Release No. 33-6336

Release No. 34-18012

Release No. IC-11892

August 5, 1981 

Disclosure of Security Ratings in Registration Statements

ACTION: Proposed rulemaking.

SUMMARY: The Commission is issuing a statement of its policy and two proposals to permit the voluntary disclosure of security ratings assigned by nationally recognized statistical rating organizations to classes of debt securities, convertible debt securities and preferred stock in registration statements filed under the Securities Act of 1933. The first proposed rule would permit the disclosure of security ratings in certain communications not deemed a prospectus under the Securities Act of 1933. The second proposed rule would exclude any nationally recognized statistical rating organization whose security rating is disclosed in a registration statement from civil liability under Section 11 of the Securities Act of 1933.

DATE: Comments must be received on or before October 30, 1981.

ADDRESSES: Comments should be submitted in triplicate to George A. Fitzsimmons, Secretary, Securities and Exchange Commission, 500 North Capitol Street, Washington, D.C. 20549. Comment letters should refer to File No. S7-898. All comments received will be available for public inspection and copying in the Commissions Public Reference Room, 1100 L Street, N.W., Washington, D.C. 20549.

FOR FURTHER INFORMATION CONTACT: Mary Ann Binno or Beverly K. Rubman Office of Disclosure Policy, Division of Corporation Finance, Securities and Exchange Commission, 500 North Capitol Street, Washington, D.C. 20549. (202) 272-2604.

SUPPLEMENTARY INFORMATION: The Commission today is publishing its policy to permit the voluntary disclosure of security ratings assigned by nationally recognized statistical rating organizations ("rating organizations") to classes of debt securities, convertible debt securities and preferred stock in registration statements under the Securities Act of 1933 ("Securities Act") (15 U.S.C. 77a et seq.) and is publishing for public comment two proposals to facilitate such disclosure. The Commission is announcing that, contrary to prior general staff positions on this matter, it now will permit the disclosure of security ratings assigned by rating organizations in registration statements. In order to give guidance to registrants, the Commission also is setting forth its views concerning the appropriate disclosure in addition to the actual security rating or ratings assigned to the particular class of securities that registrants should include in the registration statement to provide meaningful information to investors.

To facilitate this change of policy, the Commission is publishing two proposals. The first would amend Rule 134 under the Securities Act (17 CFR 230.134) to permit the disclosure of security ratings of debt securities, convertible debt securities or preferred stock assigned by a rating organization in certain communications deemed not to be a prospectus ("tombstone advertisements"). The second proposal would add a new subparagraph (g) to Rule 436 under the Securities Act (17 CFR 230.436(g)) to provide that a security rating is not a part of a registration statement prepared or certified by a person or a report or valuation prepared or certified by a person within the meaning of Sections 7 and 11 of the Securities Act (15 U.S.C. 77 (g) and (k)). If adopted, this proposal would eliminate the required filing by the registrant of the rating organizations consent under Section 7 of the Securities Act if the rating is included in the registration statement and would exempt the rating organization from liability as an expert under Section 11 of the Securities Act for security ratings included in registration statements. Nonetheless, the rating organization would continue to be subject to liability under the antifraud provisions of the Federal securities laws. ¹

These proposals should be considered in connection with the Commissions rulemaking program to establish an integrated disclosure system under the Securities Act and the Securities Exchange Act of 1934 ("Exchange Act") (15 U.S.C. 78a et seq.). Certain of these actions are being proposed or reproposed in revised form with this release. They include: (1) a three tier system for the registration of securities. Forms S-1, S-2 and S-3 (originally denominated for comment purposes as Forms A, B and C); ² (2) expansion of Regulation S-K (17 CFR 229-001 et seq.) to include additional disclosure items and the rescission of the Guides for the Preparation and Filing of Registration Statements and Reports ("the Guides"), other than Guides relating to specific industries, thereby completing the Commissions "sunset" review of the Guides; ³ (3) amendments to Regulation C under the Securities Act (17 CFR 230.400 through 230.494) and Regulation 12B (17 CFR 240.12b-1 through 12b-36) under the Exchange Act to simplify and clarify procedural requirements, thereby commencing the Commissions "sunset" review of those regulations; ⁴ (4) a new rule governing registration of securities to be sold in a delayed or continuous offering; ⁵ (5) a rule relating to the responsibility of persons subject to Section 11 of the Securities Act in an integrated disclosure system; ⁶ and (6) amendments to other Securities Act registration forms ⁷ and certain Exchange Act forms and schedules ⁸ to incorporate the new Regulation S-K provisions and make other changes. In addition to creating a simplified and integrated disclosure system under the Securities Act and the Exchange Act, these proposals represent a continuation of the Commissions "sunset" review of existing rules and regulations.

