Speech by SEC Staff:
Remarks Before the SEC Open Meeting: Final Rules Implementing the Credit Rating Agency Reform Act of 2006
Erik R. Sirri
Director, Division of Market Regulation
U.S. Securities and Exchange Commission
May 23, 2007
Thank you, Mr. Chairman. Good afternoon, Commissioners. The Division of Market Regulation recommends that the Commission adopt final rules to implement the Credit Rating Agency Reform Act of 2006. As instructed by Congress, the final rules before you are narrowly tailored, and are designed to promote the quality and integrity of credit ratings by fostering accountability, transparency, and competition in the credit rating industry.
The Commission proposed rules for comment on February 2, 2007. We were pleased to receive 62 comments during what was necessarily a very short comment period. The final rules before you today incorporate changes responsive to the comments.
We have prepared six rules and a registration form for consideration:
First, we recommend that the Commission adopt Rule 17g-1, the registration procedures for Nationally Recognized Statistical Rating Organizations, or NRSROs, and the Form NRSRO.
Rule 17g-1 will require a credit rating agency to apply to the Commission for registration as an NRSRO and, if approved, to provide updated information (when certain information provided becomes materially inaccurate) and an annual certification on Form NRSRO.
The credit rating agency will be required to provide information on Form NRSRO; such as the classes of credit ratings for which it is applying to be registered; credit ratings performance measurement statistics; a general description of its procedures and methodologies for determining credit ratings; organizational structure; procedures to prevent the misuse of material nonpublic information; procedures to address and manage conflicts of interest; a description of the minimum qualifications of its credit analysts and credit analyst supervisors; and information regarding the designated compliance officer.
Second, we recommend that the Commission adopt Rule 17g-2, concerning the records to be made and retained by NRSROs.
Rule 17g-2 will require an NRSRO to make and retain certain records relating to its business as a credit rating agency. The rule also will also prescribe the time periods and manner in which the records must be maintained.
Third, we recommend that the Commission adopt Rule 17g-3, requiring annual financial reports to be furnished by NRSROs.
Rule 17g-3 will require NRSROs to furnish the Commission, on a confidential basis, certain financial reports, on an annual basis, including audited financial statements. In addition to the audited financial statements, the rule also will require NRSROs to furnish separate unaudited financial reports that will assist the Commission in carrying out its statutory responsibilities under the Credit Rating Agency Reform Act.
Fourth, we recommend that the Commission adopt Rule 17g-4, which seeks to prevent the misuse of material nonpublic information.
Rule 17g-4 will require an NRSRO to have written policies and procedures reasonably designed to prevent: (1) the inappropriate dissemination within and outside the NRSRO of material nonpublic information obtained in connection with the performance of credit rating services; (2) a person within the NRSRO from purchasing, selling, or otherwise benefiting from any transaction in securities or money market instruments when the person is in possession of material nonpublic information obtained in connection with the performance of credit rating services that affects the securities or money market instruments; and (3) the inappropriate dissemination within and outside the NRSRO of a pending credit rating action before issuing the credit rating.
Fifth, we recommend that the Commission adopt Rule 17g-5 to address conflicts of interest.
Rule 17g-5 will require an NRSRO to disclose and manage those conflicts of interest that arise in the normal course of engaging in the business of issuing credit ratings. For example, one conflict of interest for NRSROs will include being paid by issuers or underwriters to determine credit ratings with respect to securities or money market instruments they issue or underwrite.
Finally, we recommend that the Commission adopt Rule 17g-6, to address certain prohibited acts and practices, as directed by Congress.
Rule 17g-6 will prohibit the NRSRO from engaging in certain unfair, coercive, or abusive practices. For example, an NRSRO could not threaten to issue a credit rating that is not determined in accordance with the NRSRO's established procedures and methodologies for determining credit ratings, based on whether the rated person will purchase or purchases another product of the NRSRO.
Rule 17g-6 also will prohibit an NRSRO from issuing or threatening to issue a lower credit rating, lowering or threatening to lower an existing credit rating, refusing to issue a credit rating, or withdrawing or threatening to withdraw a credit rating, with respect to securities or money market instruments issued by an asset pool or as part of any asset-backed or mortgage-backed securities transaction, unless all or a portion of the assets within such pool or part of such transaction also are rated by the NRSRO, where such practice is engaged in by the NRSRO for an anticompetitive purpose, a practice that is known as notching.
Proving anti-competitive intent will be difficult, particularly where an NRSRO has analysis to support the contention that its methodology is not arbitrary and designed to make the credit rating of a structured product more accurate. Nonetheless, we believe this prohibition, when combined with the enhanced recordkeeping requirements in Rule 17g-2, would serve as an important deterrent against anticompetitive practices.
We recommend that the Commission adopt three recordkeeping requirements in this area. These requirements would assist the Commission to better understand how these practices are developed and employed, and this information may provide a basis for the Commission to determine whether it should find a specific practice to be unfair, coercive, or abusive.
In the proposing release, the Commission also preliminarily determined that it would be unfair, coercive, or abusive for an NRSRO to issue an unsolicited credit rating and then attempt to induce the rated person to pay for the rating or for another product or service of the NRSRO or its affiliates. Consequently, paragraph (a)(5) of proposed Rule 17g-6 would have prohibited this practice.
Commenters raised a number of concerns with respect to how this prohibition would operate. For the most part, commenters were concerned that it was overbroad and, consequently, would prohibit legitimate business activities that are not coercive. We would like to gain a better understanding through our examination function of how credit rating agencies define "unsolicited credit ratings" and the practices they employ with respect to these ratings. We believe that we should gain this understanding before recommending that the Commission prohibiting any practices in this area, and therefore, we recommend that the prohibition be eliminated from Rule 17g-6.
I also would like to discuss the issue of whether credit rating agencies that register as NRSROs should be required to disclose certain performance statistics, such as standardized inputs, time horizons and metrics to allow for greater comparability among NRSROs. The Commission requested comment on whether other performance measurement statistics would be appropriate as an alternative, or in addition, to historical default and downgrade rates. For example, the Commission requested comment on whether Exhibit 1 should require measurement of the performance of a given credit rating by comparing or mapping it to the market value of the rated security or to extreme declines in the market value of the security after the rating. Commenters generally questioned whether standardizing performance statistics would be appropriate. For example, the credit rating agencies may have different definitions for their credit ratings, which would make it much more difficult to develop common metrics for evaluating the performance among credit rating agencies. Accordingly, at this time, the staff is not recommending that the Commission take action in this regard; however, we intend to study these issues and consider possible future action.
Another issue we wish to bring to your attention concerns timing. Under the Rating Agency Act, the Commission must issue final implementing rules no later than 270 days after its enactment (or by June 26, 2007). The provisions of the Rating Agency Act that relate directly to the registration and oversight of NRSROs become effective on the earlier of June 26, 2007 or the date the Commission issues final rules under the Act. However, once the Rating Agency Act is effective, a credit rating agency that has received an NRSRO no-action letter can only represent itself as an NRSRO if it has an application for registration pending before the Commission.
Pursuant to the Release and final rules being considered today, credit rating agencies that are currently the subject of Commission staff no-action letters identifying them as NRSROs would have a period of time to submit applications for registration as NRSROs before the provisions of the Rating Agency Act and the recordkeeping, reporting, and conduct rules issued under the Rating Agency Act become effective. This will avoid a gap of time when no NRSRO exists, which would disrupt the regulatory use of that term in applicable statutes and regulations and would be inconsistent with Congressional intent.
* * *
Our recommendation today represents the culmination of efforts by staff from several Divisions and Offices. I would like to thank Janice Mitnick and Michael Bloise of the Office of the General Counsel, Tony Tri, Chuck Dale, and Lori Walsh from the Office of Economic Analysis, Melanie Jacobsen and Nancy Salisbury from the Office of the Chief Accountant, and the following members of my staff, Bob Colby, Mike Macchiaroli, Tom McGowan, Randall Roy, Rose Russo Wells, and Sheila Swartz.
We are happy to answer your questions.