SEC Staff Issues Statement Reminding Market Participants of Obligations Related to LIBOR Transition | Practical Law

SEC Staff Issues Statement Reminding Market Participants of Obligations Related to LIBOR Transition | Practical Law

The SEC staff issued a statement to remind broker-dealers and investment advisers of their obligations when recommending LIBOR-linked securities, as well as to remind companies of their disclosure obligations related to the LIBOR transition.

SEC Staff Issues Statement Reminding Market Participants of Obligations Related to LIBOR Transition

by Practical Law Corporate & Securities
Published on 09 Dec 2021 • USA (National/Federal)
The SEC staff issued a statement to remind broker-dealers and investment advisers of their obligations when recommending LIBOR-linked securities, as well as to remind companies of their disclosure obligations related to the LIBOR transition.
On December 7, 2021, the staff of the SEC issued a statement to remind broker-dealers and investment advisers of their obligations when recommending LIBOR-linked securities, as well as to remind companies of their disclosure obligations related to the LIBOR transition.
The Financial Conduct Authority (FCA) and ICE Benchmark Administration (IBA), which are LIBOR's regulator and administrator, respectively, announced in March 2021 that the publication of the one-week and two-month USD LIBOR settings will cease immediately after December 31, 2021, with all other USD LIBOR settings ceasing immediately after June 30, 2023 (see Legal Updates, IBA feedback statement on intention to cease publication of LIBOR settings and FCA statement on future cessation and loss of representativeness of LIBOR benchmarks). In the US, the Alternative Reference Rates Committee (ARRC) has identified the Secured Overnight Financing Rate (SOFR) as the preferred alternative rate (see Legal Update, ARRC Formally Recommends Forward-Looking SOFR Term Rate).
The SEC's statement follows previous staff statements and guidance addressing various matters relating to the transition away from LIBOR, but with the cessation of LIBOR now certain, the staff is providing market participants with additional key considerations. Specifically, the staff addresses:
  • The obligations of broker-dealers under Regulation Best Interest.
  • Underwriting primary offerings of municipal securities or recommending municipal securities.
  • Legal obligations of registered investment advisers when recommending LIBOR-linked securities or providing advice on LIBOR-linked investments.
  • Disclosure considerations for public companies and issuers of asset-backed securities.

Regulation Best-Interest

The SEC's statement reminds broker-dealers to be mindful of their obligations under Regulation Best Interest when recommending LIBOR-linked securities. In particular, the staff notes that to have a reasonable basis to believe the recommended security is in the best interest of a retail customer, the broker-dealer should understand:
  • Whether the LIBOR-linked security has robust fallback language in its offering document or prospectus that includes a clearly defined alternative reference rate.
  • The impact of the replacement rate on the expected performance of the security.
In addition, if a broker-dealer has agreed to provide account monitoring services for retail customers, the broker-dealer must reassess the potential risks, rewards, and costs of LIBOR-linked securities in the retail customer's account at the time of each agreed-upon periodic review.
For more information on Regulation Best Interest, see Practice Note, SEC Regulation Best Interest and Key Considerations and Guidance for Complying with Regulation Best Interest Chart.

Municipal Securities

For broker-dealers that underwrite, trade, or otherwise effect transactions in municipal securities, the SEC highlights previous staff statements and guidance issued by the Office of Municipal Securities (OMS) and Municipal Securities Rulemaking Board (MSRB) that should be considered in connection with their municipal securities activities, including the OMS's January 2021 staff statement and information available on the MSRB's LIBOR Transition Information webpage.
In addition, the OMS staff notes specific considerations for broker-dealers with respect to their municipal securities activities and the LIBOR transition, including:
  • Exchange Act Rule 15c2-12 requirements for broker-dealers underwriting offerings of municipal securities.
  • Regulation Best Interest requirements when recommending a municipal securities transaction to retail customers.
  • MSRB Rule G-19's suitability standard when recommending a municipal securities transaction to non-retail customers.
  • MSRB Rule G-47's disclosure requirements.
For more information on the regulation of municipal securities, see Practice Notes, Municipal Securities Regulation: Overview and Municipal Dealer Registration.

Investment Advisers

Investment advisers have a fiduciary duty under the Advisers Act to act in their clients' best interest, including duties of care and loyalty. Similar to the obligations of broker-dealers under Regulation Best Interest, the SEC states that investment advisers should consider whether any recommended new or continued LIBOR-linked investments are in the best interest of the client, including considering:
  • Whether such LIBOR-linked investments or related contracts have robust fallback language providing an alternative rate.
  • Where fallback language references an alternative rate, whether any economic differences arising from the application of the alternative rate could cause the investment to depart from the clients' strategy or risk tolerance.
The staff also notes that investment advisers, as well as funds, should be mindful of:
  • Valuation risk and impacts to valuation inputs and assumptions associated with LIBOR and its discontinuation.
  • Conflicts of interest associated with the LIBOR transition and related disclosures.
  • Operational complexities that may require significant changes to internal operational processes and IT systems.
For more information on the duties of investment advisers, see Practice Note, Registration of Investment Advisers: Overview.

Public Company Disclosure Considerations

The SEC also encourages companies to provide qualitative disclosures and, if material, quantitative disclosures to provide context for the company's LIBOR transition efforts and related risks. Specific examples of disclosure considerations provided by the staff include:
  • Companies with material risk related to outstanding debt with inadequate fallback provisions should consider disclosing the amount of debt that will be outstanding after the applicable cessation date and steps the company is taking to address the situation, such as renegotiating contracts or refinancing the obligations.
  • Companies that have taken steps to assess LIBOR exposure and mitigate risks should consider providing investors with insight into steps the company has taken, steps that remain, and the timeline for further efforts.
  • Banking regulators issued a statement in November 2020 encouraging regulated banks to stop entering into new contracts that use USD LIBOR as a reference rate as soon as practicable. Companies subject to such supervisory guidance from regulators should consider providing detailed disclosures about their transition efforts and related material impacts.
In addition, companies that provide LIBOR-related disclosure in response to more than one disclosure requirement in a filing are encouraged to consider providing a cross-reference or otherwise tying the information together so investors have a complete and clear view of the company's plans for LIBOR's discontinuation. For further information on disclosure considerations, the staff also refers companies to its July 2019 staff statement (see Legal Update, SEC Staff Publishes Statement on LIBOR Transition).
For more information on the transition away from LIBOR, see Practical Law's LIBOR Replacement Toolkit.