible preferred securities meet a specified probability of default threshold, and that the asset-backed securities be offered pursuant to an effective shelf registration statement filed on the Commissionโ€™s Form SF-3. In addition, the proposed changes would eliminate Rule 102โ€™s exception, which is available to issuers, selling security holders, and their affiliates, for investment grade nonconvertible debt securities, nonconvertible preferred securities, and asset-backed securities.

The Commission also voted to propose a recordkeeping requirement under Rule 17a-4(b)(17) for broker-dealers who make probability of default determinations in reliance on Rule 101โ€™s proposed exception for nonconvertible debt securities and nonconvertible preferred securities.

What is Regulation M?

Regulation M is intended to protect the trading markets by prohibiting activities by distribution participants that could manipulate the market for a security that is the subject of an offering. Regulation M impacts the activities that may be conducted by issuers, broker dealers and other distribution participants around the time of a securities offering.

My understanding is Rules 101 and 102 regulate bids for and purchases of the offered securities and certain other securities.

  • Rule 101 regulates bids and purchases by distribution participants (including underwriters and selling group members) and their affiliated purchasers.
  • Rule 102 regulates bids and purchases by issuers, selling securityholders and their affiliated purchasers.

It looks like this could be on the block to be changed?

How can an underwriter protect against violations of Rule 101 for market-making activities during a distribution period of debt securities subject to a green shoe option?

Some offerings of listed non-convertible debt securities have a green shoe option. As discussed above, if an underwriter were to exceed the syndicate short position at the time that the green shoe is exercised, any previous market-making bids or purchases of such debt securities would have been deemed to occur during the distribution period and in violation of Rule 101 of Regulation M. There are two options for underwriters to prevent this type of violation: (1) obtain an investment grade rating from a nationally recognized statistical rating organization; or (2) police all sales to ensure that the syndicate short position will not be exceeded at the time of the green shoe exercise.

What is Rule 102 and how does it differ from Rule 101?

Rule 102 prohibits the same activities during the same restricted period as Rule 101; however, Rule 102 applies to issuers, selling shareholders and their respective affiliated purchasers. Additionally, it provides the same exemptions as Rule 101 except for the following activity-based exemptions listed previously:

โ€ข exemption (i) for publishing and disseminating research materials (which is typically not applicable to issuers);

โ€ข exemption (v) for de minimis transactions; and

โ€ข exemption (x) for basket transactions.

Rule 102 also limits the actively traded securities exemption to cover only reference securities that are not issued by the issuer or any of its affiliates in the actual distribution.

The Rule 102 exemptions are more limited than Rule 101 because the SEC views issuers, selling shareholders and their respective affiliate purchasers as having a more direct stake in the distribution. As a result, they may have greater incentive to engage in manipulative practices. However, Rule 102 does provide three additional exemptions for (i) certain repurchase transactions by closed-end investment companies, (ii) redemptions by commodity pools or limited partnerships and (iii) distribution of securities under securities purchase plans such as direct purchase plans and dividend reinvestment programs under certain circumstances.

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