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SEC Proposes Rules to Increase Transparency and Improve Integrity of Credit Ratings


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Washington, D.C., May 18, 2011 – The Securities and Exchange Commission today voted unanimously to propose new rules and amendments intended to increase transparency and improve the integrity of credit ratings.

The proposed rules would implement certain provisions of the Dodd-Frank Wall Street Reform and Consumer Protection Act and enhance the SEC’s existing rules governing credit ratings and Nationally Recognized Statistical Rating Organizations (NRSROs).

“In passing the Dodd-Frank Act, Congress noted that credit ratings applied to structured financial products proved inaccurate and contributed significantly to the mismanagement of risks by financial institutions and investors,” said SEC Chairman Mary L. Schapiro. “Our proposed rules are intended to strengthen the integrity and improve the transparency of credit ratings.”

Under the SEC’s proposal, NRSROs would be required to:

  • Report on internal controls.
  • Protect against conflicts of interest.
  • Establish professional standards for credit analysts.
  • Publicly provide – along with the publication of the credit rating – disclosure about the credit rating and the methodology used to determine it.
  • Enhance their public disclosures about the performance of their credit ratings.

The SEC’s proposal also requires disclosure concerning third-party due diligence reports for asset-backed securities.

Public comments on the SEC’s proposal should be received within 60 days after it is published in the Federal Register.

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Providing Enhanced Oversight of Credit Rating Agencies


Credit Rating Agencies/NRSROs:

Credit rating agencies are organizations that rate the creditworthiness of a company or a financial product such as a debt security or money market instrument. These credit ratings are often considered by investors when evaluating whether to purchase or sell securities.

In 2006, Congress passed the Credit Rating Agency Reform Act that provided the SEC with the authority to establish a registration and oversight program for credit rating agencies registered with the SEC as Nationally Recognized Statistical Rating Organizations (NRSROs). Currently, 10 credit rating agencies are registered with the SEC as NRSROs.

Third-Party Due Diligence Providers:

Often, issuers and underwriters of asset-backed securities rely on independent firms to review a sample of the assets underlying a new securitization, which is frequently required in connection with the rating of the product. In the case of a mortgage-backed security, the review might seek to ensure that the loans in the pool comply with the underwriting standards. These firms are known as due diligence providers.

Recent SEC Actions Regarding NRSROs:

Since the passage of the Dodd-Frank Act, the SEC has issued proposals that would:

  • Change existing rules related to money market funds that allow such funds to only invest in securities that have received one of the two highest categories of short-term credit ratings.
  • Remove references to credit ratings from broker-dealer capital and other financial responsibility rules and, where necessary, substitute alternative standards of creditworthiness.
  • Remove credit ratings as one of the conditions for companies seeking to use short-form registration when registering securities for public sale.

The Proposed Rules

The SEC proposed rules related to NRSROs and third-party due diligence providers as well as issuers and underwriters, of asset-backed securities. Some of the proposed rules would expand upon provisions in the Dodd-Frank Act that are self-executing, while others proceed from provisions in the Act that require SEC rulemaking.

Reporting on Internal Controls:

Section 932 of the Dodd-Frank Act requires NRSROs to have an effective internal control structure governing the way in which the NRSRO determines credit ratings. The Dodd-Frank Act also requires each NRSRO to submit an annual report to the SEC about its internal controls.

Under the proposed rule amendment, the NRSRO would be required to file a report with the SEC containing a description of management’s responsibility in establishing the internal control structure and an assessment of the effectiveness of those internal controls.

Preventing Conflicts of Interest Relating to Sales and Marketing:

Section 932 of the Dodd-Frank Act seeks to prevent an NRSRO’s “sales and marketing” considerations from influencing the NRSRO’s credit ratings.

Under the proposed rule amendments, an NRSRO would be prohibited from issuing or maintaining a credit rating where an employee of the NRSRO – who participates in the sales or marketing of a product or service of the NRSRO or of a person associated with the NRSRO – also participates in determining or monitoring a credit rating or developing or approving procedures used for determining a credit rating.

Additionally, the proposal would establish a mechanism:

  • By which small NRSROs could seek an exemption from this provision.
  • To suspend or revoke the registration of an NRSRO or impose other penalties if the SEC finds that the NRSRO has committed a violation of a conflict of interest rule that affected a rating.

Enhancing the “Look-Back” Review:

Section 932 of the Dodd-Frank Act requires NRSROs to establish policies regarding former employees:

  • Who participated in determining a credit rating, and …
  • Who were subsequently employed – within one year – by an entity subject to that credit rating – or by the issuer, underwriter, or sponsor of a product subject to that credit rating.

In such cases, the NRSRO must conduct a “look-back” review to:

  • Determine whether any conflicts of interest influenced the credit rating.
  • Take action to revise the rating, if appropriate.

Under the proposed rule, if the NRSRO “look-back” review determined that a conflict influenced a rating, the NRSRO would be required to, at a minimum:

  • Immediately place the credit rating on a credit watch and include, among other things, an explanation that the reason for the action is that the rating was influenced by a conflict of interest.
  • Promptly determine whether the credit rating must be revised so it no longer is influenced by a conflict of interest.
  • Promptly publish a revised credit rating or an affirmation of the credit rating, if appropriate.

Standardizing Disclosure of Information About the Performance of Credit Ratings:

Section 932 of the Dodd-Frank Act requires NRSROs to publicly disclose information on their initial credit ratings – and subsequent changes to such ratings – so users can evaluate the accuracy of the ratings and compare the performance of different rating agencies.

The SEC proposals would, among other things:

  • Standardize the way an NRSRO calculates and presents aggregate information about how its ratings change over time (the transition rate) and how often a rated entity or product subsequently defaulted.
  • Require the NRSRO to publicly display this information on an “easily accessible” portion of its website
  • Enhance the so-called “100% Rule.” This previously-existing rule requires an NRSRO to publish information concerning its rating actions for credit ratings that the NRSRO initially determined on or after June 26, 2007. The disclosure must be made within 12 months after determination for ratings that are issuer-paid and within 24 months after determination for ratings that are not issuer paid.

The enhancements would, among other things:

  • Require that the disclosures include any credit ratings that were outstanding as of June 26, 2007, and any subsequent rating actions taken with respect to those ratings
  • Increase the number and scope of the data fields that must be disclosed about a rating action.
  • Provide that an NRSRO may stop disclosing a rating history no earlier than 20 years after the withdrawal of the credit rating.

Strengthening Credit Rating Methodologies:

Under Section 932 of the Dodd-Frank Act, the SEC must adopt rules requiring an NRSRO to have policies and procedures governing the way the NRSRO determines credit ratings. Under the proposed rule, those policies and procedures would have to be reasonably designed to ensure, among other things, that:

  • The board of directors approves them.
  • Material changes are applied consistently and changes to surveillance procedures are applied within a reasonable period of time.
  • The NRSRO promptly publishes notice of material changes to rating methodologies and of the discovery of significant errors in rating methodologies.
  • The NRSRO discloses the version of the methodologies used with respect to a particular credit rating.

Leveraging Third-Party Due Diligence for Asset-Backed Securities:

Consistent with Section 932 of the Dodd-Frank Act, the SEC’s proposed rule would require that due diligence providers for asset-backed securities must provide a written certification to any NRSRO that rates the securities.

The certification would be made on a new form – Form ABS Due Diligence-15E – which would describe the due diligence undertaken and the findings and conclusions resulting from the due diligence. This information would be required to be made public by the NRSRO, or if the NRSRO does not do so, by the issuer or underwriter of the securities.

Enhancing the Disclosure of Information About Credit Ratings:

Section 932 of the Dodd-Frank Act requires the SEC to issue rules to require NRSROs to publish a form with each credit rating. Under the proposed rule, the NRSRO would be required to:

  • Include in the form information about the credit rating, such as information relating to the assumptions underlying the methodology used to determine the credit rating.
  • Include any certification of due diligence providers described above.

The form and certifications would have to be published in the same medium and made available to the same persons who can receive or access the credit rating. The NRSRO would need to disclose in the form substantial qualitative and quantitative information about the credit rating and methodologies used to determine the credit rating.

Upgrading Standards of Training, Experience, and Competence:

Consistent with Section 936 of the Dodd-Frank Act, the proposed rule would require NRSROs to establish standards of training, experience and competence for credit analysts and to:

  • Consider certain factors when establishing the standards, for example the complexity of the securities that will be rated by the analyst.
  • Periodically test its credit analysts on the credit rating procedures and methodologies it uses.
  • Require that at least one individual with three or more years of experience in performing credit analysis participates in determining a credit rating.

Addressing Rating Symbols:

Consistent with Section 938(a) of the Dodd-Frank Act, the rule proposal would require an NRSRO to have policies and procedures that are reasonably designed to:

  • Assess the probability that an issuer of a security or money market instrument will default.
  • Clearly define each symbol in the NRSRO’s rating scale.
  • Apply any such symbol in a consistent manner.

Mandating Electronic Filings of Form NRSRO and the Annual Reports:

Under the proposed rule amendments, an NRSRO would be required to use the SEC’s EDGAR system to electronically submit Form NRSRO:

  • To update an NRSRO registration.
  • Submit the annual certification.
  • Withdraw from registration.

The proposal also would require NRSROs to use EDGAR to file their annual reports.

Filing NRSRO Compliance Officer Reports:

Section 932 of the Dodd-Frank Act requires the designated compliance officer of an NRSRO to submit to the NRSRO an annual report on the rating agency’s compliance with the securities laws and its policies and procedures that must be filed together with the report that NRSROs must submit to the SEC annually.

What’s Next

The SEC’s proposal seeks public comments that should be received within 60 days of its publication in the Federal Register.



Modified: 05/18/2011