SEC Proposes Mandatory Credit Ratings Disclosure

Capital Markets December 2, 2009 SEC Proposes Mandatory Credit Ratings Disclosure The U.S. Securities and Exchange Commission ( SEC ) proposed new rules that would require issuers to make disclosures about their credit ratings in prospectuses for registered public offerings if they use a credit rating to market their securities. The proposed rules mark a shift in the SEC s disclosure policy on credit ratings from its current policy of permitting voluntary disclosure to one of mandating disclosure. If adopted as proposed, the rules would significantly add to the disclosure about credit ratings included in registration statements. The proposed rules would apply to registered public offerings by domestic issuers, foreign private issuers and closed-end funds. The SEC indicated that it proposed these rules to respond to four principal areas of concern: Lack of sufficient information for investors to understand the scope or meaning of credit ratings when they are used to market securities so that investors are able to place the appropriate weight on a credit rating when making an investment decision; Potential conflicts of interest between credit rating agencies and the companies whose securities they are rating; Ratings shopping ; and Investors not receiving basic information about credit ratings, a potentially key element of their investment decision, because disclosure of credit ratings in prospectuses is not required. In a companion concept release, the SEC is soliciting comments on whether it should impose liability under the Securities Act of 1933, as amended (the Securities Act ), on credit rating agencies that are Nationally Recognized Statistical Rating Organizations ( NRSROs ) by rescinding the existing exemption in Rule 436(g). The concept release is discussed in more detail below. The SEC is soliciting comments on both releases and comments are due on December 14, 2009. The releases can be found at http://www.sec.gov/rules/proposed/2009/33-9070.pdf http://www.sec.gov/rules/concept/2009/33-9071.pdf Trigger for Disclosure The proposed rules requiring disclosure about credit ratings would be triggered when a credit rating is used in connection with a registered offering of securities. The SEC is taking a broad view of used in connection with a registered offering of securities and the rule would be triggered under a wide variety of circumstances. However, the SEC s proposal recognizes that issuers may disclose their credit ratings in SEC filings for other purposes, and the new disclosure requirements are not intended to apply in those circumstances. Under the proposal, if the only disclosure of a credit rating in an SEC filing relates to changes to a credit rating, liquidity of the issuer, the cost of funds or the terms of agreements that NYDOCS01/1217110.6

2 refer to credit ratings, and the credit rating is not otherwise used in connection with a registered offering, the new disclosure requirements would not apply. In practice, it may be difficult for issuers to distinguish among these circumstances, which could lead to compliance with the disclosure requirements whenever a credit rating is disclosed in a prospectus. Does the proposed rule apply to both oral and written selling efforts? Yes, both oral and written selling efforts are covered. Written selling efforts would include disclosure in a preliminary or final prospectus or a pricing term sheet or other free writing prospectus filed with the SEC, and although not addressed in the release, presumably would include road show presentations. Oral selling efforts would include disclosure made in response to investor inquiries so that even if the credit rating was not included in a prospectus, but was provided orally in response to a question from a potential investor, the disclosure requirements of the rule would be triggered. Which offering participants can trigger disclosure of credit ratings? Disclosure would be triggered if the issuer of the securities, a selling security holder, underwriter or any member of a selling group uses a credit rating in its marketing efforts in connection with a registered offering. Are credit ratings required to be disclosed when securities are offered in private offerings in reliance on Rule 144A or another private placement exemption? The proposed rules do not apply to Rule 144A or other private placements with one important exception when the privately offered securities are exchanged shortly after the private sale for substantially identical registered securities in an Exxon Capital registered exchange offer. Disclosure would be required the exchange offer registration statement if the credit rating was used in the private placement. Will the proposed rules be triggered when a company offers equity securities in a registered public offering? As proposed, the rules apply to any class of securities offered in a registered offering. If, for example, an issuer discloses its corporate credit rating in a prospectus for an equity offering and uses the credit rating to sell the securities, the disclosure requirements would be triggered. Do the proposed rules require disclosure of unsolicited credit ratings? The proposed disclosure requirements would not be triggered when the issuer or someone acting on its behalf has not sought or otherwise solicited a credit rating, unless that credit rating is used in connection with a registered offering of the issuer s securities. Required Disclosure The proposed rules are designed to make clear to investors the elements of the securities that the credit rating addresses, the material limitations or qualifications on the credit rating and any related published designation, such as non-credit payment risks, assigned by the credit rating agency. What specific information about credit ratings is required to be disclosed? The identity of the credit rating agency and whether the organization is an NRSRO; The assigned credit rating; The relative rank of the credit rating within the agency s classification system; The date the credit rating was assigned; The credit rating agency s description of the category in which the rating falls; The identity of the party that is compensating the rating agency;

