Updated to include Federal Register corrections dated 10/14/14

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SECURITIES AND EXCHANGE COMMISSION

17 CFR Parts 232, 240, 249, and 249b

Release No. 34-72936; File No. S7-18-11

RIN 3235-AL15

Nationally Recognized Statistical Rating Organizations

AGENCY: Securities and Exchange Commission.

ACTION: Final rules.

SUMMARY: In accordance with the Dodd-Frank Wall Street Reform and Consumer Protection

Act (“Dodd-Frank Act”) and to enhance oversight, the Securities and Exchange Commission

(“Commission”) is: adopting amendments to existing rules and new rules that apply to credit

rating agencies registered with the Commission as nationally recognized statistical rating

organizations (“NRSROs”); adopting a new rule and form that apply to providers of third-party

due diligence services for asset-backed securities; and adopting amendments to existing rules and

a new rule that implement a requirement added by the Dodd-Frank Act that issuers and

underwriters of asset-backed securities make publicly available the findings and conclusions of

any third-party due diligence report obtained by the issuer or underwriter. The Commission also

is adopting certain technical amendments to existing rules.

DATES: This rule is effective November 14, 2014; except the amendments to § 240.17g-3(a)(7)

and (b)(2) and Form NRSRO, which are effective on January 1, 2015; and the amendments to §

240.17g-2(a)(9), (b)(13) through (15), § 240.17g-5(a)(3)(iii)(E), (c)(6) through (8), § 240.17g7(a) and (b), and Form ABS-15G, which are effective June 15, 2015. The addition of §§

240.15Ga-2, 240.17g-8, 240.17g-9, 240.17g-10, and Form ABS Due Diligence-15E are effective

June 15, 2015.

FOR FURTHER INFORMATION CONTACT: Randall W. Roy, Assistant Director, at (202)

551-5522; Raymond A. Lombardo, Branch Chief, at (202) 551-5755; Rose Russo Wells, Senior

Counsel, at (202) 551-5527; Division of Trading and Markets; Harriet Orol, Branch Chief, at

(212) 336-0554; Kevin Vasel, Attorney, at (212) 336-0981; Office of Credit Ratings; or, with

respect to the rules for issuers and underwriters of asset-backed securities, Michelle M. Stasny,

Special Counsel in the Office of Structured Finance, at (202) 551-3674; Division of Corporation

Finance; Securities and Exchange Commission, 100 F Street NE, Washington, DC 20549-7010.

SUPPLEMENTARY INFORMATION: The Commission, with respect to NRSROs, is

adopting amendments to rules 17 CFR 232.101 (“Rule 101 of Regulation S-T”), 17 CFR

240.17g-1 (“Rule 17g-1”), 17 CFR 240.17g-2 (“Rule 17g-2”), 17 CFR 240.17g-3 (“Rule 17g3”), 17 CFR 240.17g-5 (“Rule 17g-5”), 17 CFR 240.17g-6 (“Rule 17g-6”), 17 CFR 240.17g-7

(“Rule 17g-7”), and 17 CFR 249b.300 (“Form NRSRO”); and is adopting new rules 17 CFR

240.17g-8 (“Rule 17g-8”) and 17 CFR 240.17g-9 (“Rule 17g-9”).

In addition, the Commission, with respect to providers of third-party due diligence

services for asset-backed securities, is adopting new rules 17 CFR 240.17g-10 (“Rule 17g-10”)

and 17 CFR 249b.500 (“Form ABS Due Diligence-15E”).

Finally, the Commission, with respect to issuers and underwriters of asset-backed

securities, is adopting amendments to 17 CFR 249.1400 (“Form ABS-15G”) and is adopting new

rule 17 CFR 240.15Ga-2 (“Rule 15Ga-2”).

TABLE OF CONTENTS

I. INTRODUCTION

A. BACKGROUND

B. ECONOMIC ANALYSIS

Guiding Principles9

Baseline

a. NRSROs

b. Asset-Backed Security Issuers, Underwriters, and Third-Party Due Diligence

Providers

c. Industry Practices

3. Broad Economic Considerations

a. Amendments and Rules Enhancing NRSRO Governance and Integrity of Credit

Ratings

b. Amendments and Rules Enhancing Disclosure and Transparency of Credit Ratings

II. FINAL RULES AND RULE AMENDMENTS

A. INTERNAL CONTROL STRUCTURE

1. Prescribing Factors

2. Amendment to Rule 17g-2

3. Amendments to Rule 17g-3

4. Economic Analysis

B. SALES AND MARKETING CONFLICT OF INTEREST

1. New Prohibited Conflict

2. Exemption for “Small” NRSROs

3. Suspending or Revoking a Registration

4. Economic Analysis

C. “LOOK-BACK” REVIEW

1. Paragraph (c) of New Rule 17g-8

2. Amendment to Rule 17g-2

3. Economic Analysis

D. FINES AND OTHER PENALTIES

1. Final Rule

2. Economic Analysis

E. DISCLOSURE OF INFORMATION ABOUT THE PERFORMANCE OF CREDIT

RATINGS

1. Amendments to Instructions for Exhibit 1 to Form NRSRO

a. Proposal

b. Final Rule

2. Amendments to Rule 17g-1

3. Amendments to Rule 17g-2 and Rule 17g-7

a. Proposal

b. Final Rule

4. Economic Analysis

F. CREDIT RATING METHODOLOGIES

1. Paragraph (a) of New Rule 17g-8

2. Amendment to Rule 17g-2

3. Economic Analysis

G. FORM AND CERTIFICATIONS TO ACCOMPANY CREDIT RATINGS

1. Paragraph (a) of Rule 17g-7 – Prefatory Text

2. Paragraph (a)(1)(i) of Rule 17g-7 – Format of the Form

3. Paragraph (a)(1)(ii) of Rule 17g-7 – Content of the Form

4. Paragraph (a)(1)(iii) of Rule 17g-7 – Attestation

5. Paragraph (a)(2) of Rule 17g-7 – Third-Party Due Diligence Certification

6. Economic Analysis

H. THIRD-PARTY DUE DILIGENCE FOR ASSET-BACKED SECURITIES

1. New Rule 15Ga-2 and Amendments to Form ABS-15G

2. New Rule 17g-10

3. New Form ABS Due Diligence-15E

4. Economic Analysis

I. STANDARDS OF TRAINING, EXPERIENCE, AND COMPETENCE

1. New Rule 17g-9

2. Amendment to Rule 17g-2

3. Economic Analysis

J. UNIVERSAL RATING SYMBOLS

1. Paragraph (b) of New Rule 17g-8

2. Amendment to Rule 17g-2

3. Economic Analysis

K. ANNUAL REPORT OF DESIGNATED COMPLIANCE OFFICER

1. Amendment to Rule 17g-3

2. Economic Analysis

L. ELECTRONIC SUBMISSION OF FORM NRSRO AND THE RULE 17g-3 ANNUAL

REPORTS

1. Amendments to Rule 17g-1, Form NRSRO, Rule 17g-3, and Regulation S-T

2. Economic Analysis

M. OTHER AMENDMENTS

1. Changing “Furnish” to “File”

2. Amended Definition of NRSRO

3. Definition of Asset-Backed Security

4. Other Amendments to Form NRSRO

a. Clarification with Respect to Items 6 and 7

b. Clarification with Respect to Exhibit 8

c. Clarification with Respect to Exhibits 10 through 13

5. Economic Analysis

III. EFFECTIVE DATES

A. AMENDMENTS EFFECTIVE SIXTY DAYS AFTER PUBLICATION IN THE

FEDERAL REGISTER

B. AMENDMENTS EFFECTIVE ON JANUARY 1, 2015

C. AMENDMENTS AND NEW RULES EFFECTIVE NINE MONTHS AFTER

PUBLICATION IN THE FEDERAL REGISTER

IV. PAPERWORK REDUCTION ACT

A. SUMMARY OF THE COLLECTION OF INFORMATION REQUIREMENTS

1. Amendments to Rule 17g-1

2. Amendments to Instructions for Exhibit 1 to Form NRSRO

3. Amendments to Rule 17g-2

4. Amendments to Rule 17g-3

5. Amendments to Rule 17g-5

6. Amendments to Rule 17g-7

7. New Rule 17g-8

8. New Rule 17g-9

9. New Rule 17g-10 and New Form ABS Due Diligence-15E

10. New Rule 15Ga-2 and Amendments to Form ABS-15G

11. Amendments to Regulation S-T

12. Form ID

B. USE OF INFORMATION

1. Amendments to Rule 17g-1

2. Amendments to Instructions for Exhibit 1 to Form NRSRO

3. Amendments to Rule 17g-2

4. Amendments to Rule 17g-3

5. Amendments to Rule 17g-5

6. Amendments to Rule 17g-7

7. New Rule 17g-8

8. New Rule 17g-9

9. New Rule 17g-10 and New Form ABS Due Diligence-15E

10. New Rule 15Ga-2 and Amendments to Form ABS-15G

11. Amendments to Regulation S-T

12. Form ID

C. RESPONDENTS

D. TOTAL INITIAL AND ANNUAL RECORDKEEPING AND REPORTING BURDENS

1. Amendments to Rule 17g-1

2. Amendments to Form NRSRO Instructions

3. Amendments to Rule 17g-2

4. Amendments to Rule 17g-3

5. Amendments to Rule 17g-5

6. Amendments to Rule 17g-7

7. New Rule 17g-8

8. New Rule 17g-9

9. New Rule 17g-10 and New Form ABS Due Diligence-15E

10. New Rule 15Ga-2 and Amendments to Form ABS-15G

11. Amendments to Regulation S-T

12. Form ID

13. Total Paperwork Burdens

E. COLLECTION OF INFORMATION IS MANDATORY

F. CONFIDENTIALITY

G. RETENTION PERIOD OF RECORDKEEPING REQUIREMENTS

V. IMPLEMENTATION AND ANNUAL COMPLIANCE CONSIDERATIONS

A. INTERNAL CONTROL STRUCTURE

B. CONFLICTS OF INTEREST RELATING TO SALES AND MARKETING

C. “LOOK-BACK” REVIEW

D. FINES AND OTHER PENALTIES

E. ENHANCEMENTS TO DISCLOSURES OF PERFORMANCE STATISTICS

F. ENHANCEMENTS TO RATING HISTORIES DISCLOSURES

G. CREDIT RATING METHODOLOGIES

H. FORM AND CERTIFICATION TO ACCOMPANY CREDIT RATINGS

I. NEW RULE 15Ga-2 AND AMENDMENTS TO FORM ABS-15G

J. NEW RULE 17g-10 AND NEW FORM ABS DUE DILIGENCE-15E

K. STANDARDS OF TRAINING, EXPERIENCE, AND COMPETENCE

L. UNIVERSAL RATING SYMBOLS

M. ELECTRONIC SUBMISSION OF FORM NRSRO AND THE RULE 17G-3 ANNUAL

REPORTS

VI. FINAL REGULATORY FLEXIBILITY ANALYSIS

A. NEED FOR AND OBJECTIVES OF THE AMENDMENTS AND NEW RULES

B. SIGNIFICANT ISSUES RAISED BY PUBLIC COMMENTS

C. SMALL ENTITIES SUBJECT TO THE RULES

1. NRSROs and Providers of Third-Party Due Diligence Services

2. Issuers

D. REPORTING, RECORDKEEPING, AND OTHER COMPLIANCE REQUIREMENTS

E. AGENCY ACTION TO MINIMIZE EFFECT ON SMALL ENTITIES

VII. STATUTORY AUTHORITY

INTRODUCTION

BACKGROUND

The Dodd-Frank Act, 1 through Title IX, Subtitle C, “Improvements to the Regulation of

Credit Rating Agencies,” among other things, establishes new self-executing requirements

applicable to NRSROs and requires that the Commission adopt rules applicable to NRSROs in a

number of areas. 2 It also requires certain studies relating to NRSROs. 3 The NRSRO provisions

Pub. L. No. 111-203, 124 Stat. 1376, H.R. 4173 (July 21, 2010).

