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Statement At Open Meeting

Chair Mary Jo White

Aug. 27, 2014

Good morning.  This is an open meeting of the U.S. Securities and Exchange Commission on August 27, 2014 under the Government in the Sunshine Act.

The Commission will today consider recommendations of the staff for adopting two very important final rules in different, but closely related, areas – asset-backed securities and credit rating agencies.

The reforms before us today will add critical protections for investors and strengthen our securities markets by targeting products, activities and practices that were at the center of the financial crisis.  With these measures, investors will have powerful new tools for independently evaluating the quality of asset-backed securities and credit ratings.  And ABS issuers and rating agencies will be held accountable under significant new rules governing their activities.  These reforms will make a real difference to investors and to our financial markets.

We will first consider the recommendation related to asset-backed securities, and then we will consider the rules relating to credit rating agencies.

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Credit Rating Agencies

We will now turn to the second item on today’s agenda:  a recommendation to adopt a package of reforms that would establish new requirements for credit rating agencies registered with the Commission as nationally recognized statistical rating organizations (“NRSROs”), issuers and underwriters of asset-backed securities, and providers of third-party due diligence services on asset-backed securities.  These reforms will implement more than a dozen of the Commission’s mandates under the Dodd-Frank Act.

 

The issuance of flawed credit ratings by certain credit rating agencies was a key contributor to the financial crisis.  Investors purchased asset-backed securities – as well as other securities – in reliance on ratings they believed were based on independent, robust and methodical analysis.  As is now well understood, that was all too often not the case.  For example, in August 2007, the Commission staff initiated examinations of the three largest NRSROs that highlighted:

  • Insufficient measures to prevent business interests from influencing credit ratings;
  • Inadequate documentation and disclosure of rating methodologies and processes for addressing model errors;
  • Inadequate surveillance and monitoring of outstanding ratings; and
  • Insufficient resources for assessing the growing volume and complexity of structured finance products.

Since 2011, the Commission staff has undertaken annual examinations of each of the NRSROs registered with the Commission, as required by the Dodd-Frank Act.  While the reports from these reviews have catalogued a number of improvements, they have also identified concerns that persist, including ones related to the management of conflicts of interest, internal supervisory controls, and post-employment activities of former staff of NRSROs.

NRSROs play a critical “gatekeeper” role in the debt market.  Congress recognized this important function when it enacted the Dodd-Frank Act, where it identified the importance of credit rating agencies to capital formation, investor confidence, and the efficient performance of the U.S. economy.

The Dodd-Frank Act mandates that the Commission adopt rules governing NRSROs in a number of areas.  Many of the required rules would be significant reforms standing alone.  When combined, as they are today, these rules create an extensive framework of robust reforms.  They will significantly strengthen the governance of NRSROs by addressing internal controls, conflicts of interest, and procedures designed to protect the integrity of rating methods. 

The reforms will also significantly enhance the transparency of NRSRO activities and thereby promote greater scrutiny and accountability of NRSROs.  Together, this package of reforms will improve the overall quality of NRSRO credit ratings and protect against the re-emergence of practices that contributed to the recent financial crisis.

Today, I would like to highlight just two of the reforms that I view as among the most important to achieving this goal.

First, the Dodd-Frank Act created a new statutory requirement that an NRSRO must establish, maintain, enforce, and document an effective internal control structure governing its implementation of and adherence to policies, procedures, and methods for determining credit ratings.  It also requires the Commission to prescribe rules requiring an NRSRO to submit an annual internal controls report to the Commission attested to by the CEO or equivalent senior executive.

The recommendation before us today implements the statutory requirement for effective internal controls by establishing specific factors that the NRSRO must consider in developing and implementing its internal controls.  But, there is no safe harbor.  Rather, an NRSRO must consider the specified factors and other factors in developing its own effective internal controls, which will be tailored to its particular business and governance structure.

Importantly, however, for all NRSROs, the recommendation incorporates a strong reporting requirement that compels that an NRSRO describe each material weakness in its particular internal control structure, how each one was addressed, and a conclusion as to whether the internal control structure was effective.

The second set of reforms I want to highlight today are the measures to prevent the sales and marketing considerations of an NRSRO from influencing its production of credit ratings.  The rule first provides that an NRSRO is absolutely prohibited from issuing or maintaining a credit rating where a person within the NRSRO who participates in determining or monitoring the credit rating also participates in sales or marketing of a product or service of the NRSRO or its affiliate. 

But there are other channels of such influence that are readily identifiable as outlined in the recommendation, namely:

  • compensation arrangements or performance evaluation systems that incentivize analysts to produce inflated credit ratings to increase or retain the NRSRO’s market share;
  • clients, such as rated entities, who may pressure analysts to produce inflated credit ratings to obtain or retain their business; or
  • managers who are not involved in sales and marketing activities but may seek to pressure analysts to produce inflated credit ratings to increase or retain the NRSRO’s market share.

 

We must address these channels of influence if we are to prevent the full range of potential conflicts of interest that can lead to deficient credit ratings.  Consistent with our mandate under the Dodd-Frank Act, the recommendation therefore also prohibits an NRSRO from issuing or maintaining a credit rating where an analyst involved in the production of the credit rating is influenced by sales or marketing considerations.

While I highlight these two aspects of this rulemaking, there are many other critically important requirements in the recommendation before the Commission today, ranging from rules that would address the revolving door between NRSROs and the entities they rate to policies and procedures to apply credit rating symbols consistently.  This very strong package of reforms will improve the quality of credit ratings for the benefit of investors and the capital markets.

The SEC staff will be closely attending to the implementation of these reforms, and we will continue to actively assess potential further measures to enhance the integrity and independence of credit ratings.

Before I ask Steve Luparello, Director of the Division of Trading and Markets, and Tom Butler, the Director of the Office of Credit Ratings, to detail the proposed reforms, I would like to thank all of my fellow Commissioners for their contributions to this rulemaking.

The Commission staff has applied its expertise in this area and worked tirelessly to make this rulemaking as strong and workable as possible.  And I would like to specifically thank Steve, his deputy Director Jim Burns, and his counsel, Christian Sabella, from Trading and Markets, Tom Butler and his counsel, Annemarie Ettinger, from the Office of Credit Ratings, and Keith Higgins, Director of the Division of Corporation Finance, and his counsel, Raquel Fox, for their leadership on this rulemaking.

I also would like to thank the core rulemaking team of Randall Roy, Ray Lombardo, and Rose Wells, of the Division of Trading and Markets; Harriet Orol and Kevin Vasel, of the Office of Credit Ratings; and Kathy Hsu, Rolaine Bancroft, and Michelle Stasny, of the Division of Corporation Finance.

Thanks and credit also go to Jennifer Marietta-Westberg, Vanessa Countryman, Simona Mola-Yost, Tara Bhandari, and Jeremy Ko, from the Division of Economic and Risk Analysis, for their excellent work in analyzing the economic effects of the rules and drafting the economic analysis for this rulemaking.

Many thanks as well to Annie Small, Meridith Mitchell, Michael Conley, Lori Price, Brooks Shirey, Steve Jung, Janice Mitnick, Sarit Klein, and Bryant Morris from the Office of General Counsel, and Brian Croteau, Jeff Minton, and Kevin Stout from the Office of Chief Accountant, and Jessica Kane and Rebecca Olsen from the Office of Municipal Securities, and Alec Koch and Yuri Zelinsky, from the Division of Enforcement for their significant contributions to this rulemaking.

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