SEC Adopts Credit Rating Agency Rules

At its open meeting on December 3, 2008, the SEC voted to adopt rules regulating certain activities of nationally recognized statistical rating organizations (NRSROs). The rules adopted today require NRSROs to publicly disclose specified information concerning their ratings performance and methodologies; prohibit certain practices as impermissible conflicts of interest; and prescribe additional recordkeeping requirements for NRSROs. The new rules are intended to promote accountability, transparency and competition in credit ratings.

The rules adopted today were first proposed for public comment on June 11, 2008 and have been modified somewhat in response to the comments received. Other portions of the rules proposed on that date are being re-proposed in modified form for further comment rather than being adopted. The related rule proposals concerning the use of NRSRO ratings in SEC rules and forms, which were proposed for comment on June 25, 2008, were not acted on today but remain under consideration for future action.

Chairman Cox described the most significant of today’s rules as being aimed at “what the SEC does best”: requiring public disclosure of information. The newly-adopted rules require NRSROs to make public:

• Ratings performance statistics for one-, three- and ten-year periods for a random sample of 10% of each class of ratings for which the NRSRO is registered with the SEC and for which the NRSRO has issued at least 500 ratings. Ratings actions need not be disclosed until 6 months after they are taken, and the rule as adopted applies only to issuer-paid ratings. The required information must be disclosed on the NRSRO’s website in XBRL format; the SEC staff indicated that it would take approximately four months to develop the necessary XBRL reporting taxonomy for the required disclosures.
  
• Whether and how the NRSRO verifies underlying asset information that its ratings are based on.
  
• Whether and how the NRSRO’s assessment of the quality of the originators of securitized assets affect its ratings.
  
• The frequency of the NRSRO’s ratings surveillance and how changes in its initial ratings criteria are incorporated into its surveillance activities.

The rules as adopted also require NRSROs to maintain internal records of:

• All ratings actions taken.
  
• For structured finance products only, all material deviations from the ratings indicated by the NRSRO’s quantitative model if that model is a substantial part of the ratings analysis (which it presumably will be for virtually all structured finance products).
  
• All written communications from third parties containing complaints about ratings personnel.

These requirements are intended to permit SEC personnel with supervisory and examination authority over NRSROs to identify instances where improper influences may have affected a rating action.

The adopted rules relating to conflicts of interest provide that:

• An NRSRO may not issue a rating if the NRSRO has made a recommendation about the security or the obligor. The SEC staff acknowledged commenters’ concern about the distinction between the back-and-forth that is a necessary part of the ratings process, on the one hand, and an NRSRO making an impermissible recommendation to a structurer on the other. The staff stated that the rule and the adopting release strike an appropriate balance to address this concern.
  
• NRSRO personnel involved in ratings actions may not be involved in fee negotiations.
  
• NRSRO personnel involved in ratings actions may not receive gifts (with a de minimis exception).

The SEC re-proposed for public comment rules that would:

• Require NRSROs to disclose all actions they take with respect to issuer-paid ratings that are initially assigned after the SEC’s original Credit Rating Agency Reform Act rules took effect on June 25, 2007. Disclosure of a ratings action would not be required until 12 months after the action was taken. In the reproposal, the SEC is also soliciting comment on whether the reproposed rule should apply to subscriber-paid ratings as well as issuer-paid ratings.
  
• Prohibit NRSROs from assigning issuer-paid ratings for structured finance products unless the information being relied upon is made available to NRSROs that have not been requested to issue a rating on the product. In response to the concerns about potential securities law liability that were widely expressed on this rule as originally proposed, no public disclosure of this information would be required under the rule as reproposed. To address other comments on the rule as initially proposed, the reproposed rule would permit rating agencies to rely on an undertaking by transaction arrangers to make the information available as required, and the additional NRSROs to which the information is disclosed could be required to represent that they will use it only for the purpose of assigning a rating to the structured product. As part of this reproposal, Regulation FD would be amended to permit non-public disclosure of information to NRSROs pursuant to these new requirements.

The rules that are being reproposed are intended to foster competition in the ratings industry. Commissioner Casey observed that although there are now 10 NRSROs registered with the SEC, the three principal NRSROs account for 98% of all ratings and 95% of industry revenues.

No timetable was given for further SEC action on the two additional sets of related rules that were proposed in June of this year, including most significantly the proposals to remove references to NRSRO ratings from the SEC’s rules and forms. Erik Sirri, Director of the SEC’s Division of Trading and Markets, stated that of the 38 references under review in those releases, the SEC’s proposed elimination of many provoked little comment, while commenters pointed out serious issues with the proposed elimination of others. Commissioner Casey urged quick action on these outstanding proposals.

Click here for the SEC’s statement on today’s actions. 

The release reflecting today’s SEC actions is not yet available. Comments on the reproposed rules will be due 45 days after the release is published in the Federal Register.