DOL Removes Credit Ratings from Class Prohibited Transaction Exemptions As Required by Dodd-Frank | Practical Law

DOL Removes Credit Ratings from Class Prohibited Transaction Exemptions As Required by Dodd-Frank | Practical Law

The Department of Labor issued final amendments to class Prohibited Transaction Exemptions (PTEs) 75-1, 80-83, 81-8, 95-60, 97-41, and 2006-16 to remove credit ratings as conditions in these exemptions, as required by the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010.

DOL Removes Credit Ratings from Class Prohibited Transaction Exemptions As Required by Dodd-Frank

by Practical Law Employee Benefits & Executive Compensation
Published on 10 Mar 2022 • USA (National/Federal)
The Department of Labor issued final amendments to class Prohibited Transaction Exemptions (PTEs) 75-1, 80-83, 81-8, 95-60, 97-41, and 2006-16 to remove credit ratings as conditions in these exemptions, as required by the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010.
On March 8, 2022, the DOL published in the Federal Register a notice of final amendments to class Prohibited Transaction Exemptions (PTEs) 75-1, 80-83, 81-8, 95-60, 97-41, and 2006-16 to remove credit ratings as conditions in these class exemptions, as required by the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (Dodd-Frank Act) (87 Fed. Reg. 12985 (Mar. 8, 2022)).

The Dodd-Frank Act's Requirements

Section 939A of the Dodd-Frank Act required federal agencies, including the DOL, to review how existing regulations rely on credit ratings and remove those references when appropriate. Specifically, Section 939A required the DOL to remove any references to or requirements of reliance on credit ratings from its class exemptions and to substitute standards of creditworthiness that the DOL determines to be appropriate.
The DOL determined that PTEs 75-1 (Parts III & IV), 80-83, 81-8, 95-60, 97-41, and 2006-16 include references to, or require reliance on, credit ratings. Each PTE provides relief for a transaction involving a financial instrument, and each PTE conditioned exemptive relief on the financial instrument, or its issuer, receiving a specified minimum credit rating (including a rating of "investment grade," which is the common term for a credit rating in the highest four rating categories issued by a credit rating agency), as a safeguard to protect the interests of affected plans, participants, and beneficiaries, and IRAs.
In 2013, the DOL proposed amendments to these six PTEs that would remove references and requirements to rely on credit ratings (78 Fed. Reg. 37572 (June 21, 2013)). In June 2021, the DOL reopened the comment period for the 2013 proposed amendments.

Final Amendments to PTEs

The DOL is finalizing the amendments largely as proposed, but with minor changes. Instead of referencing or relying on credit ratings, parties relying on these class PTEs must determine whether certain credit standards are satisfied.

PTE 75-1

PTE 75-1 provides an exemption for certain transactions by registered broker-dealers on behalf of customers that are plans (see Practice Note, Prohibited Transactions and Exemptions Under ERISA and the Code: Broker-Dealer Exemption: PTCE 75-1). The final amendments replace the references to credit ratings in PTE 75-1 Part III(c)(1) and Part IV(a)(1) with a requirement that, at the time of acquisition, such securities are nonconvertible debt securities that are both:
  • Subject to no greater than moderate credit risk.
  • Sufficiently liquid that the securities can be sold at or near their fair market value within a reasonably short period of time.
The DOL's notice explains that as amended, PTE 75-1 Part III(c)(1) and Part IV(a)(1) require securities to be issued by an issuer that has been in continuous operation for no less than three years, including the operations of any predecessors, unless, among other exceptions, the fiduciary directing the plan in the transaction has made a determination that the securities satisfy the amended credit standard when they are acquired.
For purposes of this amendment, debt securities subject to a "moderate credit risk" should possess at least average credit-worthiness relative to other similar debt issues.
The DOL modeled this new standard on the SEC's adoption of Rule 6a-5 and the amendment to Rule 10f-3 of the Investment Company Act.