3 A description of any other non-rating services provided by the rating agency or its affiliates to the company or its affiliates; All material limitations on the scope of the credit rating; How the rating deals with contingencies related to the securities; Any published designation reflecting the results of any other evaluation done by the rating agency in connection with the rating, along with an explanation of the designation s meaning and the relative rank of the designation; Any material differences between the terms of the securities as assumed or considered by the credit rating agency and (i) the minimum obligations of the security as specified in the governing instruments of the security and (ii) the terms of the securities as used in the marketing or selling efforts; and A statement informing investors that a credit rating is not a recommendation to buy, sell or hold securities; that it may be subject to revision or withdrawal at any time; that the rating is applicable only to the specified class of securities to which it applies; and that investors should make their own evaluation as to whether an investment in the security is appropriate; A description of a final rating obtained by the issuer but not used in connection with the offering; and A description of any preliminary rating for the class of securities that received the rating being disclosed if the preliminary rating was obtained by or on behalf of the issuer from a credit rating agency other than the one that provided the rating that is being disclosed. What if a final credit rating is not available at the time a registration statement goes effective or if the offering is a shelf take-down? If a final rating is not assigned until after the registration statement is declared effective or if a different rating becomes available before effectiveness, the issuer would be required to convey the rating change to an investor. If the offering is being made pursuant to an already effective shelf registration statement, the prospectus supplement or a free writing prospectus, such as a term sheet, would need to contain the required disclosure. What if the credit rating includes a related published designation? If a credit rating includes a related published designation, such as a non-credit payment risk assessment, volatility assessment or other type of analysis that does not solely reflect credit risk, the issuer would need to include a description of the additional analyses performed by the rating agency to make clear how it relates to the general credit analysis. What if the final terms of the securities are different from those on which the rating agency based its rating? If the terms of the securities considered or assumed by the rating agency upon which it based its rating are materially different from the terms in the documents governing the securities and the terms of the securities marketed to the investors, the issuer would be required to disclose the differences. Disclosure of Potential Conflicts of Interest Under the proposed rules, the identity of the party who is paying the rating agency for providing the credit rating is required to be disclosed. If the rating agency or its affiliates provided non-rating services to the company or its affiliates, the proposed rules would require a description of the non-rating services and separate