See Pub. L. No. 111-203, 931 through 939H. In addition, Title IX, Subtitle D, “Improvements to the AssetBacked Securitization Process,” contains section 943, which provides that the Commission shall adopt

rules, within 180 days, requiring an NRSRO to include in any report accompanying a credit rating of an

asset-backed security a description of the representations, warranties, and enforcement mechanisms

available to investors and how they differ from the representations, warranties, and enforcement

mechanisms in issuances of similar securities. See Pub. L. No. 111-203, 943. On January 20, 2011, the

Commission adopted Rule 17g-7 to implement section 943. See Disclosure for Asset-Backed Securities

Required by Section 943 of the Dodd-Frank Wall Street Reform and Consumer Protection Act, Securities

Act of 1933 (“Securities Act”) Release No. 9175 (Jan. 20, 2011), 76 FR 4489 (Jan. 26, 2011). Prior to

enactment of the Dodd-Frank Act and the adoption of Rule 17g-7, the Commission proposed a different

rule to be codified at 17 CFR 240.17g-7. See Proposed Rules for Nationally Recognized Statistical Rating

Organizations, Securities Exchange Act of 1934 (“Exchange Act”) Release No. 57967 (June 16, 2008), 73

FR 36212 (June 25, 2008). This proposed rule would have required an NRSRO to publish a report

containing certain information with the publication of a credit rating for a structured finance product or, as

an alternative, use ratings symbols for structured finance products that differentiate them from the credit

ratings for other types of debt securities. See id. In November 2009, the Commission announced it was

deferring consideration of action on that proposal and separately proposed a different rule to be codified at

17 CFR 240.17g-7 that would have required an NRSRO to annually disclose certain information. See

Proposed Rules for Nationally Recognized Statistical Rating Organizations, Exchange Act Release No.

61051 (Nov. 23, 2009), 74 FR 63866 (Dec. 4, 2009). As discussed above, a different rule from either of

in the Dodd-Frank Act augment the Credit Rating Agency Reform Act of 2006 (the “Rating

Agency Act of 2006”), which established a registration and oversight program for NRSROs

through self-executing provisions added to the Exchange Act and implementing rules adopted by

the Commission under the Exchange Act, as amended by the Rating Agency Act of 2006. 4 Title

IX, Subtitle C of the Dodd-Frank Act also 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 asset-backed security to which the due diligence

these proposals ultimately was adopted and codified at 17 CFR 240.17g-7 in January 2011. See Disclosure

for Asset-Backed Securities Required by Section 943 of the Dodd-Frank Wall Street Reform and Consumer

Protection Act, 76 FR 4489.

See Pub. L. No. 111-203, 939(h), 939C, 939D, 939E, 939F. Pursuant to section 939(h) of the Dodd-Frank

Act, the Commission submitted a staff report to Congress on standardizing credit rating terminology. See

Report to Congress Credit Rating Standardization Study As Required by Section 939(h) of the Dodd-Frank

Wall Street Reform and Consumer Protection Act (Sept. 2012), available at

http://www.sec.gov/news/studies/2012/939h_credit_rating_standardization.pdf (“2012 Staff Report on

Credit Rating Standardization”). Pursuant to section 939F of the Dodd-Frank Act, the Commission

submitted a staff report to Congress on the feasibility of establishing a system for assigning NRSROs to

determine credit ratings for structured finance products. See Report to Congress on Assigned Credit

Ratings As Required by Section 939F of the Dodd-Frank Wall Street Reform and Consumer Protection Act

(Dec. 2012), available at http://www.sec.gov/news/studies/2012/assigned-credit-ratings-study.pdf (“2012

Staff Report on Assigned Credit Ratings”). Pursuant to section 939C of the Dodd-Frank Act, the

Commission submitted a staff report to Congress on the independence of credit rating agencies. See Report

to Congress on Credit Rating Agency Independence Study As Required by Section 939C of the DoddFrank Wall Street Reform and Consumer Protection Act (Nov. 2013), available at

http://www.sec.gov/news/studies/2013/credit-rating-agency-independence-study-2013.pdf (“2013 Staff

Report on Credit Rating Agency Independence”).

See Pub. L. No. 109-291 (2006). The Rating Agency Act of 2006, among other things, amended section 3

of the Exchange Act to add definitions, added section 15E to the Exchange Act to establish self-executing

requirements for NRSROs and provide the Commission with the authority to implement a registration and

oversight program for NRSROs, amended section 17 of the Exchange Act to provide the Commission with

recordkeeping, reporting, and examination authority over NRSROs, and amended section 21B(a) of the

Exchange Act to provide the Commission with the authority to assess penalties “against any person” in

administrative proceedings instituted under section 15E of the Exchange Act. See Pub. L. No. 109-291, 3

and 4; 15 U.S.C. 78c; 15 U.S.C. 78o-7; 15 U.S.C. 78q; 15 U.S.C. 78u-2. The Commission adopted rules to

implement a registration and oversight program for NRSROs in June 2007. See Oversight of Credit Rating

Agencies Registered as Nationally Recognized Statistical Rating Organizations, Exchange Act Release No.

55857 (June 5, 2007), 72 FR 33564 (June 18, 2007). The implementing rules were Form NRSRO, Rule

17g-1, Rule 17g-2, Rule 17g-3, Rule 17g-4, Rule 17g-5, and Rule 17g-6. The Commission has twice

adopted amendments to some of these rules. See Amendments to Rules for Nationally Recognized

Statistical Rating Organizations, Exchange Act Release No. 59342 (Feb. 2, 2009), 74 FR 6456 (Feb. 9,

2009); Amendments to Rules for Nationally Recognized Statistical Rating Organizations, Exchange Act

Release No. 61050 (Nov. 23, 2009), 74 FR 63832 (Dec. 4, 2009).

services relate. 5 Finally, Title IX, Subtitle C of the Dodd-Frank Act establishes 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. 6

On May 18, 2011, the Commission proposed for comment amendments to existing rules

and new rules in accordance with Title IX, Subtitle C of the Dodd-Frank Act and to enhance

oversight of NRSROs. 7 The Commission received a number of comment letters in response to

the proposals. 8 The comments on specific proposals are summarized below in the corresponding

See Pub. L. No. 111-203, 932(a)(8) (adding new paragraph (s)(4)(C) to section 15E of the Exchange Act);

15 U.S.C. 78o-7(s)(4)(C)).

See Pub. L. No. 111-203, 932(a)(8) (adding new paragraph (s)(4)(A) to section 15E of the Exchange Act);

15 U.S.C. 78o-7(s)(4)(A).

See Nationally Recognized Statistical Rating Organizations, Exchange Act Release No. 64514 (May 18,

2011), 76 FR 33420 (June 8, 2011). The Commission also proposed technical amendments to its existing

NRSRO rules. Id.

See letter from Jeffrey W. Rubin, Chair, Business Law Section, American Bar Association, dated Aug. 19,

2011 (“ABA Letter”); letter from Bruce E. Stern, Chairman, Association of Financial Guaranty Insurers,

dated Aug. 8, 2011 (“AFGI Letter”); letter from Gerald W. McEntee, President, American Federation of

State, County and Municipal Employees, dated Aug. 5, 2011 (“AFSCME Letter”); letter from Marcus

Stanley, Policy Director, Americans for Financial Reform, dated Apr. 1, 2014 (“AFR II Letter”); letter

from Daryl Schubert, Chair, Auditing Standards Board, American Institute of Certified Public Accountants,

dated Aug. 10, 2011 (“AICPA Letter”); letter from Larry G. Mayewski, Executive Vice President, A.M.

Best, dated Aug. 8, 2011 (“A.M. Best Letter”); letter from the Honorable Robert E. Andrews, U.S.

Congress, House of Representatives, dated Mar. 3, 2012 (“Andrews Letter”); letter from Tom Deutsch,

Executive Director, American Securitization Forum, dated Aug. 8, 2011 (“ASF Letter”); letter from Chris

Barnard dated June 30, 2011 (“Barnard Letter”); letter from Joel Barton dated Aug. 8, 2011 (“Barton

Letter”); letter from Marie Benson dated June 16, 2011 (“Benson Letter”); letter from Dennis M. Kelleher,

President & CEO, and Stephen W. Hall, Securities Specialist, Better Markets, Inc., dated Aug. 8, 2011

(“Better Markets Letter”); letter from Zenia Brown dated May 21, 2011 (“Brown Letter”); letter from John

J. Cadigan, General Partner, CECO LLC, dated June 15, 2011 (“Cadigan Letter”); letter from Nancy

Campbell dated Sept. 29, 2011 (“Campbell Letter”); letter from Barbara Roper, Director of Investor

Protection, Consumer Federation of America, and Marcus Stanley, Policy Director, Americans for

Financial Reform, dated Aug. 8, 2011 (“CFA/AFR Letter”); letter from Micah Hauptman, Financial

Services Counsel, and Barbara Roper, Director of Investor Protection, Consumer Federation of America,

dated Mar. 3, 2014 (“CFA II Letter”); letter from Robert M. Chandler dated June 8, 2011 (“Chandler

Letter”); letter from Laurel Leitner, Senior Analyst, Council of Institutional Investors, dated Aug. 8, 2011

(“CII Letter”); letter from Susan R. Clark dated June 17, 2011 (“Clark Letter”); letter from Steven Cohen,

Senior Vice President and General Counsel, Clayton Holdings LLC, dated Aug. 8, 2011 (“Clayton Letter”);

letter from Gregory W. Smith, Chief Operating Officer, General Counsel, Colorado Public Employees

Retirement Association, dated Aug. 8, 2011 (“COPERA Letter”); letter from Dave Cowen dated May 23,

2011 (“Cowen Letter”); letter from Stephen M. Renna, Chief Executive Officer, CRE Finance Council,

dated Aug. 8, 2011 (“CRE Letter”); letter from Gary D. Cristofani dated July 28, 2011 (“Cristofani

sections of this release discussing the proposals and the amendments and new rules being

adopted today.

ECONOMIC ANALYSIS

Letter”); letter from William Michael Cunningham, Creative Investment Research, Inc., dated May 23,

2005 (“Cunningham I Letter”); letter from William Michael Cunningham, Creative Investment Research,

Inc., dated July 4, 2011 (“Cunningham II Letter”); letter from Bonnie Davis dated June 16, 2011 (“Davis

Letter”); letter from Theresa Day dated June 16, 2011 (“Day Letter”); letter from Daniel Curry, President,

and Mary Keogh, Managing Director, Regulatory Affairs, DBRS, Inc., dated Aug. 8, 2011 (“DBRS

Letter”); letter from Daniel Curry, Chief Executive Officer, and Mary Keogh, Managing Director, Global

Regulatory Affairs, DBRS, Inc., dated Dec. 5, 2013 (“DBRS II Letter”); letter from Deloitte & Touche

LLP dated Aug. 8, 2011 (“Deloitte Letter”); letter from Sean Egan, Egan-Jones Ratings Company, dated

Aug. 5, 2011 (“EJR Letter”); letter from Roberta Y. Ely dated June 17, 2011 (“Ely Letter”); letter from

Ernst & Young LLP dated Aug. 8, 2011 (“Ernst & Young Letter”); letter from Anne S. McCulloch, Senior

Vice President and Deputy General Counsel, Federal National Mortgage Association, dated Aug. 8, 2011

(“Fannie Mae Letter”); letter from Charles D. Brown, General Counsel, Fitch, Inc., dated Aug. 5, 2011

(“Fitch Letter”); letter from Marianne Freebury dated June 16, 2011 (“Freebury Letter”); letter from

Richard M. Whiting, Executive Director and General Counsel, The Financial Services Roundtable, dated

Aug. 8, 2011 (“FSR Letter”); letter from Myrna D. Gardner dated June 14, 2011 (“Gardner Letter”); letter

from Corrine M. Garza dated June 14, 2011 (“Garza Letter”); letter from David Gaus dated Nov. 1, 2012

(“Gaus Letter); letter from William J. Harrington, dated Aug. 8, 2011 (“Harrington Letter”); letter from

William J. Harrington dated May 29, 2014 (“Harrington II Letter”); letter from Karrie McMillan, General

Counsel, Investment Company Institute, dated Aug. 8, 2011 (“ICI Letter”); letter from KPMG LLP dated

Aug. 8, 2011 (“KPMG Letter”); letter from Markus Krebsz dated Nov. 4, 2010 (“Krebsz Letter”); letter

from Jules B. Kroll, Chairman and CEO, Kroll Bond Rating Agency, Inc., dated Aug. 8, 2011 (“Kroll

Letter”); letter from Jules B. Kroll, Chairman and CEO, Kroll Bond Rating Agency, Inc., dated August 19,

2014 (“Kroll II Letter”); letter from Francis Lambert dated Aug. 8. 2011 (“Lambert Letter”); letter from

Kashif Latif dated May 19, 2011 (“Latif Letter”); letter from the Honorable Carl Levin, U.S. Senate,

Permanent Subcommittee on Investigations, dated Aug. 8, 2011 (“Levin Letter”); letter from Dee

Longenbaugh dated June 15, 2011 (“Longenbaugh Letter”); letter from Ray Lynch dated June 17, 2011

(“Lynch Letter”); letter from Craig R. Mills, CraigRMills LLC, dated Aug. 19, 2011(“Mills Letter”); letter

from Michel Madelain, President and Chief Operating Officer, Moody’s Investors Service, dated Aug. 8,

2011 (“Moody’s Letter”); letter from Robert Dobilas, President, Morningstar Credit Ratings, LLC, dated

Aug. 8, 2011 (“Morningstar Letter”); letter from Kevin Overholt dated June 14, 2011 (“Overholt Letter”);

letter from Maneesh Pangasa dated July 29, 2011 (“Pangasa Letter”); letter from PricewaterhouseCoopers,

LLP, dated Aug. 8, 2011 (“PWC Letter”); letter from William E. Reno dated June 16, 2011 (“Reno

Letter”); letter from LaVonne L. Rhyneer dated June 17, 2011 (“Rhyneer Letter”); letter from Andrew M.

