On December 7, 2021, the SEC Staff released a statement to remind investment professionals of their obligations when recommending LIBOR-linked securities and to remind companies and issuers of asset-backed securities of their disclosure obligations related to the LIBOR transition.4

The Statement covers several areas of concern to the SEC, summarized below:

  • Recommendations by broker-dealers of LIBOR securities or investment strategies involving LIBOR securities to retail customers;
  • Disclosure obligations of issuers with material exposure to LIBOR securities;
  • The effect on retail customers of a recommendation of LIBOR securities with no fallback provisions; and
  • The effect on retail customers of a recommendation of LIBOR securities with fallback provisions, and the resulting change in the interest rate from USD LIBOR to the secured overnight financing rate ("SOFR").5

BROKER-DEALERS. The Staff stated that broker-dealers should be "especially mindful of their obligations when recommending LIBOR-linked securities or investment strategies involving LIBOR-linked securities to retail customers." Under Regulation Best Interest, a broker-dealer recommending LIBOR securities or investment strategies involving such securities must have a reasonable basis to believe that the recommendation is in the best interest of the retail customer.6

The care obligation of Regulation Best Interest requires that a broker-dealer must exercise reasonable diligence, care and skill to understand the potential risks, rewards and costs associated with the recommendation, and in light of the retail customer's investment profile, that the recommendation is in the best interests of the particular retail customer.7 Accordingly, a broker-dealer must understand whether there are robust fallback provisions providing for a clear replacement rate after USD LIBOR is no longer available, and the effect of the replacement rate on the LIBOR security.

The Staff also stated that it would be difficult for a broker-dealer to recommend a LIBOR security with no fallback provision, absent the recommendation being premised on a specific, identified, short-term trading objective.

Legacy USD LIBOR securities with no fallback provisions would, without any external action, become fixed-rate notes after June 30, 2023, when most USD LIBOR tenors will no longer be published. The Staff's concern is the effect of this change in the interest rate, which would be material, on a retail investor. Most outstanding USD LIBOR securities with fallback provisions will switch over to SOFR, and the Staff is concerned that, even with adequate fallback provisions and because SOFR is not a perfect match for USD LIBOR, the effect on the LIBOR securities' interest payments may be material to a retail investor.

Although the Statement makes reference to Article 18-C of the New York General Obligations Law, which will cause any legacy USD LIBOR New York law governed securities without adequate fallbacks to switch over to SOFR after June 30, 2023, the Statement treats recommendations of these legacy USD LIBOR securities differently than recommendations of USD LIBOR securities with robust fallback provisions.8 Also, at this point, any legacy USD LIBOR securities without adequate fallback provisions would be available only in the secondary market.

The Staff's concern with legacy LIBOR securities without fallback provisions would be applicable to non-USD LIBOR securities, such as a GBP LIBOR floating rate note ("FRN") governed by New York or other U.S. state law. These types of FRNs will not be affected by the New York or federal legislation. However, these types of FRNs are a small slice of the market. USD LIBOR-preferred stock, which is generally governed by Delaware law, will be addressed by the upcoming federal LIBOR legislation.

Broker-dealers who agree to monitor a retail customer's account were also reminded of their obligations under Regulation Best Interest, in that the broker-dealer must reassess the potential risks, rewards and costs of any LIBOR securities in a retail customer's account at each time of the agreed-upon review, based on the current state of the LIBOR transition and the potential effect on a customer's LIBOR security holdings. The broker-dealer's recommendation at the time of each monitoring may be to buy, sell or hold, and if the broker-dealer remains silent, that is an implicit hold recommendation.

ISSUERS. Issuers must keep investors informed of their progress toward LIBOR risk identification and mitigation, and the anticipated effect on the issuer, if material. This disclosure could be included in the risk factors, management's discussion and analysis, board risk oversight and the financial statements sections of the prospectus. Issuers with material risk related to outstanding LIBOR debt with inadequate fallback provisions should consider how much debt will be outstanding after the LIBOR cessation date and the steps the company is taking to address the situation. As discussed above, this would seem to apply only to non-USD LIBOR securities or preferred stock, the latter of which will be solved by the upcoming federal LIBOR legislation. Issuers with material outstanding non-USD LIBOR securities may have to disclose upcoming plans for tender or exchange offers, or consent solicitations.

The Staff Statement also notes that the recommendations of the Alternative Reference Rates Committee on fallback language for new issuances of USD LIBOR FRNs are not binding on U.S. issuers, in that issuers are not obligated to include any particular fallback language in such securities.

Footnotes

4 The SEC Staff Statement can be found at: SEC.gov | SEC Staff Statement on LIBOR Transition—Key Considerations for Market Participants.

5 The focus of this article is on USD LIBOR floating rate notes and preferred stock, related recommendations by broker-dealers and related disclosures by issuers. The Statement also covers municipal securities underwriting by broker-dealers and the obligations of registered investment advisers and funds.

6 See Rule 15l-1(a)(2)(i) under the Securities Exchange Act of 1934.

7 See Rule 14l-1(a)(2)(ii)(B) under the Securities Exchange Act of 1934

8 The Statement makes no reference to the federal USD LIBOR legislation


Originally published in REVERSEinquiries: Volume 4, Issue 6.
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