Pursuant to Section 605(b) of the Regulatory Flexibility Act, 5 U.S.C. 605(b), the Chairman of the Commission has certified that the amendments proposed herein will not, if promulgated, have a significant economic impact on a substantial number of small entities. This certification, including the reasons therefor, is attached to this release.

Table of Contents

I. Background

A. Description of Security Ratings

A security rating is typically an alphabetical designation which attempts to quantify the likelihood that an issuer will be able to comply with the terms of a particular obligation. One rating organization describes it as a "current assessment of the credit-worthiness of an obligor with respect to a specific debt obligation." ⁹ The rating is assigned to a particular class of securities, not to an issuer. ¹⁰ In the case of debt securities, including convertible debt securities, a rating is an evaluation of the likelihood that an issuer will be able to make time interest payments and will be able to repay principal. Similarly, preferred stock rating assesses the relative security of dividend payments. A security rating is not a specific market recommendation; it does not take into account market price or individual investor suitability. ¹¹

B. Administrative History

The traditional policy of the Commission staff has been to discourage the disclosure of security ratings in Commission filings. ¹² However, in 1977, the Commission issued a concept release ¹³ ("1977 Release") which announced that it was considering whether it should encourage or require the disclosure of security ratings in Commission filings. More specifically the 1977 Release invited comment on fourteen areas of inquiry, including: whether disclosure should be made of the ratings of debt securities, equity securities, and commerical paper; whether such disclosure should be voluntary or mandatory; in which documents, if any, should such disclosure appear; would an entity issuing a security rating be the type of person whose consent is required to be filed under Section 7 of the Securities Act, and, if so, should the Commission waive such consent; and what would be the impact of a rating organization being subject to liability under Section 11 of the Securities Act.

Fifty-five letters were received in response to the 1977 Release. ¹⁴ The majority of commentators did not favor any rulemaking in this area, citing the current availability of information about security ratings, the fact that a rating represents the subjective opinion of the rating organization that cannot be verified or even explained by the issuer of the securities in question, and concerns about increasing government involvement in the rating process itself. Commentators also raised many practical problems concerning the timing and content of such disclosure particularly in registration statements under the Securities Act.

At the same time, many of the commentators acknowledged the significance and usefulness of security ratings. This significance is reflected in the use of such ratings by investors, by market professionals in establishing the appropriate price and yield for a particular security ¹⁵ and by regulatory bodies, including the Commission. ¹⁶

Finally, in its revised proposal to establish a basic framework for Securities Act registration, the Commission is proposing that a registrant not otherwise eligible to register its securities upon proposed Form S-3 may, nonetheless, utilize that abbreviated registration statement for its non-convertible debt securities if such debt is an "investment grade debt security"--that is, if it is rated in one of the four highest corporate bond rating categories by at least one nationally rated statistical rating organization. ¹⁷

II. Change in Commission Position

In light of the general usefulness of security ratings to investors and the market place, and the importance that the Commission and other regulatory entities have attached to the issuance of a security rating in certain instances, the Commission believes that the general staff position toward the disclosure of security ratings is no longer necessary or appropriate, and that investors can benefit from disclosure of security ratings in registration statements under the Securities Act.