Siff, Esquire, Siff & Associates, PLLC, dated June 13, 2011 (“Siff Letter”); letter from Deven Sharma,

President, Standard and Poor’s Ratings Services, dated Aug. 8, 2011 (“S&P Letter”); letter from Anne

Rutledge, President, TradeMetrics Corporation, dated Aug. 8, 2011 (“TradeMetrics Letter”). Copies of

these letters are available on the Commission’s website at: http://www.sec.gov/comments/s7-1811/s71811.shtml. In addition, in connection with the Commission’s solicitation of comments on the

Commission’s request pursuant to the Paperwork Reduction Act of 1995 (44 U.S.C. 3501 et seq.) for approval

of the extension of the previously approved collection of information provided for in Rule 17a-7, several

commenters submitted letters that are relevant to this rulemaking. See letter from Daniel Curry, President,

and Mary Keogh, Managing Director, Regulatory Affairs, DBRS, Inc., dated Apr. 14, 2014 (“DBRS PRA

Letter”); letter from Angela Y. Liang, Assistant General Counsel, Kroll Bond Rating Agency, Inc., dated

Apr. 17, 2014 (“Kroll PRA Letter”); and letter from Michael Kanef, Chief Regulatory and Compliance

Officer, Moody’s Investors Service, dated Apr. 28, 2014 (“Moody’s PRA Letter”).

The Commission has performed an economic analysis in connection with today’s

adoption of the amendments and new rules discussed in section II. of this release. The economic

analysis is reflected in this section I.B. of the release as well as throughout the rest of the

release. 9

Guiding Principles

Title IX, Subtitle C of the Dodd-Frank Act mandates that the Commission prescribe rules

to improve regulation of NRSROs. 10 Section 931 of the Dodd-Frank Act, “Findings,” introduces

Title IX, Subtitle C of the Dodd-Frank Act and provides context to what motivated Congress to

enact these provisions with respect to NRSROs. 11 In particular, Congress found:

•

Because of the systemic importance of credit ratings and the reliance placed on credit

ratings by individual and institutional investors and financial regulators, the activities and

performances of credit rating agencies, including NRSROs, are matters of national public

interest, as credit rating agencies are central to capital formation, investor confidence, and

the efficient performance of the U.S. economy. 12

•

Credit rating agencies, including NRSROs, play a critical ‘‘gatekeeper’’ role in the debt

market that is functionally similar to that of securities analysts, who evaluate the quality

of securities in the equity market, and auditors, who review the financial statements of

firms. Such role justifies a similar level of public oversight and accountability. 13

•

Because credit rating agencies perform evaluative and analytical services on behalf of

clients, much as other financial ‘‘gatekeepers’’ do, the activities of credit rating agencies

are fundamentally commercial in character and should be subject to the same standards of

liability and oversight as apply to auditors, securities analysts, and investment bankers. 14

The discussion of the amendments and new rules in section II of this release is organized into sections that

in large part are based on the distinct rulemaking mandates in Title IX, Subtitle C of the Dodd-Frank Act.

See sections II.A. through II.M. of this release. Each section includes an economic analysis that focuses

specifically on the amendments or rules being discussed in the section.

See Pub. L. No. 111-203, 931 through 939H, entitled “Improvements to the Regulation of Credit Rating

Agencies.”

See Pub. L. No. 111-203, 931.

See Pub. L. No. 111-203, 931(1).

See Pub. L. No. 111-203, 931(2).

See Pub. L. No. 111-203, 931(3).

•

In certain activities, particularly in advising arrangers of structured financial products on

potential ratings of such products, credit rating agencies face conflicts of interest that

need to be carefully monitored and that therefore should be addressed explicitly in

legislation in order to give clearer authority to the Commission.15

•

In the recent financial crisis, the ratings on structured financial products have proven to

be inaccurate. This inaccuracy contributed significantly to the mismanagement of risks

by financial institutions and investors, which in turn adversely impacted the health of the

economy in the United States and around the world. Such inaccuracy necessitates

increased accountability on the part of credit rating agencies. 16

The amendments and new rules being adopted today to implement sections 932, 936, and

938 of the Dodd-Frank Act are designed to address these findings of Congress. For example,

they are intended to increase the integrity and transparency of credit ratings and promote public

oversight and accountability of NRSROs as “gatekeepers” for the primary benefit of the users of

credit ratings. 17 The amendments and new rules also prescribe new disclosure requirements

relating to structured finance products and, in particular, asset-backed securities. 18 These

requirements are designed to address concerns about the role of NRSROs in the financial crisis

of 2007−2009 19 in terms of how they rated certain types of structured finance products and, in

particular, the inherent conflicts of interest in rating these products. 20

See Pub. L. No. 111-203, 931(4).

See Pub. L. No. 111-203, 931(5).

See John C. Coffee, Jr., Adolf A. Berle Professor of Law, Columbia University Law School, Turmoil in the

U.S. credit markets: the role of the credit rating agencies (Apr. 22, 2008) (testimony before the U.S. Senate

Committee on Banking, Housing and Urban Affairs), p. 1, available at

http://www.banking.senate.gov/public/_files/OpgStmtCoffeeSenateTestimonyTurmoilintheUSCreditMarke

ts.pdf (“Coffee Testimony I”).

The term structured finance product as used throughout this release refers broadly to any security or money

market instrument issued by an asset pool or as part of any asset-backed or mortgage-backed securities

transaction. This broad category of financial instrument includes an asset-backed security as defined in

section 3(a)(79) of the Exchange Act (15 U.S.C. 78c(a)(79)) and other types of structured debt instruments,

including synthetic and hybrid collateralized debt obligations (“CDOs”). The term Exchange Act-ABS as

used throughout this release refers more narrowly to an asset-backed security as defined in section 3(a)(79)

of the Exchange Act. 15 U.S.C. 78c(a)(79).

Throughout this Release, unless indicated otherwise, when the Commission uses the term “financial crisis”

it is referring to the financial crisis that took place between 2007 and 2009.

See Pub. L. No. 111-203, 931 (setting forth, among other things, Congress’ findings with respect to the role

In the market for structured finance products, the pool of assets underlying or referenced

by the product is often comprised of hundreds of thousands of loans, each requiring time and

expense to evaluate. In these markets, the separation between the borrower and the ultimate

provider of credit can introduce significant information asymmetries between the parties

involved in the securitization process that creates a structured finance product 21 and investors in

the product, who may have less information on the credit quality and other relevant

characteristics of the asset pool. 22 Further, disclosures to investors regarding the asset pool may

not be sufficiently detailed to allow investors to adequately evaluate the quality of the collateral

backing the securities and, thereby, assess the credit risk of the securities. Consequently, the

market for structured finance products has evolved as a “rated” market in which the credit risk of

the products is assessed by credit rating agencies 23 and the valuations of the products depend

significantly on credit ratings. 24 To curb their informational disadvantage, certain investors in

structured finance products may use credit ratings to inform their investment decisions. 25

played by credit ratings agencies, the services provided by credit ratings agencies, certain conflicts of

interests facing credit rating agencies, and inaccuracies in ratings on structured finance products).

Asset-backed securitization – the process used to create asset-backed securities – is a financing technique in

which financial assets are pooled and converted into instruments that may be offered and sold in the capital

markets. In a basic securitization structure, an entity – often a financial institution – originates or otherwise

acquires a pool of financial assets, such as mortgage loans, either directly or through an affiliate. It then

sells the financial assets, again either directly or through an affiliate, for the purpose of depositing them into

a specially created investment vehicle that issues securities “backed” by those financial assets. Payment on

the asset-backed securities depends primarily on the cash flows generated by the assets in the underlying

pool (and possibly other rights designed to assure timely payment, generally known as “credit

enhancements”). See Asset-Backed Securities, Securities Act Release No. 8518 (Dec. 22, 2004), 70 FR

1506 (Jan. 7, 2005).

See Adam B. Ashcraft and Til Schuermann, Understanding the Securitization of Subprime Mortgage

Credit, Staff Report, Federal Reserve Bank of New York, Working Paper No. 318 (2008). The authors

identify seven information frictions that can cause moral hazard and adverse selection problems in a

subprime mortgage securitization transaction.

See Joshua Coval, Jakub Jurek, and Erik Stafford, The Economics of Structured Finance, 23(1) J. Econ.

Perspectives 3-26 (2009).

See Adam Ashcraft, Paul Goldsmith-Pinkham, Peter Hull, and James Vickery, Credit Ratings and Security

Prices in the Subprime MBS Market, 101(3), Amer. Econ. Rev. 115-119 (2011).

See Frank Partnoy, Overdependence on Credit Ratings Was a Primary Cause of the Crisis, in The Panic of

Given that investors may not know the quality of the assets underlying structured finance

products, certain originators of these assets may attempt to adversely transfer risks of poor

origination decisions to investors by creating complex and opaque structured finance products. 26

This risk is especially pronounced when the originator, sponsor, depositor, or underwriter

receives compensation before investors learn about the quality of the assets. 27 Because

origination fees are based on transaction volume and risks are transferred to investors, an

2008: Causes, Consequences, and Implications for Reform (Edward Elgar Press 2010, Lawrence Mitchell

and Arthur Wilmarth, eds.). References to credit ratings in federal regulations also may have contributed to

investor reliance on credit ratings. Section 939A of the Dodd-Frank Act requires each federal agency,

including the Commission, to review any regulation issued by such agency that requires the use of an

assessment of the creditworthiness of a security or money market instruments and any references to or

requirements in such regulations regarding credit ratings. See Pub. L. No. 111-203, 939A. The section

further provides that each such agency shall “modify any such regulations identified by the review…to

remove any reference to or requirement of reliance on credit ratings, and to substitute in such regulations

such standard of creditworthiness as each respective agency shall determine as appropriate for such

regulations.” Id.

See Chris Downing, Dwight Jaffee, and Nancy Wallace, Is the Market for Mortgage-Backed Securities a

Market for Lemons?, 22(7) REV. FIN. STUD. 2457-2494 (2009). The authors argue that the quality of the

assets sold to investors through securitization is lower than the quality of similar assets that are not sold to

investors. They find empirical support for this proposition using a comprehensive dataset of sales of

mortgage-backed securities (Freddie Mac Participation Certificates) to special-purpose vehicles over the

period 1991 through 2002.

