Alert December 09, 2008

SEC Engages in Additional Rulemaking Affecting NRSROs

At its open meeting last week, the SEC adopted a number of changes to its rules regulating the credit rating agencies that register with it as Nationally Recognized Securities Rating Organizations (“NRSROs”).  Originally proposed in June 2008, these changes address conflicts of interest in the rating process and NRSROs’ reporting and disclosure obligations, particularly with respect to ratings for structured finance products.  The SEC also voted to propose additional changes to its NRSRO rules and Regulation FD affecting other disclosures related to the credit rating process.  These actions are the second of three phases of rulemaking that the SEC has undertaken with respect to NRSROs.  The first, which took place in 2007, created registration and oversight mechanisms for NRSROs.  The third, which was also proposed for public comment in June 2008, would eliminate references to ratings provided by NRSROs in SEC rules; no further action on this proposal has been taken to date.  (The impact of this proposal on rules under the Investment Company Act of 1940 and the Investment Advisers Act of 1940 was discussed in the July 8, 2008 Alert.)  The following description of last week’s SEC actions is based on the press release and fact sheet provided on the SEC website.  Formal releases with additional details, such as the effective date(s) of the rule changes adopted at the open meeting, have not yet been made publicly available.

Form NRSRO Disclosure.  The amendments revise Form NRSRO, the registration form used by NRSROs and applicants, to require disclosure of certain statistics regarding rating transitions (upgrades and downgrades) for each asset class of credit ratings and information regarding certain practices used in rating structured finance products

Public Availability of Records of Rating Actions.  The amendments will require an NRSRO to make publicly available a random sample of 10% of its issuer-paid credit ratings and their histories documented for each class of issuer-paid credit rating in which their ratings activity exceeds certain thresholds.

Recordkeeping and Reporting.  The amendments will require NRSROs to maintain the following additional records for inspection by the SEC staff: records regarding ratings changes, explanations for material differences between the results of quantitative models used in rating structured products and the final credit ratings issued, and records of any complaints regarding a credit analyst’s performance in various phases of the credit rating process.  In addition, an NRSRO will be required to provide the SEC with an annual report of the number of credit rating actions that occurred during the fiscal year for each class of security for which the NRSRO is registered.

Conflicts of Interest.  The amendments will impose the following restrictions designed to eliminate potential conflicts of interest affecting the credit rating process:

  • An NRSRO may not issue a credit rating with respect to an obligor or security where the NRSRO or an affiliate of the NRSRO made recommendations to the obligor or the issuer, underwriter, or sponsor of the security about the corporate or legal structure, assets, liabilities, or activities of the obligor or issuer of the security.
  • A person within an NRSRO who has responsibility for participating in determining credit ratings or for developing or approving procedures or methodologies used for determining credit ratings may not participate in any fee discussions, negotiations, or arrangements.
  • An NRSRO may not allow a credit analyst who participated in determining or monitoring the credit rating to receive gifts, including entertainment, from the obligor being rated or from the issuer, underwriter, or sponsor of the securities being rated, other than items provided in the context of normal business activities, such as meetings, that have an aggregate value of no more than $25.
Proposed Rule Amendments.  The SEC is seeking comment on a proposed requirement that NRSROs disclose certain ratings history information and on a proposed requirement regarding mandatory information sharing by NRSROs that rate structured finance products.  The SEC is also proposing to amend Regulation FD to permit the disclosure of material non-public information to NRSROs regardless of whether they make their ratings publicly available.  Public comments on the proposed amendments must be received by the SEC within 45 days after their publication in the Federal Register.