The US Department of Labor (the “DOL”) has issued individual exemptions (the “Underwriter Exemptions”) under ERISA to a number of institutions that serve as underwriters or placement agents for asset-backed and mortgage-backed securities. The Underwriter Exemptions provide relief from ERISA’s prohibited transaction provisions for the initial purchase, holding and subsequent resale of certain investment grade mortgage-backed securities and asset-backed securities by ERISA-governed investors. The Underwriter Exemptions apply only if specific conditions are met, including that the securities received a rating that is in one of the three (four, in the case of certain mortgage- and auto loan-backed securities) highest generic rating categories from a “rating agency” (previously defined by reference to S&P, Moody’s, Fitch and DBRS).
In light of regulatory developments, including certain Dodd-Frank provisions relating to statutory and regulatory references to credit ratings, on July 9, 2013, the DOL amended the Underwriter Exemptions (the “Amendment”) to modify the definition of “rating agency.” The DOL eliminated the references to specific rating agencies and defined the term to mean a credit rating agency that:
- Is currently recognized by the SEC as a nationally recognized statistical ratings organization (“NRSRO”);
- Has indicated in its most recently filed SEC Form NRSRO that it rates issuers of asset-backed securities; and
- Has had, within a period not exceeding 12 months prior to the initial issuance of the securities, at least three “qualified ratings engagements.”
A “qualified ratings engagement” is defined as an engagement (i) requested by an issuer or underwriter of securities in connection with the initial offering of securities; (ii) for which the credit rating agency is compensated for providing ratings; (iii) which is made public to investors generally; and (iv) which involves the offering of securities of the type that would be granted relief by the Underwriter Exemptions. Although the DOL noted that the rating agencies previously identified in the definition of “rating agency” should meet the revised definition of “rating agency,” the DOL did not specifically give these rating agencies “grandfathered” status under the Amendment.
The Amendment is effective for securities issued on or after July 9, 2013 (the date of publication) (the “Effective Date”).
The DOL also addressed several points raised by commentators:
- In a footnote to the proposed amendment, the DOL stated that fiduciaries of plans purchasing certificates are responsible for confirming that ratings given pursuant to the Underwriter Exemptions are issued by credit rating agencies that meet the definition of a “rating agency.” Commentators indicated that this footnote could have the unintended consequence of requiring plan fiduciaries to obtain representations directly from rating agencies. The DOL agreed with commentators and clarified that direct representations by ratings agencies to plans would be one of the possible means by which plan fiduciaries could confirm that the “rating agency” criteria are satisfied. The DOL also acknowledged that plan fiduciaries could rely on material, indirect representations in making such confirmations.
- The DOL clarified that once a credit rating agency qualifies as a “rating agency” as of the initial offering of a transaction, it will remain a “rating agency” with respect to the securities issued in the transaction when the securities are purchased on the secondary market to the extent that the rating agency is updating its ratings of the securities. However, the DOL stated that subsequent updates of the securities may not be counted as “qualified ratings engagements” for purposes of determining whether the rating agency has had three “qualified ratings engagements.”
- In the preamble to the proposed amendment, the DOL stated that the NRSRO must demonstrate that it has been selected to rate at least three similar transactions during the preceding 12 months. Commentators asked for clarification of how the reference to “similar transactions” is to be read in connection with the definition of a “qualified ratings engagement” (which references transactions involving securities of the type that would be granted relief by the Underwriter Exemptions). The DOL agreed with commentators that the term ‘similar transactions’ is intended to reference an offering of securities of the type that has been granted relief under the Underwriter Exemptions, including where the securities are backed by a different type of obligation (or types of obligations), or were issued as a certificates or notes, or were issued in transactions having different structures. However, the DOL emphasized that different structures must be of a type that are currently permitted by the Underwriter Exemptions.
- Commentators requested clarification as to whether the word “selected” (as used in the prior paragraph) means the date the rating agency is engaged to rate the securities or the date the securities are first issued. The DOL stated that the three engagement requirement is intended to ensure that a qualified rating agency is “seasoned” and clarified that the relevant date is the date the securities are issued.
As a result of the Amendment, disclosures for securities issued on or after the Effective Date and in reliance on the Underwriter Exemptions will need to be revised to reflect the new definition of “rating agency.” In addition, parties to securitization transactions that intend to rely on an Underwriter Exemption will need to consider the appropriate confirmation that at least one agency rating the securities satisfies all of the new requirements under the Amendment.