Several parties may be involved in the securitization process that creates an asset-backed security,

including an originator, sponsor, depositor, issuing entity, underwriter, and arranger. See generally AssetBacked Securities, 70 FR at 1508. The originator is the entity that creates a financial asset (for example,

mortgage loan, auto loan, or credit card receivable) that collateralizes an asset-backed security through an

extension of credit or otherwise and that sells the asset to be included in an asset-backed security. The

sponsor is the entity that organizes and initiates the asset-backed securities transaction by transferring the

financial assets underlying an asset-backed security directly or indirectly to the issuing entity. The

depositor is an entity that receives or purchases the financial assets from the sponsor and transfers them to

the issuing entity (in some cases the sponsor transfers the financial assets directly to the issuing entity,

thereby by-passing the use of a separate depositor). The issuing entity is the trust or other vehicle created

at the direction of the sponsor or depositor that owns or holds the financial assets and in whose name the

asset-backed securities are issued. The underwriter is the entity that underwrites the offering of assetbacked securities and sells them to investors. The arranger is an entity that organizes and arranges a

securitization transaction, but does not sell or transfer the assets to the issuing entity. It also structures the

transaction and may act as an underwriter for the deal. In jurisdictions where an arranger is used, the

arranger’s role is similar to that of a sponsor in other jurisdictions. In some cases, a single entity may

perform more than one function (for example, a financial institution may act as an originator and sponsor).

The issuer of a structured finance product as used in this release can mean, depending on the context, the

issuing entity or the person that organizes and initiates the offering of the structured finance product (for

example, the sponsor or depositor). Generally, when this release discusses an issuer taking a specific action

in the context of an offering of a structured finance product (for example, making a disclosure), the person

that organizes and initiates the offering would be the person taking the action (as opposed to the issuing

entity). Further, in the context of the discussion of Rules 17g-10 and 15Ga-2, the term issuer (which is

defined in Rule 17g-10) includes a sponsor or depositor.

originator may have the economic incentive to produce as many assets (for example, mortgage

loans) as possible without adequately screening their credit quality. 28

The rating process for structured finance products differs from the rating process for

corporate bonds, whose ratings are largely based on publicly available data such as audited

financial statements. The data used in rating structured finance products is primarily provided by

the sponsor, depositor, or underwriter. 29 Unlike credit ratings for corporate bonds, credit ratings

of structured finance products are “highly sensitive to the assumptions of 1) default probability

and recovery value, 2) correlation of defaults, and 3) the relation between payoffs and the

economic states that investors care about most.” 30 The rating process for these products may

happen in the reverse of how a more traditional product is rated because the sponsor, depositor,

arranger, or underwriter often decides before the structure is finalized what credit rating it would

See Amiyatosh Purnanandam, Originate-to-Distribute Model and the Subprime Mortgage Crisis, 24(6)

REV. FIN. STUD. 1881-1915 (2011). The author argues that, during the financial crisis, banks with high

involvement in the originate-to-distribute market originated excessively poor-quality mortgages, consistent

with the view that the originating banks did not expend resources to adequately screen the credit quality of

their borrowers.

See Summary Report of Issues Identified in the Commission Staff’s Examinations of Select Credit Rating

Agencies (July 2008), available at http://www.sec.gov/news/studies/2008/craexamination070808.pdf

(“2008 Staff Inspection Report”), pp. 7-10. The report describes the rating process for a residential

mortgage-backed security (“RMBS”) and CDO at the three examined credit rating agencies (Standard &

Poor’s Ratings Services, Moody’s Investor’s Services, Inc., and Fitch, Inc.). For example, with respect to a

involving subprime loans, the arranger of the RMBS typically initiates the rating process by sending the

credit rating agency data on each of the subprime loans to be held by the trust (for example, principal

amount, geographic location of the property, credit history and FICO score of the borrower, ratio of the

loan amount to the value of the property, and type of loan), the proposed capital structure of the trust and

the proposed levels of credit enhancement for each tranche issued by the trust. Id. at 7. Upon receipt of the

information, the credit rating agency assigns a lead analyst who is responsible for analyzing the loan pool,

the proposed capital structure, and the proposed credit enhancement levels and, ultimately, for formulating

a rating recommendation to a rating committee composed of analysts and/or senior-level analytic

personnel. Id. at 7. The rating committee votes on the credit ratings for each tranche and usually

communicates its decision to the issuer. Id. at 9. In most cases, the issuer can appeal a rating decision,

although the appeal is not always granted (and, if granted, may not necessarily result in any change in the

rating decision). Typically, the credit rating agency is paid for determining the credit rating only if the

credit rating is issued.

See Coval, Jurek, and Stafford, The Economics of Structured Finance, p. 23. The authors argue that,

“unlike corporate bonds, whose fortunes are primarily driven by firm-specific considerations, the

performance of securities created by tranching large asset pools is strongly affected by the performance of

the economy as a whole.” Id. at 23.

like for each tranche of securities to be issued, within the limits of what is possible, and

structures the product accordingly (for example, with regard to selecting the underlying assets

and establishing the credit enhancements applicable to the different tranches of securities).

Concerns have been raised that the inherently iterative nature of the process between the credit

rating agency and the sponsor, depositor, arranger, or underwriter may give rise to potential

conflicts of interest 31 and that credit rating agencies marketing advisory and consulting services

to their clients during this process may accentuate the conflict. 32

Just prior to the financial crisis, the size of the structured finance market was

considerable. New issuances of RMBS, for example, peaked in 2006 for a total of $801.7

billion.33 Low interest rates drove investor demand for products that had high yields but also

were highly rated by the credit rating agencies. 34 Mortgage originators largely exhausted the

supply of traditional quality mortgages and, to keep up with investor demand for RMBS,

subprime lending became increasingly popular. As the number of delinquencies on subprime

See International Organization of Securities Commissions (“IOSCO”), The Role of Credit Rating Agencies

in Structured Finance Markets (May 2008), p. 5 (“Some critics have argued that the inherently iterative

nature of this process may give rise to potential conflicts of interest.”).

See Coffee Testimony I, p. 3, (“Today, the rating agency receives one fee to consult with a client, explain

its model, and indicate the likely outcome of the rating process; then, it receives a second fee to actually

deliver the rating (if the client wishes to go forward once it has learned the likely outcome)”). Rule 17g-6

prohibits, among other things, an NRSRO from conditioning or threatening to condition the issuance of a

credit rating on the purchase by an obligor or issuer, or an affiliate of the obligor or issuer, of any other

services or products, including pre-credit rating assessment products, of the NRSRO or any person

associated with the NRSRO. See 17 CFR 240.17g-6(a)(1).

The total amount of new issuances is calculated by staff in the Commission’s Division of Economics and

Risk Analysis (“DERA”) using Asset-Backed Alert and Commercial Mortgage Alert databases. The

amounts include only non-agency RMBS sold in the United States through Commission-registered

offerings, Rule 144A offerings, or traditional private offerings.

See Testimony of John B. Taylor, the Mary and Robert Raymond Professor of Economics at Stanford

University and George P. Shultz Senior Fellow in Economics at Stanford’s Hoover Institution, before the

Subcommittee on Monetary Policy and Trade Committee on Financial Services, U.S. House of

Representatives (Mar. 5, 2013), available at http://financialservices.house.gov/uploadedfiles/hhrg-113ba19-wstate-jtaylor-20130305.pdf.

mortgages suddenly soared in late 2007, RMBS lost a considerable amount of value, 35 and

investors began to question the accuracy of credit ratings assigned to RMBS and CDOs linked to

RMBS. 36 Certain academic studies argue that, as the structured finance market boomed between

2004 and 2007, NRSROs might have had an incentive to generate revenue by relaxing rating

standards, 37 inflating credit ratings, 38 facilitating the sale of asset-backed securities by a small

number of large issuers, 39 and reducing due diligence in the presence of investors that solely rely

on credit ratings. 40 The concerns about the accuracy of credit ratings fueled an emergent

See Board of Governors of the Federal Reserve System (“Federal Reserve”), Report to the Congress on

Risk Retention (Oct. 2010), pp. 50−51(discussing the drop in the triple-A and triple-B ABX.HE 2006-2

index (−70% by the end of 2008 for triple-A rated and −95% for triple-B rated subprime RMBS issued in

2006)).

See IOSCO, The Role of Credit Rating Agencies in Structured Finance Markets, p. 2.

See John M. Griffin and Dragon Yongjun Tang, Did Subjectivity Play a Role in CDO Credit Ratings?,

67(4) J. FIN. 1293-1328 (2012). The authors analyze a sample of 916 CDOs and find that a large credit

rating agency frequently made positive adjustments outside its main model that resulted in increasingly

larger AAA tranche sizes. These adjustments are difficult to explain by likely determinants, such as

manager experience or credit enhancements, but exhibit a clear pattern: CDOs with smaller model-implied

AAA sizes receive larger adjustments and CDOs with larger adjustments experience more severe

subsequent downgrading.

See Vasiliki Skreta and Laura Veldkamp, Ratings Shopping and Asset Complexity: A Theory of Ratings

Inflation, 56 J. MONETARY ECON. 678-695 (2009); Efraim Benmelech and Jennifer Dlugosz, The Credit

Rating Crisis, NBER Working Paper No. 15045 (2009); Bo Becker and Todd Milbourn, How Did

Increased Competition Affect Credit Ratings?, 101 J. FIN. ECON. 493-514 (2011); Andrew Cohen and Mark

D. Manuszak, Ratings Competition in the CMBS Market, 45(1) J. MONEY, CREDIT AND BANKING 93-119

(2013).

See Jie He, Jun Qian, and Philip E. Strahan, Credit Ratings and the Evolution of the Mortgage-Backed

Securities Market, 101(3) AMER. ECON. REV., 131-135 (2011). The authors find that in 2006 the mortgagebacked securities (“MBS”) market was highly concentrated among large issuers, with the top five

accounting for 39% of all newly issued securities; between 2004 and 2006, a larger fraction of MBS sold

by large issuers received triple-A ratings than MBS sold by small issuers; and tranches sold by large issuers

then experienced larger price drops than those sold by smaller issuers when the “housing bubble” began to

unravel.

See Patrick Bolton, Xavier Freixas, and Joel Shapiro, The Credit Ratings Game, 67(1) J. OF FINANCE 85111 (2012), available at http://onlinelibrary.wiley.com/doi/10.1111/j.1540-6261.2011.01708.x/full. The

authors develop a model of competition among credit rating agencies that includes two types of investors

with different incentives to perform due diligence: sophisticated and “trusting” investors. Trusting

investors take credit ratings at face value because their compensation depends only marginally on the expost returns of the assets they manage. In the authors’ view, regulation that forces money managers to only

purchase investments with good credit ratings could also provide incentives to be trusting. The authors find

that competition can reduce efficiency, as it facilitates rating shopping. Moreover, credit ratings are more

likely to be inflated during booms and when investors are more trusting.

reluctance to invest in these products. 41 The new issuances of RMBS totaled $715.3 billion in

2007 and plunged to $34.5 billion in 2008.

In August 2007, the Commission staff initiated examinations of the three largest credit

rating agencies to review their role in the turmoil in the subprime mortgage-related securities

markets. 42 Among other things, these examinations revealed that the credit rating agencies

struggled to adjust the number of staff and resources employed in the rating process to the

increasing volume and complexity of RMBS and CDOs. 43 Certain significant aspects of the

rating process and methodologies used to rate RMBS and CDOs were not documented or

disclosed. 44 The credit rating agencies examined did not have specific written procedures for

rating RMBS and CDOs. 45 Also, the credit rating agencies did not appear to have specific

written policies and procedures to identify or address errors in their models or methodologies. 46

In certain instances, Commission staff believed that adjustments to models were made without

appropriately documenting a rationale for deviations from the model. 47 Processes for performing

surveillance and monitoring of outstanding credit ratings on an ongoing basis appeared to be less

robust than the processes for determining initial credit ratings. 48 Moreover, in the Commission

See Coval, Jurek, and Stafford, The Economics of Structured Finance.

See 2008 Staff Inspection Report.

See 2008 Staff Inspection Report, p. 10-13.

See 2008 Staff Inspection Report, p. 13.