4 disclosure of the fee paid for the rating being disclosed and the aggregate fees paid for any non-rating services provided during the issuer s last fiscal year and any interim period up to the date of the filing. Do issuers need to disclose the amount of the fee paid for the rating of the security it is selling? The amount of the fee is not required to be disclosed, unless the rating agency provides other non-rating services to the issuer. Ratings Shopping Under the proposed rules, if a credit rating is used to market a class of securities, then all preliminary ratings of that class of securities must be disclosed. Any credit rating that an issuer obtains must also be disclosed even if it is not used. The purpose of this proposed rule is to make investors aware of situations where an issuer may have engaged in ratings shopping and sought a rating of the same securities from other rating agencies. The SEC believes this practice raises serious issues about the integrity of the credit ratings process because it could potentially cause inflated credit ratings if the issuer disregards the lower rating in favor of a higher rating from another rating agency. Unsolicited preliminary ratings, however, would not be required to be disclosed. What is a preliminary credit rating? The proposed rules construe preliminary credit ratings broadly so that the term would be read to include any rating that is not published, any range of ratings, any oral or other indications of a potential rating or range of ratings and all other preliminary indications of a rating. What information about preliminary ratings must be disclosed? Disclosure of preliminary ratings or an unused rating would be similar to the disclosure required for a final rating. Would disclosure of preliminary ratings be required even if the final terms of the security are changed? Yes. Would preliminary ratings on a structure of a security for an asset-backed offering be required to be disclosed? Yes. If, for example, an underwriter asks a rating agency to rate a newly developed structure for an asset-backed offering that is not tied to a particular issuer or pool of assets, the issuer would be required to disclose the preliminary rating if a rating is used in connection with a registered offering of securities by the underwriter with that structure. Disclosure in Periodic Reports Once the credit ratings disclosure has been triggered, the proposed rules would require issuers to file a Current Report on Form 8-K if the credit rating agency changes or withdraws a previously disclosed rating. What is required to be disclosed? The Form 8-K disclosure would include the date that the issuer received the credit rating agency s notice or communication, the name of the rating agency and the nature of the rating agency s decision. An issuer would not be required to discuss the impact of the change in its Form 8-K, but would be required to add a discussion of any material impact in its next periodic report filed with the SEC. Do all changes in credit ratings need to be disclosed? The only time that a credit rating needs to be updated is when a credit rating was previously disclosed pursuant to the proposed rules. Credit ratings used prior to the adoption of these proposed new rules are intended to be grandfathered and changes would not need to be reported on a Form 8-K.

5 Is disclosure required if a rating agency puts a company on credit watch or changes its outlook for the company? As currently proposed, the rules only require a Form 8-K to be filed when a rating agency changes a specific rating, but not if it takes other actions. SEC Concept Release on Subjecting all Credit Rating Agencies to Liability under the Securities Act as Experts In a companion concept release, the SEC announced that it is considering subjecting Nationally Recognized Statistical Rating Organizations ( NRSROs ) to potential liability under the Securities Act as experts when an issuer uses a credit rating that they provide in a registration statement. The SEC is considering rescinding Rule 436(g), which has been in place for nearly 30 years, and provides that a credit rating assigned by an NRSRO is not part of a registration statement that has been prepared by an expert. Rule 436(g) has had the effect of insulating NRSROs from potential liability under Section 11 of the Securities Act for material misstatements or omissions in a registration statement. Rating agencies that are not NRSROs, are not covered by Rule 436(g) and under the current rules, if a rating they issue is included in a registration statement, they would be subject to potential liability. Rescission of Rule 436(g) would put NRSROs and other credit rating agencies on equal footing and subject all of them to potential Securities Act liability. Rescission of the rule would also require companies doing registered public offerings that include a credit rating in their registration statements to obtain the consent of the rating agency to the use of its name in the prospectus similar to the consent required from auditors. Among the reasons put forth by the SEC for rescinding Rule 436(g), is that when credit ratings are used to sell securities, investors rely on NRSROs and other rating agencies as experts such that it is appropriate to subject them to liability under the Securities Act in the same manner that other experts, such as auditors, are. The SEC also suggested that subjecting all rating agencies to liability under the Securities Act could have the effect of causing them to improve the quality of their ratings and analysis in order to reduce their risk of liability. This memorandum is intended only as a general discussion of these issues. It should not be regarded as legal advice. We would be pleased to provide additional details or advice about specific situations if desired. If you wish to receive more information on the topics covered in this memorandum, you may contact your regular Shearman & Sterling contact person or any of the following: Danielle Carbone +1.212.848.8244 dcarbone@shearman.com Robert Evans +1.212.848.8830 revans@shearman.com Stuart K. Fleischmann +1.212.848.7527 sfleischmann@shearman.com Nathan J. Greene +1.212.848.4668 ngreene@shearman.com Joel Klaperman +1.212.848.8021 jklaperman@shearman.com. 599 LEXINGTON AVENUE NEW YORK NY 10022-6069 WWW.SHEARMAN.COM 2009 Shearman & Sterling LLP. As used herein, Shearman & Sterling refers to Shearman & Sterling LLP, a limited liability partnership organized under the laws of the State of Delaware.