DOL Issues Amendment Changing Definition of "Rating Agency" for the Underwriters Exemptions

Practical Law Legal Update 6-534-0826 (Approx. 4 pages)

DOL Issues Amendment Changing Definition of "Rating Agency" for the Underwriters Exemptions

by Practical Law Employee Benefits & Executive Compensation

The Underwriters Exemptions

When pension plans and other retirement arrangements invest in an ABS transaction, they must ensure the transaction does not violate the fiduciary responsibility or prohibited transaction provisions of ERISA and Section 4975 of the Internal Revenue Code. The DOL has granted to certain financial institutions individual prohibited transaction exemptions (underwriter exemptions) to cover activities in these transactions that may otherwise be considered prohibited relating to their underwriting of ABS unsubordinated certificates rated in the three highest generic rating categories by certain specified nationally recognized rating agencies (see Practice Note, Guide to ERISA Issues in Mortgage-backed Securities and Asset-backed Securities Transactions: Analyzing ABS Equity Offerings for ERISA Purposes: PTE 2007-5 (The Underwriters Exemptions)

The first time an exemption or authorization is granted to a specific underwriter, it must be applied for individually. As the number of individual exemptions increased over time, the DOL granted so-called quasi-class omnibus amendments to the underwriter exemptions to expand their application or to liberalize certain requirements, which were each made automatically applicable to every individual underwriter exemption outstanding at the time of their respective issuance dates. The most recent quasi-class omnibus restated underwriter exemption is PTE 2007-5. This PTE amends PTE 2007-5 and therefore amends all of the individual underwriters exemptions issued to date, in addition to granting additional underwriters exemptions (see New Individual PTEs Granted).

The Definition of Rating Agency and the Dodd Frank Act

Section 939A of the Dodd Frank Act requires each federal agency to review its "regulations" and modify them to remove the requirement of reliance on specific credit ratings and to substitute in these regulations a standard of credit-worthiness that each respective agency determines is appropriate for their regulations. The DOL takes the position that prohibited transaction class exemptions are deemed regulations for the purposes of the Dodd Frank Act.

While the underwriters exemptions are considered individual PTEs, the conditions that must be satisfied to obtain relief rely heavily on the standards of creditworthiness that are specified by particular rating agencies. Accordingly, in light of Section 939A of the Dodd Frank Act, the DOL on its own initiative has proposed to apply a new definition of rating agency to the underwriter exemptions.

Final Amendment to Definition of "Rating Agency"

On December 28, 2012, the DOL published a proposed amendment to the underwriter exemptions which replaced the current definition of "rating agency" with a definition referencing generic rating agency requirements. The DOL's amendment to PTE 2007-5 finalizes the proposed amendment with certain changes. Under the amended PTE, a rating agency is a credit rating agency that:

Is currently recognized by the SEC as a nationally recognized statistical ratings organization (NRSRO).
Has indicated on its most recently filed SEC Form NRSRO that it rates "issuers of asset-backed securities."
Has had, within a period not exceeding 12 months before the initial issuance of the securities, at least three "qualified ratings engagements". A qualified ratings engagement is one:
- requested by an issuer or underwriter of securities in connection with the initial offering of the securities;
- for which the credit rating agency is compensated for providing ratings;
- which is made public to investors generally; and
- which involves the offering of securities of the type that are granted relief by the underwriter exemptions.

Fiduciaries of employee benefit plans investing in ABS transactions are responsible for confirming that any rating given for a certificate acquired pursuant to the underwriters exemption was issued by a rating agency that satisfies this criteria. For more information on the rating requirements for plan investments in ABS transactions, see Practice Note, Guide to ERISA Issues in Mortgage-backed Securities and Asset-backed Securities Transactions: Rating, LTV and Subordination-related Conditions for Exemptive Relief.

Clarifications to Proposed Amendment

In response to comments, the DOL clarified the meaning of certain terms and incorporated two changes to the definition of ratings agency in the proposed amendment. The changes are intended to clarify that:

The DOL acknowledges that plan fiduciaries may demonstrate that they have fulfilled their fiduciary duty to confirm the acceptability of a rating agency by relying on material, indirect representations by rating agencies (for example, representations made by the agency to related parties such as the issuer or underwriter in the offering documents for the securitization transaction) rather than solely by a direct representation from a rating agency to the plan.
Once an organization qualifies as a rating agency as of the initial offering of a securitization transaction, it should remain qualified as a rating agency for purposes of the particular securities issued in that transaction to the extent that the rating agency is still updating its rating of the security.
Qualified ratings engagements are ones which are made public to investors generally, rather than to only a controlled number of investors (although the DOL noted that a rating may be made public to investors generally in addition to being set forth in an offering document, such as in a private placement memorandum that is received by a controlled number of recipients).

New Individual PTEs Granted

This amendment to PTE 2007-5 also grants new individual underwriter exemptions to 15 additional companies, and provides a complete list of the underwriter exemptions issued to date.

Practical Impact

Plan fiduciaries and financial institutions that make use of the underwriters exemptions should ensure that the ABS transactions in which an employee benefit plan has invested continue to satisfy the revised conditions of the underwriters exemption relating to the new definition of rating agency.

DOL Issues Amendment Changing Definition of "Rating Agency" for the Underwriters Exemptions | Practical Law