U.S. Securities and Exchange Commission Proposes Rules to Improve Transparency & Integrity of Credit Ratings

Date Published 5/23/2011

On May 19, 2011, the Securities and Exchange Commission voted unanimously to propose new rules and amendments intended to increase transparency and improve the integrity of credit ratings.

The proposed rules would implement certain provisions of the Dodd-Frank Wall Street Reform and Consumer Protection Act and enhance the SEC’s existing rules governing credit ratings and Nationally Recognized Statistical Rating Organizations (NRSROs).  

The Proposed Rules

The SEC proposed rules related to NRSROs and third-party due diligence providers as well as issuers and underwriters, of asset-backed securities, including:

1.  Reporting on Internal Controls:
Under the proposed rule amendment, the NRSRO would be required to file a report with the SEC containing a description of management’s responsibility in establishing the internal control structure and an assessment of the effectiveness of those internal controls. 

2.  Preventing Conflicts of Interest Relating to Sales and Marketing:

Under the proposed rule amendments, an NRSRO would be prohibited from issuing or maintaining a credit rating where an employee of the NRSRO – who participates in the sales or marketing of a product or service of the NRSRO or of a person associated with the NRSRO – also participates in determining or monitoring a credit rating or developing or approving procedures used for determining a credit rating.

Additionally, the proposal would establish a mechanism:

  • By which small NRSROs could seek an exemption from this provision.
  • To suspend or revoke the registration of an NRSRO or impose other penalties if the SEC finds that the NRSRO has committed a violation of a conflict of interest rule that affected a rating.

3.  Enhancing the “Look-Back” Review: 

Section 932 of the Dodd-Frank Act requires NRSROs to establish policies regarding former employees:

  • Who participated in determining a credit rating, and …
  • Who were subsequently employed – within one year – by an entity subject to that credit rating – or by the issuer, underwriter, or sponsor of a product subject to that credit rating.
In such cases, the NRSRO must conduct a “look-back” review to:

  • Determine whether any conflicts of interest influenced the credit rating.
  • Take action to revise the rating, if appropriate.
Under the proposed rule, if the NRSRO “look-back” review determined that a conflict influenced a rating, the NRSRO would be required to, at a minimum:

  • Immediately place the credit rating on a credit watch and include, among other things, an explanation that the reason for the action is that the rating was influenced by a conflict of interest.
  • Promptly determine whether the credit rating must be revised so it no longer is influenced by a conflict of interest.
  • Promptly publish a revised credit rating or an affirmation of the credit rating, if appropriate. 

4. Standardizing Disclosure of Information About the Performance of Credit Ratings:

The SEC proposals would, among other things:

  • Standardize the way an NRSRO calculates and presents aggregate information about how its ratings change over time (the transition rate) and how often a rated entity or product subsequently defaulted.
  • Require the NRSRO to publicly display this information on an “easily accessible” portion of its website
  • Enhance the so-called “100% Rule.” This previously-existing rule requires an NRSRO to publish information concerning its rating actions for credit ratings that the NRSRO initially determined on or after June 26, 2007.  The disclosure must be made within 12 months after determination for ratings that are issuer-paid and within 24 months after determination for ratings that are not issuer paid. 

5.  Strengthening Credit Rating Methodologies:

Under the proposed rule, policies and procedures governing the way the NRSRO determined credit rating would have to be reasonably designed to ensure, among other things, that:

  • The board of directors approves them.
  • Material changes are applied consistently and changes to surveillance procedures are applied within a reasonable period of time.
  • The NRSRO promptly publishes notice of material changes to rating methodologies and of the discovery of significant errors in rating methodologies.
  • The NRSRO discloses the version of the methodologies used with respect to a particular credit rating. 

6.  Leveraging Third-Party Due Diligence for Asset-Backed Securities:

SEC’s proposed rules would require that due diligence providers for asset-backed securities must provide a written certification to any NRSRO that rates the securities (Form ABS due Diligience-15E).

7.  Enhancing the Disclosure of Information About Credit Ratings: 

Under the proposed rule, the NRSRO would be required to publish a form with each credit rating:

  • Include in the form information about the credit rating, such as information relating to the assumptions underlying the methodology used to determine the credit rating.
  • Include any certification of due diligence providers described above.
The form and certifications would have to be published in the same medium and made available to the same persons who can receive or access the credit rating.  The NRSRO would need to disclose in the form substantial qualitative and quantitative information about the credit rating and methodologies used to determine the credit rating.

8.  Upgrading Standards of Training, Experience, and Competence

The proposed rule would require NRSROs to establish standards of training, experience and competence for credit analysts and to:

  • Consider certain factors when establishing the standards, for example the complexity of the securities that will be rated by the analyst.
  • Periodically test its credit analysts on the credit rating procedures and methodologies it uses.
  • Require that at least one individual with three or more years of experience in performing credit analysis participates in determining a credit rating.

9.  Addressing Rating Symbols: 

The rule proposal would require an NRSRO to have policies and procedures that are reasonably designed to:

  • Assess the probability that an issuer of a security or money market instrument will default.
  • Clearly define each symbol in the NRSRO’s rating scale.
  • Apply any such symbol in a consistent manner. 

10.   Mandating Electronic Filings of Form NRSRO and the Annual Reports: 

Under the proposed rule amendments, an NRSRO would be required to use the SEC’s EDGAR system to electronically submit Form NRSR:

  • To update an NRSRO registration.
  • Submit the annual certification.
  • Withdraw from registration. 
The proposal also would require NRSROs to use EDGAR to file their annual reports.

11.  Filing NRSRO Compliance Officer Reports:

Section 932 of the Dodd-Frank Act requires the designated compliance officer of an NRSRO to submit to the NRSRO an annual report on the rating agency’s compliance with the securities laws and its policies and procedures that must be filed together with the report that NRSROs must submit to the SEC annually.

Read the complete proposed rules>>

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