Accordingly, the Commission is announcing its position that a registrant may include a security rating or ratings assigned to a class of debt securities or preferred stock in its registration statement. ¹⁸ The Commission wishes to make clear that it is not proposing a mandatory rule in this area ¹⁹ nor is it indicating that issuers should disclose security ratings. Instead, this release primarily is intended to make clear to the general public that the position in this area has changed. Also, because commentators on the 1977 Release raised many practical problems and issues concerning the timing and content of security rating disclosure, the Commission believes that a statement of its views on these issues may provide guidance to registrants who may desire to disclose a security rating or ratings in a registration statement. ²⁰

Many commentators on the 1977 Release were concerned that a security rating presented without any further explanation could mislead or confuse investors. The Commission shares this concern but also does not believe that lengthy and detailed explanations are necessary. Nonetheless, the Commission believes that it would be misleading to disclose a security rating in a Commission filing ²¹ without including certain additional information to provide the reader with a concise explanation of the fundamental characteristics of security ratings while making clear the source of the rating to which the interested investor can turn for further details. Such additional information would include: the name of each rating organization; the rating organizations own description or definition of the characteristics of the category in which the security has been rated; ²² the relative rank of the rating received within the overall classification system used by the rating organization, ²³ and an explanation to the effect that a security is not a recommendation to buy, sell or hold these securities, that it is subject to revision or withdrawal at any time by the rating organizations and that, when a security has received more than one security rating, each such rating should be evaluated independently.

The Commission also believes that, if a registrant chooses to disclose a rating in a registration statement, it should include all ratings assigned to the class of securities being registered that are available on the initial date of filing that registration statement. In referring to ratings that are "assigned to" a particular class of securities, the Commission is aware that rating organizations may provide issuers with non-public preliminary indications of the rating that they expect to assign, these preliminary indications may even be subject to an appeal process within the rating organization by the issuer. The Commission does not consider such preliminary indications to be actual assignments of a security rating and would not expect registrants to disclose such ratings.

If one security rating is disclosed in the initial registration statement and an additional rating is assigned subsequent to the filing date but prior to the effective date of the registration statement, that additional rating ordinarily should be set forth in the final prospectus used as part of the registration statement. The Commission does not believe that, ordinarily, the assignment of a second or third security rating by another rating organization or organizations would necessitate an amendment to and recirculation of the preliminary prospectus that contained the first security rating. Nonetheless, if, subsequent to the initial filing of the registration statement but prior to its effectiveness, another rating organization assigns a security rating that is substantially different from the first rating disclosed, the Commission believes the registrant should give serious consideration to amending the registration statement to include the additional rating and to recirculating the preliminary prospectus. ²⁴ Similarly, if an additional rating is assigned in the post-effective period while the distribution is still in progress, the registrant should consider making disclosure of the additional rating by means of a post-effective amendment or sticker to the prospectus pursuant to Rule 424(c) under the Securities Act 17 CFR 230.424(c). Again, the Commission would expect such disclosure to be made when the additional rating is substantially different from those previously assigned.

An issue similar to the disclosure of additional ratings could arise in the unusual event that a security rating disclosed in the initial filing was changed during the course of the distribution by the rating organization that assigned it. Such a change would compel the registrant to analyze the nature of the change in order to determine whether, during the pre-effective period, it should amend the previously filed registration statement and should recirculate the preliminary prospectus and, during the post-effective period, whether it should disclose the change by means of a post-effective amendment or sticker to the prospectus pursuant to Rule 424(c).

The Commission also recognizes that, under certain circumstances, registrants might wish to include security ratings in periodic reports filed under the Exchange Act. The Commission has no objection to such a practice.

III. Rating Organization Consent

The Commission is aware that a major barrier to the disclosure of security ratings in Securities Act registration statements has been the issue of whether a rating organization which assigns such rating is an "expert" whose consent must be filed under Section 7 of the Securities Act, ²⁵ and who may be subject to civil liability under Section 11 of the Securities Act. ²⁶ For the reasons discussed below, the Commission does not believe that it is necessary or appropriate to subject the rating organizations to those provisions of Sections 7 and 11. The Commission, therefore, is proposing Rule 436(g) which, if adopted, would not require a rating organization to consent under Section 7 and would exempt it from liability as an expert under Section 11 of the Act.

1. Comments Received on the 1977 Release. In response to the request for comments contained in the 1977 Release, commentators identified several areas of concern with respect to the applicability of Sections 7 and 11 of the Securities Act to disclosure of a security rating. Those concerns included possible interference with the registration process, changes in the way security ratings are issued, and increased costs and uncertainty over the scope of liability that might be imposed upon the rating organizations.