PTE 80-83

PTE 80-83 generally provides relief for a fiduciary causing a retirement plan or IRA to purchase a security when the proceeds of the securities issuance may be used by the issuer to retire or reduce indebtedness to the fiduciary or an affiliate.
Similar to PTE 75-1 Parts III and IV, the final amendments replace the reference to credit ratings in PTE 80-83 with a requirement that at the time of acquisition, such securities are non-convertible debt securities that are both:
  • Subject to no greater than moderate credit risk.
  • Sufficiently liquid that the securities can be sold at or near their fair market value within a reasonably short period of time.

PTE 81-8

PTE 81-8 permits employee benefit plans to invest plan assets in certain short-term investments, including commercial paper, issued by a party in interest.
The DOL is amending PTE 81-8II(D) to delete the reference to the credit rating of commercial paper and replace it with a requirement that at the time of acquisition, the commercial paper is both:
  • Subject to a minimal or low amount of credit risk.
  • Sufficiently liquid that such securities can be sold at or near their fair market value within a reasonably short period of time.
The DOL's notice explains that this is a higher standard than the new standard replacing the "investment grade" credit rating in PTEs 75-1 (Parts III and IV) and 80-83. Commercial paper subject to a minimal or low credit risk would have a lower risk of default than commercial paper with a moderate credit risk.

PTE 95-60

The DOL granted PTE 95-60 in response to the Supreme Court's decision in John Hancock Mutual Life Insurance Co. v. Harris Trust & Savings Bank (510 US 86 (1993)), which created uncertainty with respect to a number of existing exemptions, such as PTE 83-139 and the "Underwriter Exemptions" that had been granted for operating asset pool investment trusts that issue asset-backed, pass-through certificates to retirement plans.
PTE 95-60 Section III provided an exemption for the operation of asset pool investment trusts if, among other things, the conditions of either PTE 83-1 or an applicable Underwriter Exemption are met, other than the requirements that the certificates acquired by the general account:
  • Not be subordinated.
  • Receive a rating that is in one of the three highest generic rating categories from an independent rating agency.
The final amendments to PTE 95-60 Section III delete this reference to credit ratings and replace it with a general reference to the credit quality of the certificates, as required by the relevant underwriter exemption.

PTE 97-41

PTE 97-41 allows a retirement plan to purchase shares of mutual funds in exchange for plan assets that are transferred in-kind to the mutual fund from a collective investment fund (CIF), if certain conditions are met.
The DOL's final amendments to this PTE delete the requirement that the securities transferred in-kind from a CIF to a mutual fund have the same credit ratings and replace it with a requirement that the securities must be of the same credit quality.

PTE 2006-16

PTE 2006-16 permits lending securities that are employee benefit plan assets to certain banks and broker-dealers that are parties in interest to the plan.
Previously, this PTE required foreign sovereign debt securities for foreign collateral used in securities lending transactions to be rated in one of the two highest categories of at least one nationally recognized statistical rating organization (NRSRO).
The final amendments to this PTE delete the reference to credit ratings and provide that "foreign collateral" will include foreign sovereign debt securities that are:
  • Subject to a minimal amount of credit risk.
  • Sufficiently liquid that the securities can be sold at or near their fair market value in the ordinary course of business within seven calendar days.
The DOL's notice indicates that:
  • To satisfy this credit-worthiness requirement the foreign sovereign debt security should have a very strong ability to repay its debt obligations and a very low vulnerability to default.
  • The credit risk associated with this amendment would differ only slightly from the prior language requiring the highest credit quality.

Practical Implications

The DOL's published its notice containing the final amendments to the class PTEs on March 8, 2022, and the amendments will be effective 60 days after that date (May 7, 2022). Generally, the DOL views the new standards as reflecting the same level of credit quality that was required before the amendment. As discussed in the DOL's notice, the final amendments to the PTEs affect:
  • Participants and beneficiaries of employee benefit plans.
  • Owners of individual retirement accounts (IRAs).
  • Fiduciaries of employee benefit plans and IRAs.
  • The financial institutions that engage in transactions with, or provide services or products to, benefit plans and IRAs.
To learn more about the Dodd-Frank Act, see Practice Note, Summary of the Dodd-Frank Act: Credit Rating Agencies.