SEC Adopts Credit Rating Agency Reform Rules

Rules Require Stronger Conflicts of Interest and Governance Controls and Enhanced Transparency to Improve the Quality of Credit Ratings and Increase Credit Rating Agency Accountability

FOR IMMEDIATE RELEASE
2014-178

Washington D.C., Aug. 27, 2014 — The Securities and Exchange Commission today adopted new requirements for credit rating agencies to enhance governance, protect against conflicts of interest, and increase transparency to improve the quality of credit ratings and increase credit rating agency accountability.  The new rules and amendments, which implement 14 rulemaking requirements under the Dodd-Frank Wall Street Reform and Consumer Protection Act, apply to credit rating agencies registered with the Commission as nationally recognized statistical rating organizations (NRSROs).

“This expansive package of reforms will strengthen the overall quality of credit ratings, enhance the transparency of credit rating agencies and increase their accountability,” said SEC Chair Mary Jo White. “Today’s reforms will help protect investors and markets against a repeat of the conduct and practices that were central to the financial crisis.”

The new requirements for NRSROs address internal controls, conflicts of interest, disclosure of credit rating performance statistics, procedures to protect the integrity and transparency of rating methodologies, disclosures to promote the transparency of credit ratings, and standards for training, experience, and competence of credit analysts.  The requirements provide for an annual certification by the CEO as to the effectiveness of internal controls and additional certifications to accompany credit ratings attesting that the rating was not influenced by other business activities.

The Commission also adopted requirements for issuers, underwriters, and third-party due diligence services to promote the transparency of the findings and conclusions of third-party due diligence regarding asset-backed securities.

Certain amendments will become effective 60 days after publication in the Federal Register.  The amendments with respect to the annual report on internal controls and the production and disclosure of performance statistics will be effective on Jan. 1, 2015, which means that the first internal controls report to be submitted by an NRSRO would cover the fiscal year that ends on or after Jan. 1, 2015, and the first annual certification on Form NRSRO relating to performance statistics is required for the annual certifications filed after the end of the 2015 calendar year. 

The following provisions are effective nine months after publication in the Federal Register: prohibiting the sales and marketing conflict; addressing look-back reviews to determine whether the credit analyst’s prospects of future employment influenced a credit rating; requiring the disclosure of rating histories; addressing rating methodologies; requiring the form and certification to accompany credit ratings; addressing issuer and underwriter disclosure of third-party due diligence findings; addressing the certification of a third-party due diligence provider; addressing NRSRO standards of training, experience, and competence; and addressing universal rating symbols.  This period is intended to provide time for NRSROs, issuers, underwriters, and providers of third-party due diligence services to prepare for the changes resulting from the new requirements.

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FACT SHEET

May 2011 Proposals – The Commission proposed for comment amendments to existing rules and new rules in accordance with Title IX, Subtitle C of the Dodd-Frank Wall Street Reform and Consumer Protection Act.  The amendments and new rules approved today finalize the May 2011 proposals.

The Dodd-Frank Act – Title IX, Subtitle C of the Dodd-Frank Act, among other things, established new self-executing requirements applicable to NRSROs and required that the Commission adopt rules applicable to NRSROs in a number of areas.  The NRSRO provisions in the Dodd-Frank Act augment the Credit Rating Agency Reform Act of 2006, which established a registration and oversight program for NRSROs through self-executing provisions added to the Securities Exchange Act of 1934 and the implementation of rules adopted by the Commission.  Title IX, Subtitle C of the Dodd-Frank Act also established a new requirement for issuers and underwriters of asset-backed securities to make publicly available the findings and conclusions of any third-party due diligence report obtained by the issuer or underwriter.  In addition, Title IX, Subtitle C of the Dodd-Frank Act provides that the Commission shall prescribe the format of a certification that providers of third-party due diligence services must provide to each NRSRO producing a credit rating for an ABS to which the due diligence services relate.

NRSROs – NRSROs are credit rating agencies registered with the Commission under section 15E of the Exchange Act.  An NRSRO can be registered in one or more of five classes of credit ratings: financial institutions, brokers, or dealers; insurance companies; corporate issuers; issuers of ABS; and issuers of government securities, municipal securities, or securities issued by a foreign government.  Currently, 10 credit rating agencies, including the three largest credit rating agencies (Moody’s, Standard & Poor’s and Fitch Group), are registered as NRSROs.

Highlights of the Amendments and New Rules

Factors an NRSRO must consider when establishing, maintaining, enforcing, and documenting an Internal Control Structure

The Dodd-Frank Act amended the Exchange Act to require an NRSRO to establish, maintain, enforce, and document an effective internal control structure governing the implementation of and adherence to policies, procedures, and methodologies for determining credit ratings, taking into consideration such factors as the Commission may prescribe, by rule.

The rule amendments require an NRSRO to consider certain identified factors.  In particular, with respect to establishing an internal control structure, the NRSRO must consider:

With respect to maintaining the internal control structure, the NRSRO must consider:

When enforcing the internal control structure, the NRSRO must consider:

Report on the Effectiveness of the NRSRO’s Internal Control Structure

The Dodd-Frank Act also amended the Exchange Act to provide that the Commission shall prescribe rules requiring an NRSRO to annually submit to the Commission an internal controls report that contains information on management’s responsibilities relating to the internal control structure, the effectiveness of the internal control structure, and an attestation of the CEO or equivalent on the report. 

The rule amendments require an NRSRO to file an annual report with the Commission regarding the NRSRO’s internal control structure that contains a:

The amendments also provide that management is not permitted to conclude that the internal control structure of the NRSRO was effective as of the end of the fiscal year if there were one or more material weaknesses in the internal control structure as of the end of the fiscal year.  The amendments further prescribe when a material weakness exists for purposes of this reporting requirement.

