Statement on the Commission’s Issuance of Certain Exemptive Orders Related to Rule 17g-5(c)(1)

Public Statement

Statement on the Commission’s Issuance of Certain Exemptive Orders Related to Rule 17g-5(c)(1)

 

Commissioner Luis A. Aguilar

U.S. Securities and Exchange Commission[1]


Jan. 8, 2014

Rule 17g-5(c)(1) (the “Rule”) of the Securities Exchange Act of 1934 addresses nationally recognized statistical rating organization (“NRSRO”) conflict of interest concerns by prohibiting an NRSRO from issuing a credit rating where the person soliciting the rating was the source of 10% or more of the total net revenue of the NRSRO during the most recently ended fiscal year.[2]  As noted by the Commission, this prohibition is necessary because such a person “will be in a position to exercise substantial influence on the NRSRO” and, as a result, “it will be difficult for the NRSRO to remain impartial, given the impact on the NRSRO’s income if the person withdrew its business.”[3]  The Commission also recognized that the intent of the prohibition “is not to prohibit a business practice that is a normal part of an NRSRO’s activities,” and that the Commission may evaluate whether exemptive relief would be appropriate.[4]

Last week, the Commission issued exemptive orders (“Orders”) regarding Morningstar Credit Ratings, LLC and Kroll Bond Rating Agency, Inc.,[5] each of which is an NRSRO.  The Orders temporarily exempt Morningstar and Kroll from Rule 17g-5(c)(1) (the “Rule”) of the Securities Exchange Act of 1934.

Unfortunately, these Orders are the third exemptive orders granted to both Morningstar and Kroll, or their predecessor entities, with regard to the Rule’s conflict of interest prohibition.[6]  Exemptive relief from compliance with the law should not be granted in perpetuity.  Moreover, relief is granted in situations like this with the expectation that the companies must take steps to comply with the law as soon as possible.

Here, while the Orders generally described the reasons that such exemptive relief is needed—and the efforts that each NRSRO will undertake to comply fully with the Rule[7]—neither Order provides a concrete timetable indicating when each NRSRO will comply with the Rule.  Thus, at my request, both Morningstar and Kroll have submitted letters providing additional information regarding their plans to be in full compliance with the Rule.[8]  Based on their representations, I expect both companies to undertake good faith efforts to come into full compliance with the Rule over the next two years.  Clearly, the Commission cannot issue such exemptive orders ad infinitum.

I look forward to these companies pro-actively managing their compliance with this Rule and no longer needing additional exemptive relief from the Commission.  Should another exemptive order be required in the future, I expect to see clear evidence that meaningful steps have been taken to comply with the Rule.  In addition, I expect that the Orders’ limitation on the maximum percentage of net revenues that each NRSRO may earn from a single client will be lowered as a condition for granting any necessary future relief.[9]



[1] The views expressed by Commissioner Luis A. Aguilar are his own and do not necessarily reflect the views of the U.S. Securities and Exchange Commission (“Commission” or “SEC”), his fellow Commissioners, or members of the staff.

[2] Exchange Act Release No. 34-55857 (June 5, 2007). 

[3] Id. 

[4] Id.  As noted in the Orders, both Kroll and Morningstar have informed Commission staff that in the current fiscal year they may receive more than 10% of their revenues from one or more clients that paid it to rate asset-backed securities.  In the adopting release, the Commission noted that it intended “to monitor how the prohibition operates in practice, particularly with respect to structured products.”  Id.   

[5] See, Exchange Act Release No. 34-71219 and Exchange Act Release No. 34-71220 (December 31, 2013).

[6]  Rule 17g-5 (c)(1) became effective on June 26, 2007.  On September 14, 2011, the Commission granted Kroll, previously known as LACE Financial Corp., a temporary exemption from Rule 17g-5(c)(1). Exchange Act Release No. 34-65339 (Sept. 14, 2011).  The Commission also granted LACE a temporary exemption from the rule on February 11, 2008.  The Commission granted Morningstar, previously known as Realpoint, LLC, an exemption from Rule 17g-5(c)(1) on March 5, 2012, and also granted Realpoint LLC a temporary exemption from the rule on June 23, 2008.  Exchange Act Release No. 34-66514 (March 5, 2012) and Release No. 34-58001 (June 23, 2008). 

[7] For example, as noted in the Morningstar order, Morningstar has indicated that the exemption will enable it to further diversify its revenue into other markets and products, and that it expects to have more diverse revenue sources over time such that it will not need an exemption.  Similarly, as noted in the Kroll order, Kroll has informed the Commission that it intends to further expand its existing NRSRO business into other sectors of the capital markets, and that it expects to have more diverse revenue sources over time such that it will not need an exemption.  See, Exchange Act Release No. 34-71219 and Exchange Act Release No. 34-71220.

[8] See, December 31, 2013 Letter from Morningstar Credit Ratings, LLC to Commissioner Aguilar, available at http://www.sec.gov/rules/exorders/2013/34-71219-letters.pdf, and December 31, 2013 Letter from Kroll Bond Ratings Agency, Inc. to Commissioner Aguilar, available at http://www.sec.gov/rules/exorders/2013/34-71220-letters.pdf.

[9] As one of the conditions for the Commission’s granting the exemptive orders, Morningstar’s net revenue from a single client shall not exceed 20% of Morningstar’s total net revenue for the either the fiscal year ending December 31, 2013 or the fiscal year ending December 31, 2014.  See, Exchange Act Release No. 34-71219.  Similarly, Kroll’s net revenue from a single client shall not exceed 25% of Kroll’s total net revenue for the either the fiscal year ending December 31, 2013 or the fiscal year ending December 31, 2014.  See, Exchange Act Release No. 34-71220.


Last modified: Jan. 8, 2014