By Evan M. Drutman, Carol M. McGee and Tara E. Castillo, Alston & Bird LLP
On May 18, 2011, the Securities and Exchange Commission (SEC) unanimously approved for public comment proposed rules and amendments (Release) to pre-existing rules regulating credit rating agencies registered with the SEC as nationally recognized statistical rating organizations (NRSROs). According to Chairman Mary L. Shapiro, the proposals "are part of a concerted effort by the SEC to enhance the credit rating industry in light of the financial crisis" and seek to enhance transparency and to improve the integrity of credit ratings.1
Under the SEC's proposal, NRSROs would be required to:
— Report on Internal Controls
The SEC proposes amending Rule 17g-3 to add a new paragraph (a)(7) to require an NRSRO to file an Internal Controls Report with the SEC. The Internal Controls Report will include:
— Implementation of an Effective Internal Controls Structure and Record Keeping Requirements
Although this requirement is self-executing, Section 15E(c) presently does not prescribe any factors relating to the implementation of an effective internal controls structure. The SEC has requested comment on whether at this time it would be appropriate for it to prescribe such factors. Based on the comments received, the SEC will decide whether to prescribe by rule or identify through guidance the factors an NRSRO must consider in establishing an effective internal controls structure in accordance with Section 15E(c).
Section 15E(c) also does not provide guidance as to how an NRSRO should maintain records to document its internal controls structure. In the Release, the SEC notes that the NRSRO should document its internal controls structure in accordance with the recordkeeping requirements set forth in Rule 17g-2 and proposes to add paragraph (b)(12) to that rule.
— Conflicts of Interest Relating to Sales and Marketing
New Rule 17g-8, however, will require an NRSRO to publish an explanation as to why a credit rating was revised or affirmed after a conflict of interest has been determined. The enhanced look-back review will permit users of such information to evaluate the ability of the NRSRO to manage conflicts of interest in the production of credit ratings, and allow such users to consider the potential risks associated with using an NRSRO's credit rating to make investments or other credit-based decisions.
— Standardized Disclosure of Information about Credit Rating Performance
Section 15E(q) also provides that the rules adopted by the SEC must at a minimum require NRSROs to make certain disclosures that:
— Standardized Methodology to Calculate and Present Performance Measurement Statistics
— Enhancing Accessibility of Certain NRSRO Information
Enhancing the 100% Rule
The SEC also proposes to enhance Rule 17g-2, the so-called "100% Rule." This pre-existing rule requires an NRSRO to publish on its corporate website any information relating to a ratings action for credit ratings that the NRSRO initially determined on or after June 26, 2007. Presently, obligors, securities, and money market instruments assigned a credit rating by an NRSRO prior to June 26, 2007, are excluded from this disclosure requirement even if a ratings action was taken after that date. The 100% Rule applies to all types of credit ratings. The SEC proposes to enhance the 100% Rule by moving it to Rule 17g-7, which includes certain non-Form NRSRO disclosure requirements.
The 100% Rule as proposed will be codified in a new paragraph (b)(1) and will require an NRSRO to do the following:
— Strengthening Credit Rating Methodologies
— Form and Certifications to Accompany Credit Ratings
As proposed, the form must include information about the credit rating resulting from or subject to the rating action and disclose:
— Upgrading Standards of Training, Experience, and Competence
Pursuant to new rule 17g-9, an NRSRO will be required to:
— Universal Rating Symbols.
— New Electronic Filings Requirements for Form NRSRO and Annual Reports
Evan M. Drutman is a partner in the firm's New York office, and Carol M. McGee is a partner in the firm's Washington, D.C. office and is co-leader of Alston & Bird’s Securities practice. Tara Castillo is an associate in the Washington, D.C. office of Alston & Bird.
1 SEC Speech, Mary L. Schapiro, Opening Statement at SEC Open Meeting (May 18, 2011). In the same Release, the SEC also adopted proposed rules that require disclosure of third-party due diligence reports relating to asset-backed securities and used by NRSROs, issuers, or underwriters. A summary of these proposed rules are the subject of an Alston & Bird advisory entitled "SEC Proposes Rules Regarding Third-Party Due Diligence Reports and Certifications for Asset-Backed Securities."2 See Release at 25.
3 Release at 32.
4 Release at 39-40.
5 Release at 72.
6 Exhibit 1 to Form NRSRO is part of the registration application a credit rating agency must submit to the SEC to become an NRSRO. After a credit rating agency becomes an NRSRO, it must file with the SEC on Exhibit 1 any updates to its registration application. Instruction H requires an applicant to provide, among other items of disclosure, performance measurement statistics for credit ratings of the applicant or NRSRO.
7 Section 936 of Dodd-Frank requires the SEC to issue rules that are reasonably designed to ensure that any person employed by an NRSRO to perform ratings (1) meets certain standards of training, experience, and competence necessary to produce ratings for the categories of issuers whose securities such person rates, and (2) is tested for knowledge of the credit rating process.
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