NRSRO Conflicts Relating to Sales and Marketing Activities

The Dodd-Frank Act amended the Exchange Act to provide that the Commission shall issue rules to prevent an NRSRO’s sales and marketing considerations from influencing the production of credit ratings.  It also specifies that the Commission shall provide for exceptions for small NRSROs and for the suspension or revocation of an NRSRO’s registration for violating a rule addressing conflicts of interest. 

The rule amendments:

NRSRO Look-Back Reviews

The Dodd-Frank Act amended the Exchange Act to require an NRSRO to have policies and procedures for conducting a “look-back” review to determine whether the prospect of future employment by an issuer or underwriter influenced a credit analyst in determining a credit rating, and, if such influence is discovered, to revise the credit rating in accordance with rules the Commission shall prescribe. 

New Rule 17g-8 requires that the NRSRO’s look-back review procedures must address instances in which a review determines that a conflict of interest influenced a credit rating by including, at a minimum, procedures that are reasonably designed to ensure that the NRSRO will:

Public Disclosure of NRSRO Credit Rating Performance Statistics

The Dodd-Frank Act amended the Exchange Act to provide that the Commission, by rule, shall require NRSROs to publicly disclose information about their initial credit ratings and subsequent changes to the credit ratings to allow users of credit ratings to evaluate the accuracy and compare the performance of credit ratings across NRSROs. 

Before the SEC’s rule amendments approved today, NRSROs were required to disclose the percent of credit ratings in each class for which they are registered that over a one-year, three-year, and 10-year period were downgraded or upgraded (transition rates) or classified as a default (default rates). 

The rule amendments enhance the disclosures of transition and default rates by, among other things:

Public Disclosure of NRSRO Credit Rating Histories

Before the SEC’s rule amendments, NRSROs were required to disclose in an XBRL format histories of their credit ratings (e.g., the initial credit rating and all subsequent modifications to the credit rating (such as upgrades and downgrades) and the dates of such actions).  The goal of the proposed amendments is to allow users of credit ratings to compare how different NRSROs rated an individual obligor, security, or money market instrument and how and when those ratings were changed over time.  The disclosure of rating histories also is designed to provide “raw data” that can be used by third parties to generate independent performance statistics such as transition and default rates.  The amendments increase the amount of information that must be disclosed by expanding the scope of the credit ratings that must be included in the histories and by adding additional data elements that must be disclosed in the rating history for a particular credit rating.

NRSRO Credit Rating Methodologies

The Dodd-Frank Act amended the Exchange Act to provide that the Commission shall prescribe rules with respect to the procedures and methodologies, including qualitative and quantitative data and models, used by NRSROs to determine credit ratings that require each NRSRO to ensure that certain objectives are met. 

Paragraph (a) of new Rule 17g-8 requires an NRSRO to have policies and procedures reasonably designed to ensure that:

Form and Certifications to Accompany Credit Ratings

The Dodd-Frank Act amended the Exchange Act to provide that the Commission shall require, by rule, NRSROs to disclose with the publication of a credit rating a form containing certain qualitative and quantitative information about the credit rating.  It also requires an NRSRO at the time it produces a credit rating to disclose any certifications from providers of third-party due diligence services with respect to ABS. 

The SEC’s rule amendments require an NRSRO to publish two items when taking certain rating actions: a form containing the quantitative and qualitative information about the credit rating specified in the statute; and any certification of a provider of third-party due diligence services received by the NRSRO that relates to the credit rating.  Under the new amendments, “rating action” includes preliminary credit ratings, initial credit ratings, upgrades and downgrades of credit ratings, and affirmations and withdrawals of credit ratings if they are the result of a review using the NRSRO’s procedures and methodologies for determining credit ratings.

The information that must be disclosed in the form includes:

Issuer/Underwriter Disclosure of ABS Third-Party Due Diligence Report

The Dodd-Frank Act amended the Exchange Act to require the issuer or underwriter of an ABS to make publicly available the findings and conclusions of any third-party due diligence report obtained by the issuer or underwriter.  New Rule 15Ga-2 requires an issuer or underwriter of an ABS that is to be rated by an NRSRO to furnish Form ABS–15G on the EDGAR system containing the findings and conclusions of any third-party due diligence report obtained by the issuer or underwriter.  The rule applies to both registered and unregistered offerings of ABS.

Certification of ABS Third-Party Due Diligence Provider

The Dodd-Frank Act amended the Exchange Act to require a provider of third-party due diligence services for ABS to provide a written certification to any NRSRO that produces a credit rating to which the services relate and provides that the Commission shall establish the format and content of the written certification.  New Rule 17g-10 requires third-party due diligence providers to use new Form ABS Due Diligence-15E to make the written certification to be provided to the NRSRO.  The form elicits information about the due diligence including a description of the work performed, a summary of the findings and conclusions of the third party, and the identification of any relevant NRSRO due diligence criteria that the third party intended to meet in performing the due diligence.   The amendments require the NRSRO to disclose a certification (if it receives the certification) with each rating action to which the certification relates.

NRSRO Standards of Training, Experience, and Competence

The Dodd-Frank Act provides that the Commission shall issue rules reasonably designed to ensure that NRSRO credit analysts meet standards of training, experience, and competence necessary to produce accurate ratings for the categories of issuers whose securities the person rates and are tested for knowledge of the credit rating process. 

New Rule 17g-9 requires an NRSRO to:

Universal NRSRO Rating Symbols

The Dodd-Frank Act provides that the Commission shall by rule require each NRSRO to establish, maintain, and enforce written policies and procedures with respect to the use of rating symbols.  Paragraph (b) of new Rule 17g-8 requires an NRSRO to have policies and procedures that are reasonably designed to: