March 8, 2022, the U.S. Department of Labor (DOL) amended Prohibited Transaction Exemptions (PTEs) 75-1, 80-83, 81-8, 95-60, 97-41 and 2006-16 in order to remove the use of credit ratings as a condition of the PTEs. Section 939A of the Dodd-Frank Wall Street Reform and Consumer Protection Act (Act) required the DOL to remove the use of credit ratings from its class exemptions and substitute standards of creditworthiness. First proposed in 2013, these amendments replace the credit rating requirements with creditworthiness standards as required by the Act and according to the DOL in a manner consistent with actions taken by other regulators, particularly the Securities and Exchange Commission (SEC). These changes become effective May 9, 2022. Any fiduciary relying on these PTEs should review this alert and the PTE to assure compliance.
It is important to note that the DOL determined that the collection of individual exemptions issued to all major financial counterparties referred to as the “Underwriter Exemptions” are not subject to the Act and therefore remain unchanged and continue to contain references to credit ratings as conditions to the exemptive relief provided.
The amendments were adopted substantially as proposed in 2013 with only minor changes in response to changes adopted by the SEC and comments.
- PTE 75-1 and 80-83 formerly required that a security be “investment grade” or in one of the four highest rating categories: the new standard requires that the securities be subject to no grater than moderate credit risk and sufficiently liquid that they can be sold at or near fair market value within a reasonably short period.
- PTE 2006-16 formerly required foreign sovereign debt securities in securities lending transactions be rated in one of the two highest categories of at least one nationally recognized statistical rating organization (NRSRO) and for letters of credit, the issuer had to receive a credit rating of at least “investment grade.” The new standard requires foreign sovereign debt be subject to a minimal amount of credit risk and sufficiently liquid that it can be sold at or near fair market value within a reasonably short period, and for letters of credit the applicable foreign bank must be subject to no greater than moderate credit risk.
- PTE 81-8 formerly required that the commercial paper be in one of the three highest rating categories by one rating service: the new standard requires that the commercial paper be subject to a minimal or low amount of credit risk and sufficiently liquid that it can be sold at or near fair market value within a reasonably short period.
- PTE 97-41 permitted the non pro-rata transfers between a collective investment trust and mutual fund if at the time of transfer the securities transferred had the same credit rating. The amendment removed this credit rating requirement and instead now requires that the securities must be of the same credit quality.
- PTE 95-60 which exempts certain transactions involving insurance company general accounts and refers to the Underwriter Exemptions’ requirements were amended to remove its reference to credit ratings and no longer require that the certificates meet the credit quality requirement under the relevant Underwriter Exemption.
The DOL did not set forth any specific financial ratios or tests to determine credit quality and instead left fiduciaries broad discretion to evaluate investments in the manner they determine most appropriate. The DOL clarified that fiduciaries may still use the credit rating of a security as “an element or data point to analyze credit quality.”
For further information on these amendments, please contact S. John Ryan at (212) 574-1679, Michael O’Brien at (212) 574-1505, or Bradley Fay at (212) 574-1429.