See 2008 Staff Inspection Report, p. 16 (“One rating agency maintained comprehensive written procedures

for rating structured finance securities, but these procedures were not specifically tailored to rating RMBS

and CDOs. The written procedures for the two other rating agencies were not comprehensive and did not

address all significant aspects of the RMBS and/or CDO ratings process. For example, written materials

set forth guidelines for the structured finance ratings committee process (including its composition, the

roles of the lead analyst and chair, the contents of the committee memo and the voting process) but did not

describe the ratings process and the analyst’s responsibilities prior to the time a proposed rating is

presented to a ratings committee.”).

See 2008 Staff Inspection Report, p. 17.

Id. at 19.

Id. at 21.

staff’s view, sufficient steps were not taken to prevent considerations of fees, market share, or

other business interests from influencing credit ratings or rating criteria. 49 Finally, the examined

credit rating agencies appeared to solely rely on the information provided by RMBS sponsors. 50

In particular, they did not appear to verify the integrity and accuracy of such information as, in

their view, due diligence duties belonged to other parties and they did not appear to seek

representations from sponsors that due diligence was performed. 51

Following the financial crisis, the Dodd-Frank Act mandated regulatory actions intended

to enhance regulation, accountability, and transparency of NRSROs. 52 Generally, the majority of

the rulemaking mandated by the Dodd-Frank Act addresses all classes of credit ratings, rather

than credit ratings for only structured finance products. 53 In implementing the mandate, the

amendments and new rules being adopted today are designed to further enhance the governance

of NRSROs in their role as “gatekeepers” 54 and increase the transparency of the credit rating

process as a whole. Further, as discussed in section II. of this release, the amendments and new

rules being adopted today include new requirements designed to enhance transparency with

respect to structured finance products, including requirements for NRSROs to disclose

Id. at 24.

Id. at 18.

See Pub. L. No. 111-203, 932, entitled “Enhanced Regulation, Accountability, and Transparency of

Nationally Recognized Statistical Rating Organizations.”

One commenter suggested that the proposed rules are overly broad in their application and “fail to

sufficiently account for the differences between corporate ratings (such as financial strength ratings of

insurance companies) and ratings of the structured and asset-backed financial products that contributed to

the recent economic crisis.” See A.M. Best Letter. The Commission notes that the amendments and new

rules being adopted today reflect the statutory mandate that generally, with one exception, was not limited

to certain classes of credit ratings. In particular, sections 932, 936 and 938 of the Dodd-Frank Act

generally do not focus exclusively on activities relating to rating structured finance products, with the

exception of section 932(s)(4) (which focuses on third-party due diligence services with respect to assetbacked securities).

See John C. Coffee, Jr., Gatekeepers: The Professions and Corporate Governance, Oxford University Press

(2006).

information about the performance and history of credit ratings for subclasses of structured

finance products and requirements for NRSROs, issuers, underwriters, and providers of thirdparty due diligence services to disclose information about due diligence services performed with

respect to asset-backed securities. 55

Baseline

The amendments and new rules being adopted today primarily affect NRSROs, issuers,

and underwriters of asset-backed securities, and providers of third-party due diligence services

for asset-backed securities. To the extent that the new requirements change the business

practices of the primarily affected parties, such changes may also affect clients of NRSROs (that

is, obligors who pay NRSROs to obtain entity credit ratings, issuers who pay NRSROs to obtain

credit ratings for their issued securities, subscribers who pay NRSROs to access credit ratings

and research, and persons who pay NRSROs for other services), credit raters or credit rating

agencies other than NRSROs, parties involved in asset-backed securities markets (other than

issuers, underwriters, third-party due diligence providers, and NRSROs), and users of credit

ratings in general.

The baseline against which economic costs and benefits, as well the impact of the

amendments and new rules being adopted today on efficiency, competition, and capital

formation, are measured is the situation in existence today, prior to the adoption of the

amendments and rules. The baseline includes an estimate of the number of entities that will

likely be directly affected by the amendments and rules and a description of the relevant features

of the regulatory and economic environment in which the affected entities operate. The

See sections II.E.1. and II.E.2. of this release (discussing requirements for NRSROs to disclose

performance statistics and rating history information for subclasses of structured finance products); sections

II.G. and II.H. of this release (discussing requirements to disclose information about third-party due

diligence services provided for asset-backed securities).

discussion below identifies the main features of the regulatory and economic baseline, which will

be further developed in section II of this release discussing the amendments and rules, including

in the focused economic analyses that follow the discussions of the amendments and rules.

NRSROs

As discussed above, the Rating Agency Act of 2006, among other things, amended

section 3 of the Exchange Act to add definitions, added section 15E to the Exchange Act to

establish self-executing requirements for NRSROs and provide the Commission with the

authority to implement a registration and oversight program for NRSROs, amended section 17 of

the Exchange Act to provide the Commission with recordkeeping, reporting, and examination

authority over NRSROs, and amended section 21B(a) of the Exchange Act to provide the

Commission with the authority to assess penalties “against any person” in administrative

proceedings instituted under section 15E of the Exchange Act. 56

To implement the Rating Agency Act of 2006, the Commission adopted Rules 17g-1

through 17g-6 and Form NRSRO. 57 Section 943 of the Dodd-Frank Act mandates that the

Commission adopt rules requiring an NRSRO to include in any report accompanying a credit

rating of an asset-backed security a description of the representations, warranties, and

enforcement mechanisms available to investors and how they differ from the representations,

warranties, and enforcement mechanisms in issuances of similar securities. 58 In January 2011,

the Commission adopted Rule 17g-7 to implement section 943. 59 The Exchange Act, Rules 17g1 through 17g-7, and Form NRSRO represent the baseline for the amendments and new rules

See Pub. L. No. 109-291, 3, 4; 15 U.S.C. 78c; 15 U.S.C. 78o-7; 15 U.S.C. 78q; 15 U.S.C. 78u-2.

See Oversight of Credit Rating Agencies Registered as Nationally Recognized Statistical Rating

Organizations, 72 FR 33564.

See Pub. L. No. 111-203, 943.

See Disclosure for Asset-Backed Securities Required by Section 943 of the Dodd-Frank Wall Street

Reform and Consumer Protection Act, 76 FR 4489.

being adopted today in terms of requirements applicable to NRSROs.

Pursuant to section 6 of the Rating Agency Act of 2006, the Commission is required to

submit an annual report to the Committee on Banking, Housing, and Urban Affairs of the Senate

and the Committee on Financial Services of the House of Representatives that includes the views

of the Commission on the state of competition, transparency, and conflicts of interest among

NRSROs. 60 In addition, section 15E(b) of the Exchange Act provides that not later than ninety

days after the end of each calendar year, each NRSRO shall file with the Commission an

amendment to its registration application, in such form as the Commission, by rule, may

prescribe: (1) certifying that the information and documents in the application for registration

continue to be accurate; (2) listing any material change that occurred to such information or

documents during the previous calendar year; and (3) amending its credit ratings performance

statistics. 61 Rule 17g-1 requires these filings (“annual certifications”) to be made on Form

NRSRO. 62 Further, each NRSRO is required to furnish the Commission with annual reports

containing audited financial statements and information about revenues and other matters. 63 The

Commission’s annual reports submitted to Congress and the NRSROs’ annual certifications and

annual reports are an integral part of establishing the baseline for the amendments and new rules

being adopted today, as discussed below.

As of today, there are ten credit rating agencies registered with the Commission as

NRSROs. 64 Based on the annual reports the NRSROs furnish with the Commission, in their

See Pub. L. No. 109-291, 6. The Commission staff annual reports are available at http://www.sec.gov/ocr.

See 15 U.S.C. 78o-7(b).

See paragraph (f) of Rule 17g-1. See also Oversight of Credit Rating Agencies Registered as Nationally

Recognized Statistical Rating Organizations, 72 FR at 33567, 33569-33582.

See 17 CFR 240.17g-3.

The ten NRSROs are: A.M. Best Company, Inc. (“A.M. Best”); DBRS, Inc. (“DBRS”); Egan-Jones

Ratings Company (“EJR”); Fitch, Inc. (“Fitch”); HR Ratings de Mexico, S.A. de C.V. (“HR Ratings”);

2013 fiscal years, the ten NRSROs had $5.4 billion of total revenue – an approximate 6%

increase over their 2012 fiscal years. In addition, based on their annual certifications, the

NRSROs employed a total of 4,218 credit analysts at the end of the 2013 calendar year. Table 1

shows the number of credit analysts employed by each NRSRO at the end of the 2013 calendar

year and, of the total number of credit analysts employed by the NRSROs, the percent of credit

analysts at S&P, Moody’s, and Fitch (90%) and the remaining seven NRSROs (10%).

Table 1 – Credit analysts employed by NRSROs (as of [--])

NRSROs

S&P, Moody’s, &

Fitch

Other NRSROs

A.M. Best

DBRS

EJR

Fitch

HR Ratings

JCR

Kroll

Moody’s

Morningstar

S&P

Total

Total Credit Analysts

90%

10%

123

1,102

1,244

1,465

4,218

Note: The total number of credit analysts, including credit analyst supervisors, is provided by each NRSRO in Exhibit 8 to Form

NRSRO, which is available on each NRSRO’s website.

Among other things, the operations of the ten NRSROs differ in terms of business model,

classes of credit ratings for which they are registered, history of issuing credit ratings, size, and

market share. Of the ten NRSROs, seven operate primarily under the issuer-pay model, 65 in

which an obligor pays the NRSRO to rate it as an entity or an issuer pays the NRSRO to rate the

Japan Credit Rating Agency, Ltd. (“JCR”); Kroll Bond Rating Agency, Inc. (“Kroll”); Moody’s Investor’s

Services, Inc. (“Moody’s”); Morningstar Credit Ratings, LLC (“Morningstar”); and Standard & Poor’s

Ratings Services (“S&P”). See Commission staff, Annual Report on Nationally Recognized Statistical

Rating Organizations (Dec. 2013), p. 6, available at

http://www.sec.gov/divisions/marketreg/ratingagency/nrsroannrep1213.pdf. (“2013 Annual Staff Report on

NRSROs”).

The seven NRSROs are A.M. Best, DBRS, Fitch, HR Ratings, JCR, Moody’s, and S&P. See 2013 Annual

Staff Report on NRSROs, p. 6.

securities it issues. 66 One NRSRO operates exclusively under the subscriber-pay model, 67 in

which subscribers pay a fee to access the credit ratings issued by the NRSRO. 68 Two NRSROs

previously operated primarily under the subscriber-pay model but for several years have been

issuing an increasing number of credit ratings paid for by the obligor being rated or the issuer of

the securities that are rated. 69

The ten NRSROs also differ by the scope of their business and, in particular, by whether

their operations include products and services other than credit ratings, 70 which can be provided

The issuer-pay model often raises concerns of potential conflicts of interest because the collection of fees

from rated entities and issuers of rated securities, as a principal source of revenue, may provide an NRSRO

with an economic incentive to issue inflated ratings as a way to promote business with its clients. Several

academic studies try to answer theoretically and empirically the question of whether reputational concerns

of a credit rating agency effectively neutralize potential conflicts of interest in the issuer-pay model. The

conclusions of these studies are neither unanimous nor definite. For example, recently, Kashyap and

Kovrijnykh (2013) found that, under the issuer-pay model, a credit rating is less accurate than under the

subscriber-pay model. However, the authors found that subscribers tend to ask for a credit rating

inefficiently (that is, when the expected quality of the rated entity or security is sufficiently high) and that

the subscriber-pay model suffers from a potential free-riding problem. Cole and Cooley (2014) argue that

much of the regulatory concerns with the conflict created by issuers paying for ratings are a distraction.

The authors argue that in equilibrium, reputation ensures that credit ratings have value and reflect sound

assessments of creditworthiness. Regulatory reliance on credit ratings and the importance of risk-weighted

capital in prudential regulation more likely contributed to distorted credit ratings than the matter of who

pays for them. See Anil Kashyap and Natalia Kovrijnykh, Who Should Pay for Credit Ratings and How?,

NBER working paper No. 18923 (Mar. 2013); Harold Cole and Thomas F. Cooley, Rating Agencies,

NBER working paper No. 19972 (Mar. 2014).

The one NRSRO is EJR. See 2013 Annual Staff Report on NRSROs, p. 6.

See 2013 Annual Staff Report on NRSROs, p. 23. The subscriber-pay model also is subject to potential

conflicts of interest. See id. at p. 23. For example, the NRSRO may be aware that an influential subscriber

holds a securities position (long or short) that could be advantaged if a credit rating upgrade or downgrade

causes the market value of the security to increase or decrease; or that the subscriber invests in newly

issued bonds and would obtain higher yields if the bonds were to have lower credit ratings. Another

example of a conflict in the subscriber-pay model is that the NRSRO may be aware that a subscriber wishes

to acquire a particular security but is prevented from doing so because the credit rating of the security is

lower than internal investment guidelines or an applicable contract permit.

The two NRSROs are Kroll and Morningstar. See 2013 Annual Staff Report on NRSROs, p. 7.

Ancillary services often raise concerns of potential conflicts of interest because, for example, an NRSRO

might issue a more favorable credit rating to an issuer in exchange for purchasing ancillary services, or an

issuer that purchases a large amount of ancillary services might pressure the NRSRO to issue a more

favorable credit rating for the issuer. See 2013 Staff Report on Credit Rating Agency Independence, pp.

21-24. Another concern with respect to ancillary services is that they might have involved an NRSRO

making recommendations on the structure of a security to be rated. Id. at 22-23. Paragraph (c)(5) of Rule

17g-5 prohibits an NRSRO from issuing or maintaining a credit rating with respect to an obligor or security

where the NRSRO or a person associated with 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

through business lines, segments, groups, or divisions within the NRSROs or through affiliated

companies or other businesses not within the NRSRO. 71 For credit ratings, there are five classes

of credit ratings for which a credit rating agency can be registered as an NRSRO: (1) financial

institutions, brokers, or dealers; (2) insurance companies; (3) corporate issuers; (4) issuers of

asset-backed securities (as that term is defined in section 1101(c) of part 229 of Title 17, Code of

Federal Regulations, “as in effect on the date of enactment of this paragraph”); and (5) issuers of

government securities, municipal securities, or securities issued by a foreign government. 72

Eight of the NRSROs are registered in multiple classes, while two NRSROs are registered in one

class. 73 Table 2 shows the approximate number of outstanding credit ratings as reported by each

NRSRO in its annual certification for the 2013 calendar year end, in each of the five categories

for which the NRSRO is registered.

activities of the obligor or issuer of the security. See 17 CFR 240.17g-5(c)(5). In addition, Rule 17g-6

prohibits, among other things, an NRSRO from: (1) conditioning or threatening to condition the issuance of

a credit rating on the purchase by an obligor or issuer, or an affiliate of the obligor or issuer, of any other

services or products, including pre-credit rating assessment products, of the NRSRO or any person

associated with the NRSRO; (2) issuing, or offering or threatening to issue, a credit rating that is not

determined in accordance with the NRSRO’s established procedures and methodologies for determining

credit ratings, based on whether the rated person, or an affiliate of the rated person, purchases or will

purchase the credit rating or any other service or product of the NRSRO or any person associated with the

NRSRO; and (3) modifying, or offering or threatening to modify, a credit rating in a manner that is

contrary to the NRSRO’s established procedures and methodologies for modifying credit ratings based on

whether the rated person, or an affiliate of the rated person, purchases or will purchase the credit rating or

any other service or product of the NRSRO or any person associated with the NRSRO. See 17 CFR

240.17g-6.

See 2013 Staff Report on Credit Rating Agency Independence, p. 19.

See 15 U.S.C. 78c(a)(62) (defining the term nationally recognized statistical rating organization).

See 2013 Annual Staff Report on NRSROs, p. 8.

Table 2 – Approximate number of NRSRO credit ratings outstanding by class of credit rating (as of

[December 31, 2013])

NRSROs

S&P, Moody’s, &

Fitch

Other NRSROs

A.M. Best

DBRS

EJR

Fitch

HR Ratings

JCR

Kroll

Moody’s

Morningstar

S&P

Total

Financial

Institutions

Insurance

Companies

Corporate

Issuers

AssetBacked

Securities

84%

16%

N/R

13,624

104

49,821

N/R

150

15,982

53,383

N/R

59,000

192,064

74%

26%

4,492

150

3,222

N/R

3,418

N/R

7,200

18,599

92%

1,653

3,790

877

15,299

N/R

463

2,749

40,008

N/R

49,700

114,539

90%

10%

10,706

N/R

53,612

N/R

1,401

76,464

11,567

90,000

243,806

Government

Securities

Total

Ratings

99%

N/R

16,038

N/R

204,303

189

728,627

N/R

918,800

1,868,038

97%

6,201

44,308

1,027

326,257

189

696

20,201

901,900

11,567

1,124,700

2,437,046

Note: The approximate number of NRSRO credit ratings outstanding as of December 31, 2013 is provided by each NRSRO in its

annual certification, which is available on each NRSRO’s website. “N/R” indicates that an NRSRO is not registered for that

class of credit rating.

As shown in Table 2, S&P has the greatest number of outstanding credit ratings in each

of the five classes. S&P, Moody’s, and Fitch are the top three producers of credit ratings in

every class of credit ratings except for insurance companies (in this class, A.M. Best has the

second highest number of outstanding credit ratings after S&P). Overall, S&P accounts for

about 46% of the total NRSRO credit ratings outstanding, followed by Moody’s (37%) and Fitch

(13%), implying that two NRSROs (S&P and Moody’s) account for 83% of all credit ratings

outstanding and three NRSROs (S&P, Moody’s, and Fitch) account for approximately 97%.

Also, as discussed above, Table 1 shows that these three NRSROs employ 90% of the total

number of NRSRO credit analysts. Comparing the number of credit ratings outstanding for

established NRSROs and newly registered NRSROs may not provide a complete picture of

competition in the industry. The incumbent NRSROs (particularly S&P, Moody’s, and Fitch)

have a longer history of issuing credit ratings, and their credit ratings include those for debt

obligations and obligors that were rated long before the establishment of the newer entrants. 74

Recent trends in the industry structure are shown in Table 3, which reports the inverse of

the Herfindahl-Hirschman Index (HHI) as a measure of industry concentration by rating class. 75

The HHI inverse is calculated from 2007 to 2013 for credit ratings outstanding as reported by the

NRSROs in each rating class. Table 3 shows that the NRSRO industry concentration for all

rating classes has moderately increased as suggested by the decrease in the HHI inverse since

2010. Despite a monotonic increase in competition in the rating class of asset-backed securities,

the NRSRO industry remains concentrated, with the three largest NRSROs accounting for

approximately 95% of the NRSROs’ 2013 fiscal year total revenue, based on the annual reports

the NRSROs furnish to the Commission.

Table 3 – Inverse of Herfindahl-Hirschman index by class of credit rating

Year

2007

2008

2009

2010

2011

2012

2013

Financial

Institutions

3.37

3.72

3.85

3.99

4.16

4.04

3.99

Insurance

Companies

4.02

4.05

3.84

3.37

3.76

3.72

3.68

Corporate

Issuers

3.27

3.79

3.18

3.17

3.02

3.00

3.03

Asset-backed Government

Securities

2.71

2.35

2.82

2.83

3.18

2.65

3.20

2.69

3.38

2.47

3.44

2.50

3.48

2.46

Total

Ratings

2.65

2.99

2.86

2.88

2.74

2.75

2.72

Note: The inverse of HHI is determined using the approximate numbers of NRSRO credit ratings outstanding reported in the

Commission staff annual reports on NRSROs published in June 2008, September 2009, January 2011, March 2012, December

2012, and December 2013. For the 2013 calendar year end, the inverse of HHI is calculated using the number of outstanding

credit ratings reported by NRSROs in their annual certifications.

In particular, for the asset-backed security class – which includes, among other things,

RMBS, commercial mortgage backed securities (“CMBS”), and consumer finance and other

asset-backed securities – Table 4 below shows the number of credit ratings outstanding from

2007 to 2013. The total number of outstanding credit ratings has significantly decreased (by

38%) since 2007, mostly due to pay-downs of existing asset-backed securities that have not been

See 2013 Annual Staff Report on NRSROs, p. 12.

The inverse of HHI can be interpreted as the number of equally-sized firms necessary to replicate the

degree of concentration in a particular industry.

replaced by newly issued asset-backed securities that are rated by NRSROs. 76 While the three

largest NRSROs accounted for 97% of the outstanding credit ratings for asset-backed securities

in 2007, this number decreased to 90% in 2013.

Table 4 – Approximate number of credit ratings outstanding in the asset-backed security class

NRSROs

S&P, Moody’s, &

Fitch

Other NRSROs

A.M. Best

DBRS

EJR

Fitch

HR Ratings

JCR

Kroll

Moody’s

Morningstar

R&I

S&P

Total

2007

2008

2009

2010

2011

2012

2013

97%

840

–

72,278

–

246

110,000

10,235

214

197,700

391,635

96%

7,470

77,480

–

109,261

9,200

210

198,200

401,960

94%

8,430

69,515

–

106,337

8,856

186

124,600

318,056

94%

10,091

64,535

–

N/R

101,546

8,322

N/R

117,900

302,461

91%

9,889

58,315

–

N/R

93,913

16,070

–

108,400

286,696

91%

10,054

N/R

56,311

N/R

352

82,357

13,935

–

97,500

260,564

90%

10%

10,706

N/R

53,612

N/R

1,401

76,464

11,567

–

90,000

243,806

Note: “N/R” indicates that an NRSRO is not registered for the asset-backed security class of credit ratings and “–” indicates that

the credit rating agency was not registered as an NRSRO for the applicable year. Kroll acquired LACE Financial Corp. in

August 2010. Morningstar, formerly known as Realpoint LLC, changed its name in 2011. Rating and Investment Information,

Inc. (“R&I”) withdrew its registration as an NRSRO with the Commission in October 2011. HR Ratings became registered as an

NRSRO in 2012. Statistics come from the Commission staff annual reports on NRSROs published in June 2008, September

2009, January 2011, March 2012, December 2012, and December 2013. For calendar year 2013, the statistics come from the

annual certifications of the NRSROs.

In 2013, some of the relatively newer or smaller NRSROs increased their market shares

in terms of rating asset-backed securities. Table 5 reports full-year credit rating agency

information for 2013, compared to 2007, the year immediately prior to the financial crisis. As

the total issuances of asset-backed securities decreased considerably from 2007 to 2013, DBRS

has maintained its market share in rating new issuances and has become the most active

participant in rating RMBS, while S&P, Moody’s and Fitch have lost market shares. DBRS,

Kroll, and Morningstar have gained market shares in rating CMBS after the financial crisis and

have rated a significant number of newly issued CMBS in 2013. Finally, in the market for rating

See 2013 Annual Staff Report on NRSROs, p. 12.

consumer finance and other asset-backed securities, which has the largest number of issuances,

DBRS and Kroll have increased their market shares, although S&P, Moody’s and Fitch continue

to play a significant role.

Table 5 – Market shares of credit rating agencies for RMBS, CMBS, and consumer finance and other assetbacked securities, 2013 and 2007

2013

Market

Issuance

No. of

Rank

NRSROs

($ mil.)

Offerings

(%)

Residential mortgage-backed securities

DBRS

$12,501.90

61.4

Fitch

9,969.60

48.9

S&P

9,597.50

47.1

Kroll

7,908.70

38.8

Moody’s

3,796.00

18.6

Total

$20,372.00

100.0

Commercial mortgage-backed securities

Moody’s

$62,802.60

72.9

Fitch

50,447.70

58.6

Kroll

45,140.10

52.4

S&P

34,255.20

39.8

DBRS

18,574.90

21.6

Morningstar

17,089.00

19.8

Total

$86,135.80

122

100.0

Consumer finance and other asset-backed securities

S&P

$134,860.60

244

69.3

Moody’s

114,569.90

155

58.9

Fitch

113,213.80

156

58.2

DBRS

16,530.60

8.5

Kroll

3,983.10

2.0

Total

$194,600.70

341

100.0

No. of

Offerings

Market

(%)

20072013

Change

(%)

$12,817.60

253,721.10

409,532.40

N/A

324,923.50

$435,815.60

318

534

N/A

421

575

2.9

58.2

94.0

N/A

74.6

100.0

-2.5

-96.1

-97.7

N/A

-98.8

-95.3

$171,787.00

159,687.30

N/A

202,381.00

13,295.30

N/A

$230,195.80

N/A

74.6

69.4

N/A

87.9

5.8

N/A

100.0

-63.4

-68.4

N/A

-83.1

39.7

N/A

-62.6

$576,417.90

563,982.90

342,140.10

43,102.70

N/A

$596,016.20

884

735

418

N/A

981

96.7

94.6

57.4

7.2

N/A

100.0

-76.6

-79.7

-66.9

-61.6

N/A

-67.3

2007

Issuance

($ mil.)

Note: A single offering of asset-backed securities may consist of multiple tranches of securities. An NRSRO may rate one or

multiple tranches of the securities issued in the offering. Market shares of individual NRSROs do not add up to 100% since more

than one NRSRO may rate a particular offering. “N/A” indicates that statistics are not available for 2007. CMBS data relates to

U.S. CMBS, including U.S. conduit/fusion and U.S. single borrower. Data comes from Asset-Backed Alert and Commercial

Mortgage Alert websites, publicly available at http://www.abalert.com/ranks.php and http://www.cmalert.com/ranks.php.

Asset-Backed Security Issuers, Underwriters, and Third-Party

Due Diligence Providers

The asset-backed security market that existed in the United States as of the end of 2013

differed significantly from the market prior to the crisis. In 2004, issuing entities of non-agency

asset-backed securities held $2.6 trillion in assets, which grew to $4.5 trillion in 2007 and

declined to $1.6 trillion in 2013. 77 Table 6 presents issuance amounts, number of offerings, and

number of unique issuers for non-agency asset-backed securities, categorized by type of

offering. 78 While new issuances of registered asset-backed securities represented the majority of

offerings and totaled $1.0 trillion in 2004, they drastically dropped to $140.7 billion in 2008. In

2013, the asset-backed security market totaled $393.6 billion, of which $174.1 billion is the new

issuance amount of registered asset-backed securities.

Table 6 – Issuance amount, number of offerings, and number of unique

issuers for non-agency asset-backed securities

Year

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011

2012

2013

Issuance Amount ($ bln)

Number of Offerings

Regist’d 144A Private Total Regist’d 144A Private Total

617.13 122.07

2.00 741.20

1,074 491

31 1,596

790.47 149.20

0.17 939.85

1,271 589

3 1,863

1,024.16 186.53

0.85 1,211.53

1,370 670

2 2,042

1,450.33 322.64

3.70 1,776.68

1,594 907

3 2,504

1,446.07 623.38

0.50 2,069.95

1,508 1,551

1 3,060

1,048.81 518.59

0.55 1,567.95

1,088 1,102

1 2,191

140.70 130.80

0.00 271.49

163 240

0 403

85.45 120.14

0.00 205.58

80 266

0 346

51.01 163.30 14.01 228.32

65 401

4 470

74.94 139.06 13.58 227.59

86 291

15 392

157.15 186.53

0.00 343.68

157 465

0 622

174.06 219.47

0.08 393.61

182 532

1 715

Number of Unique Issuers

Regist’d 144A Private Total

143 226

327

139 223

309

131 218

298

134 300

376

116 406

460

111 342

396

128

29 145

160

39 163

179

51 242

270

61 294

336

Note: Statistics are calculated by DERA using the Asset-Backed Alert and Commercial Mortgage Alert databases. A single

offering of asset-backed securities may consist of multiple tranches of securities. An NRSRO may rate one or multiple tranches

of the securities issued in the offering. The offerings are categorized by offering year and offering type (Commission registered,

Rule 144A, or traditional private offerings). Non-agency asset-backed securities include RMBS, CMBS, and other asset-backed

securities. Non-agency RMBS include residential, Alt-A, subprime RMBS, high loan-to-value ("no-equity") loans, and non-U.S.

residential loans. Auto loan asset-backed securities include asset-backed securities backed by auto loans and auto leases, both

prime and subprime, motorcycle loans, recreational vehicle loans, and truck loans. The first set of columns show the total

issuance amounts in billions of dollars. The second set of columns show the total number of asset-backed security offerings. The

third set of columns show the number of unique issuers of asset-backed securities in each category. The number in the column

“Total” may not be the sum of numbers in the columns “Regist’d”, “144A” and “Private” because some issuers may initiate

offerings in several categories. Only non-agency asset-backed security offerings sold in the United States and issuers of such

offerings are counted.

Issuers of asset-backed securities often include banks, mortgage companies, finance

companies, investment banks, and other entities that originate or acquire and package financial

This information is derived from data compiled by the Federal Reserve and published in quarterly Z.1

releases, which are available at http://www.federalreserve.gov/releases/Z1/default.htm. Statistics include

private mortgage pools, consumer credit, business loans, student loans, consumer leases, and trade credit

securitization.

In this section of the release, the issuer of the asset-back security means the person that primarily organizes

and initiates the offering of the asset-backed security, often referred to as the sponsor.

assets for resale as asset-backed securities. 79 As reported in Table 6, in 2004 there were 298

unique issuers, while in 2013 there were 336 unique issuers, mostly involved in Rule 144A

offerings. 80 The ten most active issuers were responsible for about 30% of the total issuance

amounts at the end of 2013. 81

As noted in Figure 1 below, an analysis of the segments of the asset-backed security

market shows that all segments experienced significant downturns during the crisis but only a

few of them have experienced a recovery in the aftermath. Figure 1 focuses on non-agency

asset-backed security offerings and reports the issuance volume by main asset classes (RMBS,

CMBS, auto loans/leases, credit card loans, student loans, and other asset-backed securities).

See Asset-Backed Securities, Securities Act No. 8518 (Dec. 22, 2004), 70 FR 1506 (Jan. 7, 2005).

The number of issuers varies across segments of the asset-backed security market. For example, as of

December of 2013 there were twenty-two and eighty-three issuers involved in RMBS and CMBS offerings,

respectively.

The market share attributed to the issuer of an asset-backed security is calculated by DERA staff using the

Asset-Backed Alert and Commercial Mortgage Alert databases.

Figure 1 - Issuance volume (in billions of dollars) of asset-backed security offerings

by main asset classes, 2004-2013

RMBS

800.00

700.00

CMBS

600.00

Auto loans/leases

500.00

400.00

Credit card loans

300.00

200.00

Student loans

100.00

Other ABS

0.00

2004

2005

2006

2007

2008

2009

2010

2011

2012

2013

Note: The offerings are categorized by offering year and underlying asset type. A single offering of asset-backed securities may

consist of multiple tranches of securities. An NRSRO may rate one or multiple tranches of the securities issued in the offering.

Non-agency RMBS include residential, Alt-A, and subprime RMBS, and asset-backed securities backed by home equity loans

and lines of credit. Only non-agency RMBS offerings sold in the United States are counted. Auto loan asset-backed securities

include asset-backed securities backed by auto loans, both prime and subprime, motorcycle loans, truck loans, and recreational

vehicle loans. Data is compiled from Asset-Backed Alert and Commercial Mortgage Alert databases.

As shown in Figure 1, new issuances of non-agency RMBS in 2004 totaled $542 billion,

with registered offerings representing the majority of non-agency RMBS issued before the crisis.

Non-agency RMBS issuance – which totaled $715 billion in 2007 – dropped drastically to $35

billion in 2008. As of the end of 2013, the non-agency RMBS market remains weak and consists

almost exclusively of unregistered RMBS offerings. In particular, new issuances of non-agency

RMBS totaled $25 billion in 2013, which represents about 5% of the issuance level in 2004.

CMBS experienced a similar drop in issuance levels, though it has rebounded to a level that is

closer to the 2004 issuance level than RMBS. In particular, CMBS issuance rose from $96

billion in 2004 to $231 billion in 2007. It then dropped to $12 billion in 2008. It was $86 billion

in 2013, which is about 90% of the issuance level in 2004. The consumer finance asset-backed

security market also declined drastically in terms of number of offerings and issuance volume

after the financial crisis. For example, $70 billion of securities backed by auto loans and leases

were issued in 2004, but issuance decreased to $38 billion in 2008. The issuances of consumer

finance asset-backed securities, especially those securities backed by auto loans and leases, and

other asset-backed securities have steadily increased since 2008 to reach pre-crisis levels of

about $75 billion in 2013.

Among the asset-backed security segments, the non-agency RMBS segment has

experienced a significant decline in the number of issuers with twenty-two issuers arranging nonagency RMBS (and only one issuer arranging non-agency registered RMBS) as of the end of

2013, compared to fifty-eight issuers in 2004. In the RMBS market, issuers arranging nonagency RMBS encounter competitive pressure from government-sponsored enterprises that

arrange RMBS that are guaranteed 82 and exempt from registration and reporting requirements. 83

As non-agency RMBS issuance has declined, issuance of agency RMBS has increased.

Issuances of RMBS arranged by the Federal National Mortgage Association, the Federal Home

Loan Mortgage Corporation, and the Government National Mortgage Association were $1.4

trillion in 2004 and grew to $1.9 trillion in 2013.84

Table 7 shows the number of unique underwriters of non-agency asset-backed securities.

As of the end of 2013, it is a highly concentrated industry with ninety underwriters (if

international securitizations are included in the data) and fifty underwriters (if international

See N. Eric Weiss, GSEs and the Government’s Role in Housing Finance: Issues for the 113th Congress,

Congressional Research Service Report for Congress (2013).

Mortgage-backed securities issued by government-sponsored enterprises and the Government National

Mortgage Association have been and continue to be exempt from registration under the Securities Act and

most provisions of the federal securities laws. For example, the mortgage-backed securities issued by the

Government National Mortgage Association are exempt securities under section 3(a)(2) of the Securities

Act (15 U.S.C. 77c(a)(2)) and section 3(a)(12) of the Exchange Act (15 U.S.C. 78c(a)(12)). The chartering

legislation for the Federal National Mortgage Association and the Federal Home Loan Mortgage

Corporation contain exemptions with respect to the mortgage-backed securities issued by these entities.

See 12 U.S.C. 1723c; 12 U.S.C. 1455g.

See Securities Industry Financial Market Association (“SIFMA”), US Mortgage-Related Issuance and

Outstanding Data from 1996 to May 2014 (issuance), 2002 to 2014 Q1 (outstanding) (June 3, 2014 update).

securitizations are excluded), with the top ten underwriters by volume underwriting about 70%

of the securitizations. 85

Table 7 – Number of unique asset-backed security underwriters

Year

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011

2012

2013

Regist’d

144A

Private

Total

Excluding

Internat’l

101

114

109

Total

Including

Internat’l

107

109

123

118

137

132

113

Note: Statistics are calculated by DERA staff using the Asset-Backed Alert and Commercial Mortgage Alert databases. A single

offering of asset-backed securities may consist of multiple tranches of securities. An NRSRO may rate one or multiple tranches

of the securities issued in the offering. The number of unique underwriters of asset-backed securities is divided into categories

by type of offering (registered, 144A, private, or international). The total number in the last column may not be the sum of

numbers in the columns labeled “Public”, “144A”, “Private,” and “Internat’l” because some underwriters may market offerings

in several categories. Only non-agency asset-backed security offerings and underwriters of such deals are counted.

Finally, providers of third-party due diligence services with respect to asset-backed

securities are significantly affected by the amendments and new rules being adopted today. The

Commission has little information about these firms and the characteristics of the industry. The

Commission estimates that there are approximately fifteen providers of third-party due diligence

services. 86 Because there are very few publicly traded firms specializing in due diligence, little

The market share attributed to an asset-backed security underwriter is calculated by DERA staff using

Asset-Backed Alert and Commercial Mortgage Alert databases.