In connection with the requirement under Section 7 that the issuer file the consent of any expert together with the registration statement, commentators stated that procuring such consent would disrupt the issuers registration timetable. They anticipated that the rating organization, if it would consent at all, might not be willing to furnish a consent until it had reviewed all information in the registration statement, in order to ensure that its rating was based on the same data. Others noted that this involvement with both the content of the registration statement and the timing of the public offering would inject the rating organization into the registration process as a participant, not as an objective evaluator, thus lessening its independence from the issuer.

While some commentators believed that the prospect of being held liable under Section 11 would assure that rating organizations gave due attention to their rating activities, others cited possible adverse changes to the rating process that might result. In particular, these commentators believed that the prospect of additional liability would reduce the reliance of the rating organizations on informal subjective factors, resulting in an evaluation based solely on quantifiable data. In the view of the commentators who raised the issue, this change would be detrimental to the rating process. In addition, commentators asserted that the possibility of liability and the uncertainty of the scope of such liability would necessarily result in increased fees charged by rating organizations, as well as possible issuer indemnification to offset any liability incurred under Section 11. They pointed out that these additional costs would be particularly detrimental to new or smaller issuers. Also, commentators claimed that the possibility of additional liability might result in rating agencies refusing to issue ratings for lower quality securities.

2. Proposed Rule 436(g). The Commission recognizes that the disclosure of security ratings in Securities Act registration statements raises practical and legal issues under Sections 7 and 11 of the Securities Act. The Commission also is aware that, if a rating organization refuses to consent, ²⁷ disclosure of security ratings may not be permitted in a registration statement. In revising its position to allow the disclosure of security ratings, the Commission is not mandating the creation of a new piece of information. Instead, it is seeking to ensure that information that currently is relied on extensively by many members of the investing public and by securities professionals be permitted, if the issuer so chooses, to reach investors directly in the prospectus, not indirectly through newspapers or by word of month. The Commission does not seek to alter, in an indirect fashion, the way those security ratings are prepared nor does it intend to interfere with the issuers timetable for the registration process. The Commission also is aware that, unlike the case of other experts such as attorneys or accountants, there are few national rating organizations, that they prepare ratings for inclusion in their publications and not for the exclusive proprietary use of the issuer (although issuers generally pay a fee for the rating services), and that issuers do not necessarily have the ability to ensure that the requisite consent is given.

Therefore, the Commission believes it is appropriate to resolve these issues in order to make its revised position concerning security rating disclosure meaningful and is now proposing Rule 436(g) which provides that a security rating assigned to any class of debt security, convertible debt security or preferred stock by a "nationally recognized statistical rating organization" shall not be considered a part of a registration statement prepared or certified by a person or a report or valuation prepared or certified by a person within the meaning of Sections 7 and 11 of the Securities Act. Accordingly, the issuer would not be required to file the consent of the rating organization pursuant to Section 7 and the rating organization would not be subject to civil liability as an expert pursuant to Section 11 of the Securities Act.

The proposed rule exempts only ratings assigned by a "nationally recognized statistical rating organization" and provides that this term shall have the same meaning as in the Commissions uniform net capital rule. ²⁸ The Commission recognizes that the purposes behind the net capital rule ²⁹ differ from those underlying the proposals made herein and that there may be entities rating corporate debt securities but not commercial paper that ought to be accorded the status of a "nationally recognized statistical rating organization" with regard to those ratings. Despite these differences, the Commission believes that the investigation and analysis performed by the Commission staff in determining what organizations should be deemed "nationally recognized statistical rating organizations" for purposes of the net capital rule probably also are sufficient for security rating disclosure so that two different definitions of the same term are not necessary. However, the Commission specifically invites comment on this issue and on other possible definitions or clarifications of the term.

Proposed Rule 436(g) follows the approach taken by the Commission in exempting reports issued by accountants following a review of unaudited interim financial information pursuant to Statement on Auditing Standards No. 24 ³⁰ that are included in Securities Act filings from potential liability under Section 11 of the Act. ³¹ In that instance, the Commission deemed such action appropriate in order to further its goals of encouraging increased auditor involvement with interim financial information and greater usage of reports containing a limited statement of assurance by accountants concerning unaudited financial information.

