Including Credit Ratings in Registration Statements

One of the lesser publicized provisions of the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”) requires a registrant to obtain the written consent of a Nationally Recognized Statistical Rating Organization (“NRSRO”) in order to disclose in a registration statement or prospectus (or documents incorporated by reference into registration statements or prospectuses) that NRSRO’s credit rating of any class of debt securities, convertible debt securities or preferred stock of the registrant.

Rule 436(a) under the Securities Act of 1933 (the “Securities Act”) requires issuers to file consents for portions of reports of expert opinions used in a registration statement or prospectus. Rule 436(g), which was repealed by the Dodd-Frank Act, had provided an exception to Rule 436(a) by providing that credit ratings assigned to a class of debt securities, a class of convertible debt securities or preferred stock by an NRSRO were not considered part of a registration statement prepared or certified by an expert within the meaning of Sections 7 and 11 of the Securities Act. Therefore, prior to the repeal of Rule 436(g), issuers did not need to obtain an NRSRO’s consent in order to provide ratings information in a registration statement or prospectus. In response to the Dodd-Frank Act, certain NRSROs have stated that they will not consent to the use of their ratings in Securities Act registration statements and prospectuses since by doing so it would expose them to potential Section 11 liability for material misstatements or omissions. This position may lead to a decrease in the disclosure of ratings in registered offerings.

Prior to the enactment of the Dodd-Frank Act, the SEC had been examining the use of credit ratings in SEC filings in connection with its review of the recent economic crisis. In an effort to promote transparency in the ratings process and to provide investors useful information in connection with registered offerings, the SEC proposed in 2009 a rule that would require registrants to include certain credit ratings related disclosures in registered offerings when the rating was “used” in connection with the offering. [1] To date, this proposed rule has not been adopted. A separate SEC concept release issued the same day solicited comment on whether or not Rule 436(g) should remain in effect, in particular whether there is sufficient basis to exempt NRSROs from Sections 7 and 11 of the Securities Act. Comment letters submitted by credit rating agencies cautioned against repealing Rule 436(g), noting that the repeal would lead to less disclosure and publicly-available information for investors to consider as issuers would likely provide fewer ratings in their disclosure documents, raise the cost of conducting registered offerings as the agencies would need to conduct complete due diligence prior to issuing a consent and, finally, lead to fewer registered offerings.

Subsequent Commission Guidance

The SEC issued interpretive guidance in the form of Compliance and Disclosure Interpretations, or C&DIs, following the enactment of the Dodd-Frank Act. The C&DIs provide the Staff’s position in a number of areas, including:

• “Issuer Disclosure-Related Ratings Information.” The repeal of Rule 436(g) would not require a consent from an NRSRO if the NRSRO’s credit ratings are provided in registration statements or prospectuses as part of a disclosure related to (i) changes to a credit rating, (ii) the liquidity of the registrant, (iii) the cost of funds for a registrant or (iv) terms of agreements that refer to credit ratings (these disclosures being referred to as “issuer disclosure-related ratings information”). Common examples of issuer disclosure-related ratings information include risk factor disclosure, discussion of ratings with respect to the company’s access to capital in the Management’s Discussion and Analysis of Financial Condition and Results of Operations section and disclosures of compliance with debt covenants, interest or other measures tied to credit ratings.
• Shelf Registration Statements. Issuers with registration statements on Form S-3 or F-3 that were declared effective prior to July 22, 2010 and either include or incorporate by reference ratings information (whether or not limited to issuer disclosure-related ratings information) may continue to use the registration statement until the next post-effective amendment to the registration statement. The Staff noted in particular that annual reports on Forms 10-K, 20-F and 40-F are all deemed post-effective amendments, and after the annual report is filed, the issuer could no longer use the registration statement that discloses ratings information (other than issuer disclosure-related ratings information) without a consent from the rating agency. Likewise, an issuer filing a quarterly report on Form 10-Q or other document that contains ratings information (other than issuer disclosure-related ratings information) which is incorporated by reference into a registration statement would need to provide the credit rating agency’s consent as an exhibit to the registration statement.
• Free Writing Prospectuses. Consent would not be required in free writing prospectuses compliant with Rule 433 under the Securities Act or in a term sheet or press release compliant with Rule 134 that includes ratings information. These documents are not considered “registration statements” or “prospectuses” within the meaning of Rule 436, and therefore the consent requirement would not apply to the use of credit ratings within them. If, however, any of these documents are filed as a prospectus pursuant to Rule 424 and contained ratings information, a consent would be required.
• Consents Required. Other than asset-backed issuers subject to Regulation AB, discussed below, issuers would need to provide a consent by a ratings agency if ratings information (other than issuer disclosure-related ratings information) is included in or incorporated by reference into a registration statement or post-effective amendment becoming effective after July 22, 2010 or a prospectus or prospectus supplement (including documents incorporated therein by reference) filed after July 22, 2010.

Asset-Backed Issuers

Under Regulation AB, which governs offerings of asset-backed securities, a registrant is required to disclose whether an issuance or sale of any class of asset-backed securities is conditioned on the assignment of a rating by a credit rating agency, and if so, the minimum credit rating and identity of each rating agency. In order to provide asset-backed issuers some time to transition to the new requirement, the SEC Staff issued a no action letter [2] on July 22, 2010 indicating that the Corporation Finance Division would not recommend enforcement if prior to January 24, 2011 asset-backed issuers omitted credit ratings from asset-backed offerings. This six-month transition period will allow asset-backed issuers to continue to conduct registered offerings, given the reluctance by rating agencies to provide consent. However, it remains unclear how asset-backed issuers will conduct registered offerings at the end of this period if the NRSROs remain unwilling to provide consent.

Impact and Recommendations

There are a number of considerations for issuers considering conducting offerings in light of the Dodd-Frank Act and the SEC’s guidance:

• 144A Offerings. Issuers that want to include ratings in an offering document may consider private placements pursuant to Rule 144A more appealing, particularly as the SEC continues to examine the inclusion of credit ratings in other disclosure documents.
• Review Disclosure and Incorporated Material. Issuers should review credit ratings disclosures currently included in both registration statements and periodic reports that are incorporated by reference into registration statements. Reviewers will want to focus in particular on whether any disclosure related to their ratings would not be considered issuer disclosure-related information (e.g., discussions of liquidity, risk factors or debt covenants) under the SEC’s guidance in order to timely resolve any consent issues (particularly in light of the apparent refusal of most NRSROs to provide the required consent). In future filings, issuers should draft disclosures containing ratings information with an eye toward such disclosures being considered “issuer disclosure-related ratings information.”
• Asset-Backed Issuers. The SEC’s no-action letter has provided a limited window to conduct offerings without credit rating agency consent, asset-backed issuers should consider the timing of any future capital raises and monitor any SEC regulatory action in the area to resolve the tension created by the Dodd-Frank Act and the refusal of NRSROs to provide consent.

Endnotes

[1] Please see our memorandum entitled SEC Proposes to Require Credit Ratings Disclosures in Registered Offerings, Jan. 11, 2010, at http://www.friedfrank.com/siteFiles/Publications/12F886140BD8F84D10C1ADF3CAA69004.pdf.
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[2] No–Action Letter, Office of Chief Counsel, Division of Corporation Finance, Ford Motor Credit Company LLC, July 22, 2010.
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