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Credit Rating Agencies Face New Disclosure Rules

The SEC has adopted rules for nationally recognized statistical rating organizations and re-proposed for further comment a number of amendments to supplement rules adopted under the Credit Rating Agency Reform Act of 2006. SEC Chairman Christopher Cox said that there are 10 credit rating agencies registered with the SEC since the passage of the Act. However, the top three NRSROs continue to dominate the credit rating industry. Commissioner Kathleen Casey said the three largest credit rating agencies have failed investors. Until there is a penalty for being wrong, the top three will continue to dominate, she said.

The final rules that were adopted yesterday are based on proposals that were issued in June. The final rules include a number of revisions to the proposals. NRSROs will be required to provide transition statistics for each asset class of credit ratings for which they are registered or are seeking registration in one, three and 10 year periods.

NRSROs must also disclose the extent to which the verification performed on assets underlying or referenced by a structured finance transaction was relied upon in determining the credit ratings. NRSROs also must disclose the extent to which assessments of the quality of originators of structured finance transactions played a part in determining the credit rating, and must provide additional information about their surveillance processes.

NRSROs will be required to make publicly available a random sample of 10% of their issuer-paid credit ratings and their histories with respect to each class of ratings for which they issued 500 or more ratings. They must maintain records of all rating actions related to a current rating starting with the beginning rating.

If a quantitative model is a substantial component of the credit rating process for a structured finance product, the NRSRO must keep a record of the rationale for any material differences between the rating implied by the model and the rating that is issued. NRSROs also must keep records of any complaints with respect to the performance of a credit analyst in determining, maintaining, monitoring, changing or withdrawing a credit rating.

Credit rating agencies must provide an annual report to the SEC that includes the number of rating actions that occurred during the fiscal year for each class of security for which the NRSRO is registered.

NRSROs are prohibited from issuing a credit rating with respect to an obligor or a security where the agency or its affiliate 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 the issuer of the security. A person within an NRSRO who has the responsibility for participating in the credit rating or for developing or approving procedures or methodologies for determining credit ratings is prohibited from participating in any fee discussions, negotiations or arrangements.

Credit analysts who participate in determining or monitoring the credit rating are prohibited from receiving any gifts other than items provided in connection with ordinary business activities and that have an aggregate value of no more than $25.

The SEC is seeking comment on whether NRSROs should be required to disclose their ratings history information for 100% of the current issuer-paid credit ratings. The proposal would apply to ratings determined after June 25, 2007 and would include actions 12 months prior to the disclosure.

The re-proposed amendments would prohibit an NRSRO from issuing a rating for a structured finance product that is paid for by the product's issuer, sponsor or underwriter, unless the information about the product that is provided to the NRSRO to determine and monitor the rating is also made available to other NRSROs. The SEC also proposed an amendment to Regulation FD to permit the disclosure of material nonpublic information to NRSROs regardless of whether they make their ratings publicly available. The comment period on the proposals will be open for 45 days.

Casey supported the adoption of the rules and the proposal of additional rules, but urged the staff to act quickly on two outstanding proposals. The credit agency reforms will not be complete until the Commission acts on a proposal to eliminate references to the NRSROs in its rules, in her view. The references were never intended to establish or preserve the NRSROs' position in the industry, she said.

Erik Sirri, the director of the Division of Trading and Markets, said the staff had identified 38 references to NRSROs for possible removal from SEC's rules. The SEC received a lot of comments on this proposal, he said, many of which raised serious questions about the removal of certain references. For other references, it should be easy to remove them from the rules, he said.

"The SEC is seeking comment on whether NRSROs should be required to disclose their ratings history information for 100% of the current issuer-paid credit ratings."