As previously discussed, the Commission is taking this action, in part, because it is concerned about the practical problems that were raised by the commentators, particularly the possible interference with the rating process and the possible difficulty in obtaining rating organization consents. However, equally significant to the Commissions decision is the fact that rating organizations are already subject to substantial liability under the antifraud provisions of the federal securities laws ³² so that they now must adhere to the highest professional standards in determining a security rating. ³³ This obligation will in no way be diminished by the adoption of proposed Rule 436(e).

The Commission wishes to emphasize that, in addition to the general anti-fraud provisions, it has jurisdiction over the activities of rating organizations under the Investment Advisers Act of 1940 ("Advisers Act"). ³⁴ As fiduciaries, investment advisers have a special duty to base their opinions and recommendations upon current and adequate information. ³⁵ Not only does Section 206 of the Advisers Act prohibit fraudulent practices and activities which operate as a fraud, but it also contains authority for the Commission to adopt appropriate rules to "define, and prescribe means reasonably designed to prevent, such acts, practices, and courses of business as are fraudulent, deceptive or manipulative." ³⁶ The Commission believes that this provision gives it ample authority to regulate the improper issuance of security ratings should abuses develop which necessitate such action.

IV. Tombstone Advertisements

In accordance with the views expressed herein concerning voluntary disclosure of security ratings in registration statements, the Commission believes it is appropriate that issuers also be permitted to disclose such ratings in tombstone advertisements. The Commission notes that such disclosure currently appears in advertisements for securities that are exempt from registration under the Securities Act, notably municipal securities. Accordingly, the Commission is proposing to amend Rule 134(a) under the Securities Act to add a new subparagraph (14) which would provide that any security rating or ratings of a class of debt securities, convertible debt securities and preferred stock and the name or names of the rating organization which assigned the rating would not be deemed a prospectus as defined in Section 2(10) of the Securities Act 15 U.S.C. 77b(10). As in the case of proposed Rule 436(g), this proposal would define the term "nationally recognized statistical rating organization" by reference to the Commissions uniform net capital rule.

V. Request for Comments

Any interested persons wishing to submit written comments on proposed Rule 134(a)(14) or proposed Rule 436(g) are requested to do so. The Commission also requests comment concerning possible revisions or amendments to any other rules or forms under the Securities Act or the Exchange Act that may be necessary or appropriate to further the purposes discussed herein. The Commission further solicits comment as to whether the proposals would have an adverse effect on competition or would impose a burden on competition that is not necessary or appropriate in furtherance of the purposes of the Securities Act or the Exchange Act.

VI. Text of Proposals

In accordance with the foregoing, it is proposed to amend Title 17, Chapter II of the Code of Federal Regulations as follows:

PART 230--GENERAL RULES AND REGULATIONS, SECURITIES ACT OF 1933

1. By adding paragraph (a)(14) to §230.134 to read as follows:

§230.134 Communications not deemed a prospectus.

* * * * *

(a) * * *

(14)(i) With respect to any class of debt securities, any class of convertible debt securities or any class of preferred stock, the security rating or ratings assigned to the class of securities by any nationally recognized statistical rating organization and the name or names of the nationally recognized statistical rating organization(s) which assigned such rating(s).

(ii) For the purpose of paragraph 14(a)(i) of this section, the term "nationally recognized statistical rating organization" shall have the same meaning as used in Rule 15c3-1(c)(2)(vi)(E) under Securities Exchange Act of 1934 (17 CFR 240.15c3-1(c)(2)(vi)(E)).

* * * * *

2. By adding paragraph (g) to §230.436 to read as follows:

§230.436 Consents required in special cases.

* * * * *

(g)(1) Notwithstanding the provisions of paragraphs (a) and (b) of this section, a security rating or ratings assigned to a class of debt securities, a class of convertible debt securities, or a class of preferred stock by a nationally recognized statistical rating organization shall not be considered a part of a registration statement prepared or certified by a person or a report or valuation prepared or certified by a person within the meaning of sections 7 and 11 of the Act.

(2) For the purpose of paragraph (g)(1) of this section, the term "nationally recognized statistical rating organization" shall have the same meaning as used in Rule 15c3-1(c)(2)(vi)(E) under the Securities Exchange Act of 1934 17 CFR 240.15c3-1(c)(2)(vi)(E).

VII. Statutory Authority

This rulemaking is being promulgated pursuant to Sections 7, 10 and 19(a) of the Securities Act (15 U.S.C. 77g, 77i and 77s(a)).

By the Commission.

George A. Fitzsimmons,

Secretary.

August 6, 1981.

Regulatory Flexibility Act Certification

I, John S.R. Shad, Chairman of the Securities and Exchange Commission, hereby certify, pursuant to 5 U.S.C. 605(b), that the proposed rulemaking published in Securities Act Release No. 6336 (August 6, 1981), "Disclosure of Security Ratings in Registration Statements," will not, if promulgated, have a significant economic impact on a substantial number of small entities. The reason for such certification is that the proposed rules will impose no mandatory requirements upon issuers but, instead, will remove certain regulatory impediments to the voluntary disclosure of security ratings. It is anticipated that the effects of the proposed rules will not be significant for any class of registrants. Thus, the proposed rules will not have a significant economic impact on any small entities.

Dated: August 6, 1981.

John S.R. Shad,

Chairman.

¹See, e.g., Section 17(a) of the Securities Act (15 U.S.C. 77q(a)); Section 10(b) of the Securities Exchange Act of 1934 (15 U.S.C. 78j(b)) and Rule 10b-5 thereunder (17 CFR 240.10b-5); and Section 206 of the Investment Advisers Act of 1940 (15 U.S.C. 80b-6).

²Securities Act Release No. 6331 (August 6, 1981), as originally proposed in Securities Act Release No. 6235 (September 2, 1980) (45 FR 63693).

³ Securities Act Release No. 6332 (August 6, 1981), as originally proposed in Securities Act Release No. 6276 (December 23, 1980) (45 FR 78).

⁴ Securities Act Release No. 6333 (August 6, 1981).

⁵ Securities Act Release No. 6334 (August 6, 1981). Originally proposed as part of Securities Act Release No. 6276 (December 23, 1980) (45 FR 78).

⁶ Securities Act Release No. 6335 (August 6, 1981).

⁷ Securities Act Release No. 6337 (August 6, 1981).

⁸ Securities Act Release No. 6338 (August 6, 1981).

⁹ Standard and Poors Bond Guide (July 1980) at 6, See also Dykstra, Disclosure of Security Ratings in SEC Filings, IV Det. Coll. L. Rev. 545, 547-49 (1978) ("ratings are only current projuections as to future risk").

¹⁰ To assist the investor in interpreting the alphabetical letter symbols, each of the rating organizations furnishes its own definitions for its respective rating categories. These definitions appear in the publications of the various ratings services and provide the investor with an explanatory scale on which to compare the relative standing of a security.

For example, Standard & Poors Corporation ("Standard & Poors") and Fitch Investors Service ("Fitch") utilize a system of grading bonds ranging from AAA (highest investment quality) to D (in default) Moodys Investor Service ("Moodys"), on the other hand, rates bonds from Aaa to C. The letter ratings accorded preferred stock vary somewhat, but generally follow the declining order as described for debt securities. Fitch rates preferred stock with the same designation it employs for debt securities, that is, from AAA to D. Standards & Poors assigns ratings to preferred stock from AAA to C; and Moodys issues preferred stock ratings from aaa to caa.

¹¹ As one commentator noted, an AAA-rated bond night be an unwise investment if it were selling at 100% of par while a BBB-rated bond might be an excellent investment at 50% of its par. See also Dykstra, supra, at 548-49.

¹² Nonetheless, such disclosure has occurred when the issuer considered the downgradig of a security rating to be material under Rule 408 under the Securities Act 17 CFR 230.408 or Rule 12b-20 17 CFR 240.12b-20, Rule 14a-9 17 CFR 240.14a-9 or Schedule 14A 17 CFR 240.14a-101 under the Exchange Act or Item 5 of Form 8-K 17 CFR 249.308. In addition, the staff of the Division of Investment Management generally has taken the position that security rating disclosure in registration statements filed by investment companies is permitted provided that either a consent or a waiver of consent is obtained. The policy discussed herein and the proposed rules also would apply to investment company registration statements, thereby providing a consistent policy for all registrants under the Securities Act.

¹³ Securities Act Release No. 5882 (November 3, 1977) 45 FR 58414 (hereinafter "the 1977 Release").

¹⁴ Letters were received from the following categories of commentators: corporations (34); the securities industry (6); law firms an associations (5); other associations (4); rating organizations (4); banks (1) and academicians (1). Copies of these letters are available for public inspection and copying in the Commissions Public Reference Room (File No. S7-727). For the convenience of the public, a copy of the summary of comments prepared by the staff of the Commission has been placed in File No. S7-727 and also is available for public inspection and copying.

¹⁵See Dykstra, supra, at 550-52; H.C. Sherwood, How Corporate and Municipal Debt is Rated, at 9-10; Ross, "Higher Stakes in the Bond Rating Game," Fortune 132 (April 1976).

¹⁶ For example, under many state laws, legal investments by entities such as savings banks and insurance companies are defined in terms of security ratings. See, e.g., Me. Rev. Stat. tit. 9b., §553 (1980); Or. Rev. Stat. §§ 708.388, 716.530, 716.545 (1977); S.D. Codified Laws Ann. §58-27-42 (1978); Tenn. Code Ann. §56-3-303 (1980); Vt. Stat. Ann. tit. 8, §§ 1154, 1155, and 3463 (1970).

 In addition, the Commission relies upon security ratings in its uniform net capital rule so that broker-dealers receive certain reduced deductions from net capital if the short term commercial paper they hold is assigned one of the three highest ratings by at lest two nationally recognized statistical rating organizations. 17 CFR 240,15c3-1(c)(2)(vi)(E).

See also Rule 10f-3 17 CFR 270.10f-3 under the Investment Company Act of 1940 15 U.S.C. 80a-1 et seq. which, in part, conditions an exemption from a ban on a registered investment company ("fund") buying municipal securities from an underwriting syndicate in which an interested person of the fund is a member upon the issue receiving an investment grade rating from at least one of the nationally recognized statistical rating organizations.

¹⁷See Securities Act Release No. 6331, supra.

¹⁸ Although the reassessment of the Commission position regarding security rating disclosure was prompted, in part, by the proposals in Form S-3, the policy set forth in the release will remain in effect even if the security rating criterion for debt is eliminated from the Form upon adoption. The Commission notes that although registrants henceforth may include security rating disclosure in their registration statements in accordance with the policy set forth in this release, they are not likely to do so until final action is taken concerning rating organization consents pursuant to proposed Rule 436(g). See discussion of rating organization consent, infra. Until such time as the proposed rule is adopted, the disclosure of a security rating in a registration statement will necessitate the filing of a consent.

¹⁹ In the Commissions view, the current availability of security ratings in the marketplace, the practical problems of disclosure that are discussed herein and that would be exacerbated by any mandatory disclosure requirement, as well as its recognition that no pressing need for such additional requirements has been demonstrated, argue persuasively against such a rule at this time.

²⁰ Because the Commission is not specifically encouraging disclosure of securities ratings in Commission filings as it has encouraged disclosure of projections, the Commissions views concerning the voluntary disclosure of security ratings are being set forth in a policy release rather than in the context of Regulation S-K, the repository for standard disclosure items for forms filed under the Securities Act and the Exchange Act. The Commission believes that the issuance of policy and interpretive releases relating to disclosure is a useful mechanism for communicating its views to the public in areas where rules are not appropriate. After completion of a sunset review of releases issued in the past and listed in Part 231 of Title 17 of The Code of Federal Regulations, the Commission intends to provide a list of applicable releases on disclosure policy in Regulation S-K.

²¹ As discussed infra, the Commission is proposing to amend Rule 134 so that the registrant could include only the security rating and the name of the rating organization that assigned such rating in a tombstone advertisement. The additional disclosure discussed herein would not appear in a tombstone advertisement.

²² The rating organizations generally print these definitions at the beginning of their publications so that they would be readily available to the registrant.

²³ For example, a rating of "A" might be the third highest of six categories for nonconvertible debt securities.

²⁴ In many instances, a change in a rating or an additional, different rating might be attributable to intervening events affecting the issuer which would require amended disclosure, even in the absence of the inclusion of the security rating itself in the filing.

²⁵ Section 7 states in pertinent part: 

If... any person whose profession gives authority to a statement made by him, is named as having prepared... a report or valuation for use in connection with the registration statement, the written consent of such person shall be filed with the registration statement. If any such person is named as having prepared... a report or valuation... which is used in connection with the registration statement but is not named as having prepared... such report or valuation for use in connection with the registration statement, the written consent of such person shall be filed with the registration statement unless the Commission dispenses with such filing as impracticable or as involving undue hardship on the person filing the registration statement.

²⁶ Section 11(a) provides that any person acquiring a security registered with the Commission by means of a registration statement which contains an untrue statement of a material fact, or omits to state a material fact required to be stated therein or necessary to make the statements therein not misleading, may sue "any person whose profession gives authority to a statement made by him, who has with his consent been named as having prepared... any report or valuation which is used in connection with the registration statement, with respect to the statement in such... report, or valuation, which purports to have been prepared or certified by him."

 Under Section 11(a) a plaintiff need not establish privity to the defendant and need only make a prima facie showing of the material misstatement or omission to meet his burden of proof. The burden then shifts to the defendant/expert under Section 11(b)(3)(i) to prove that "he had, after reasonable investigation, reasonable ground to believe and did believe... that the statements therein were true and that there was no omission to state a material fact required to be stated therein or necessary to make the statements therein not misleading."

²⁷ In fact, all three existing rating organizations that meet the proposed definition in Rule 436(g) indicated in their comments on the 1977 Release that they would not provide the requisite consents.

²⁸ 17 CFR 240.15c3-1(c)(2)(vi)(E). Although the net capital rule contains no specific definition, staff interpretations thereunder suggest the entities which are accepted as nationally recognized statistical rating organizations. In a "no-action" letter to Lehman Commercial Paper Incorporated. 1975-1976 Transfer Binder Fed. Sec. L. Rep. (CCH) 80,513 (March 18, 1976), the Commission staff stated that:

 With respect to "nationally recognized statistical rating organizations", no question will be raised by the Division (of Market Regulation) when the following organizations are utilized for the purposes of applying subdivision (c)(2)(vi)(E) of Rule 15c3-1: Standard & Poors Corporation.., Moodys Investors Services, Inc... and Fitch Investors Services, Inc...

²⁹ Commercial paper ratings under the net capital rule are sought to assure the liquidity of a broker-dealers investments.

³⁰ SAS No. 24, "Review of Interim Financial Information" AICPA, March 1979. SAS No. 24 delineates the procedures to be followed by accountants in conducting reviews of unaudited interim financial information and the standards to be used in issuing reports based on these reviews.

³¹See Securities Act Release No. 6173 (December 28, 1979) 45 FR 1601.

³² Section 17(a) of the Securities Act, Section 10(b) of the Exchange Act and Rule 10b-5 thereunder and Section 206 of the Investment Advisers Act.

³³See, e.g., Mallinckrodt Chemical Works v. Goldman, Sachs & Co., 420 F. Supp. 231 (S.D.N.Y. 1976); University Hill Foundation v. Goldman, Sachs & Co., 422 F. Supp. 879 (S.D.N.Y. 1976).

³⁴ 15 U.S.C. 80b-1 et seq. The three major rating organizations, Standard & Poors, Moodys and Fitch, are all registered with the Commission as investment advisers.

³⁵See Statement of Philip A. Loomis, Jr., Commissioner, Securities and Exchange Commission, at hearings on Municipal Bonds Rating Regulation before the House Subcommittee on Consumer Protection and Finance of the Committee on Interstate and Foreign Commerce, 94th Cong., 2d Sess. 17 (1976); In re John R. Brick, Securities Exchange Act Release No. 11763 (Oct. 24, 1975), 8 SEC Docket 240; Paul K. Peers, Inc., 42 S.E.C. 539 (1965); Anne Caseley Robin, 41 S.E.C. 634 (1963).

³⁶ Section 206 provides in relevant part that: It shall be unlawful for any investment adviser, by use of the mails or any means or instumentality of interstate commerce, directly or indirectly-- (1) to employ any device, scheme, or artifice to defraud any client or prospective client; (2) to engage in any transaction, practice, or course of business which operates as a fraud or deceit upon any client or prospective client;.. (4) to engage in any act, practice, or course of business which is fraudulent, deceptive, or manipulative. The Commission shall, for the purposes of this paragraph (4) by rules and regulations define, and prescribe means reasonably designed to prevent, such acts, practices, and courses of business as are fraudulent, deceptive, or manipulative.