This number comes from combining the names of third-party due diligence firms cited by Vicki Beal,

Senior Vice President of Clayton Holdings, in her testimony before the Financial Crisis Inquiry

Commission, and the names of third-party due diligence firms that S&P reviews as a part of its U.S. RMBS

rating process. See Testimony of Vicki Beal, Senior Vice President of Clayton Holdings before the

Financial Crisis Inquiry Commission, (Sept. 23, 2010), available at http://fcicstatic.law.stanford.edu/cdn_media/fcic-testimony/2010-0923-Beal.pdf (“Clayton Testimony”). S&P’s

updated list of third-party due diligence firms reviewed for U.S. RMBS is available at

https://www.globalcreditportal.com/ratingsdirect/renderArticle.do?articleId=1246530&SctArtId=208825&f

rom=CM&nsl_code=LIME. The Commission does not know whether the estimate of fifteen providers of

third-party due diligence services captures all of the primary participants in this business but believes that,

based on available information, this is a reasonable estimate for purposes of this economic analysis.

is known about these service providers in terms of loan review volume, market share, and

revenue. 87

Asset-backed security issuers and underwriters may use third-party due diligence services

to identify issues with loans, to negotiate better prices on pools of loans they are considering for

purchase, and to negotiate expanded representations and warranties in purchase and sale

agreements from sellers. 88 The reviews of third-party due diligence providers are performed on

an adverse or random sample of loans consistent with the guidelines of clients. Compensation is

likely not contingent on due diligence findings or the ultimate performance of the loans

reviewed. Instead, third-party due diligence providers may be paid a standard service fee for

each loan reviewed. 89

Industry Practices

The Commission staff conducts annual examinations of each NRSRO and publishes a

report summarizing the essential findings of the examinations, as required by section 15E(p)(3)

of the Exchange Act. 90 The staff’s 2013 report noted improvements, relative to prior

examinations, among the NRSROs in five general areas that are related to the amendments and

new rules being adopted today: enhanced documentation, disclosure, and board of director

oversight of criteria and methodologies; investment in software or computer systems for

electronic recordkeeping and monitoring employee securities trading; increased prominence of

See Clayton Testimony, p. 1 (describing the market for due diligence services as “highly fragmented,

highly competitive and rapidly changing”).

See id. at 2.

See id. at 3.

Section 923(a)(8) of the Dodd-Frank Act struck the existing text in paragraph (p) of section 15E of the

Exchange Act, which related to the date of applicability of the Rating Agency Act of 2006, and added new

text. See Pub. L. No. 111-203, 932(a)(8). Section 15E(p)(3) of the Exchange Act requires, among other

things, the Commission staff to conduct an examination of each NRSRO at least annually. See 15 U.S.C.

78o-7(p)(3). Annual inspection reports for 2011, 2012, and 2013 are available at

http://www.sec.gov/divisions/marketreg/ratingagency.htm.

the role of the designated compliance officer within NRSROs; implementation or enhancement

of internal controls over the rating process (for example, use of audits and other testing to verify

compliance with federal securities laws, and employee training on compliance matters); and

adherence to internal policies and procedures. 91 The report also discussed certain weaknesses or

concerns in a number of review areas: adherence to policies, procedures, and methodologies; 92

management of conflicts of interest; 93 implementation of ethics policies; 94 internal supervisory

controls; 95 governance; 96 the activities of the designated compliance officer; 97 the processing of

complaints; 98 and the policies governing post-employment activities of former staff of the

NRSRO. 99 These essential findings were related to several areas of NRSRO operations and were

not limited to activities relating to rating asset-backed securities.

Broad Economic Considerations

In this section, the Commission describes the primary economic impacts that may derive

from the amendments and new rules being adopted today, relative to the baseline discussed

above. A detailed analysis of the particular economic effects – including the costs and benefits

and the impact on efficiency, competition, and capital formation – that may result from the

amendments and rules is presented in the focused economic analyses in section II of this

See Commission staff, 2013 Summary Report of Commission Staff’s Examinations of Each Nationally

Recognized Statistical Rating Organization (Dec. 2013) (“2013 Annual Staff Inspection Report”), pp. 7-9.

See 2013 Annual Staff Inspection Report, pp. 9-11.

Id. at 11-13.

Id. at 13-14.

Id. at 14-19.

Id. at 19-20.

Id. at 20-21.

Id. at 21-22.

Id. at 22-23.

release. 100

Section 3(f) of the Exchange Act requires the Commission, when engaging in rulemaking

that requires the Commission to consider or determine whether an action is necessary or

appropriate in the public interest, to also consider whether the action will promote efficiency,

competition, and capital formation. 101 Further, section 23(a)(2) of the Exchange Act requires the

Commission, when adopting rules under the Exchange Act, to consider the impact that any new

rule would have on competition and to not adopt any rule that would impose a burden on

competition that is not necessary or appropriate in furtherance of the purposes of the Exchange

Act. 102 The Commission’s analysis of the economic effects, including the likely costs and

benefits and the likely impact on efficiency, competition, and capital formation of the

amendments and new rules, include those attributable to the rulemaking that the Commission is

mandated to undertake in accordance with the Dodd-Frank Act and those attributable to the

exercise of the Commission’s discretionary authority.

In the proposing release, the Commission solicited comments on all aspects of the costs

and benefits associated with the proposed rules. In addition to comments on the economic

effects of specific provisions, which will be discussed in section II of this release, the

Commission received comments on the overall economic effects of the proposed amendments

and new rules. Generally, commenters expressed concerns that the potential cumulative burden

and costs associated with the proposed amendments and new rules could be so onerous that they

would have negative effects on competition by imposing an excessive burden on smaller

100

See sections II.A.4., II.B.4., II.C.3., II.D.2., II.E.4., II.F.3., II.G.6., II.H.4., II.I.3., II.J.3., II.K.2., II.L.2., and

II.M.5. of this release.

101

See 15 U.S.C. 78c(f).

102

See 15 U.S.C. 78w(a)(2); see also Current Guidance on Economic Analysis in SEC Rulemakings (available

at: http://insider.sec.gov/divisions_offices/hqo/dera/rsfi-guidance-econ_analysis-rulemaking.pdf)

NRSROs and raising barriers to entry for credit rating agencies that seek to register as

NRSROs. 103 In particular, one commenter suggested that “fostering competition among rating

agencies was a primary goal of both the Rating Agency Act of 2006 and the Dodd-Frank Act”

but that “the proposed rules will be so costly to implement that additional credit rating agencies

are unlikely to register as NRSROs and the existing pool of registrants may contract.” 104

As discussed in section II of this release, the Commission has considered these comments

and has modified the amendments and new rules being adopted today from the proposals in a

number of ways that are designed to reduce the cumulative burden and costs associated with

complying with the new requirements. Nonetheless, the Commission recognizes – as reflected in

the economic analysis – that the amendments and rules establish a substantial package of new

requirements applicable to NRSROs and that complying with these requirements will entail

significant costs to NRSROs. 105 The amendments and rules also impose burdens on issuers and

underwriters of asset-backed securities and providers of third-party due diligence services with

respect to asset-backed securities. As discussed throughout the economic analysis, the

Commission believes that the new requirements should result in substantial benefits and should

not impose a burden on competition that is not necessary or appropriate in furtherance of the

purposes of the Exchange Act.

In particular, the amendments and new rules being adopted today are designed to

103

See A.M. Best Letter; DBRS Letter; EJR Letter; Kroll Letter; Morningstar Letter; S&P Letter;

TradeMetrics Letter.

104

See DBRS Letter. This commenter also stated that a “contradiction lies in the fact that, while directing the

Commission to impose costly and onerous new obligations on rating agencies who choose to register as

NRSROs, the Dodd-Frank Act also directs the Commission to remove all references to credit ratings from

the federal securities regulations.” See DBRS Letter. See also Pub. L. No. 111-203, 939A.

105

Some NRSROs may be subject to rules in foreign jurisdictions under which certain of their policies and

procedures or other practices are affected by requirements of these foreign jurisdictions that may be similar

to some of the requirements imposed by the amendments and new rules. While the requirements of foreign

jurisdictions are not analyzed here in detail, they may impact the incremental costs and benefits of the

amendments and new rules.

implement Title IX, Subtitle C of the Dodd-Frank Act, which, in turn, was designed to address

the causes of certain market failures (that is, the principal-agent problem, 106 including conflicts of

interest, and asymmetric information) that may impair the integrity and transparency of NRSRO

credit ratings and the procedures and methodologies NRSROs use to determine credit ratings.

Some of the amendments and new rules are primarily designed to enhance the integrity of how

NRSROs determine credit ratings by improving internal governance of NRSROs, managing

potential principal-agent problems and conflicts of interest in the credit rating process, and

promoting adherence to the procedures and methodologies for determining credit ratings and

compliance with laws and regulations. 107 For example, provisions in the amendments and new

rules require an NRSRO, among other things, to: (1) assess and report on the effectiveness of

internal controls; (2) address conflicts of interest relating to sales and marketing activities and

employment of former analysts; (3) have policies and procedures relating to their procedures and

methodologies for determining credit ratings; (4) have standards of training, experience and

competence for their credit analysts; and (5) have policies and procedures to promote the

consistent use of credit rating symbols. 108

Other provisions in the amendments and new rules being adopted today are designed

mainly to enhance the transparency of NRSRO credit ratings by increasing disclosure and

reducing information asymmetries that may adversely affect users of credit ratings. This should

106

A principal–agent problem occurs when one person (the “agent”) is able to act in the person’s own best

interest rather than in the interest of another person (the “principal”). The problem arises when the parties

have different interests and the agent has more information than the principal so that the principal cannot

ensure that the agent is always acting in the principal’s best interests, especially where activities that are

useful to the principal are costly to the agent and where monitoring of the agent’s activities is costly to the

principal. For example, a principal-agent problem may arise if an NRSRO produces credit ratings that, as a

result of conflicts of interest, are not informative to the users of credit ratings.

107

These requirements are discussed below in sections II.A., II.B., II.C., II.D., II.F., II.I., II.J., and II.K. of this

release.

108

These requirements are discussed below in sections II.A., II.B., II.C., II.F., II.I., and II.J. of this release.

facilitate external scrutiny of NRSRO activities. More specifically, provisions in the

amendments and new rules require an NRSRO, among other things, to disclose: (1) standardized

performance statistics; (2) increased information about credit rating histories; (3) information

about material changes and significant errors in the procedures and methodologies used to

determine credit ratings; and (4) information about a specific rating action. 109 The main

objective of these requirements is to improve the information provided to users of credit ratings,

including investors. The enhanced disclosure may reduce information asymmetries between the

NRSRO and the users of its credit ratings, enabling the users to make more informed investment

and credit related decisions and allowing them to compare the performance of credit ratings by

different NRSROs. Additionally, there are requirements in the amendments and new rules that

are designed to reduce information asymmetries among issuers and underwriters of asset-backed

securities, NRSROs rating asset-backed securities, and the users of credit ratings for assetbacked securities. 110 These requirements may benefit NRSROs and users of credit ratings,

including investors in these securities.

Amendments and Rules Enhancing NRSRO Governance and

Integrity of Credit Ratings

The requirements in the amendments and new rules being adopted today that are

primarily designed to enhance an NRSRO’s internal governance should have economic benefits,

relative to the existing baseline, in terms of promoting the integrity of how NRSROs determine

and monitor credit ratings. In particular, there are new requirements applicable to NRSROs that

assign responsibilities to an NRSRO’s management and board of directors, which should

promote accountability and facilitate internal oversight over the processes governing the

109

These requirements are discussed below in sections II.E., II.F., II.G., and II.L. of this release.

110

These requirements are discussed below in sections II.E., II.G., and II.H of this release.

determination of credit ratings and the implementation of the procedures and methodologies an

NRSRO uses to determine credit ratings. For example, an NRSRO is required to file an annual

report containing an assessment by management of the effectiveness during the fiscal year of the

internal control structure governing the implementation of and adherence to policies, procedures,

and methodologies for determining credit ratings. 111 Similarly, an NRSRO is required to

establish, maintain, enforce, and document policies and procedures reasonably designed to

ensure that the procedures and methodologies, including qualitative and quantitative data and

models, the NRSRO uses to determine credit ratings are approved by its board of directors or a

body performing a function similar to that of a board of directors. 112 The board’s oversight may

prevent situations in which an NRSRO seeks to implement a procedure or methodology to

determine credit ratings that is designed to inappropriately issue favorable credit ratings for

existing and prospective clients in order to retain or gain market share. 113

There are new requirements applicable to NRSROs pursuant to which they must avoid

certain conflicts of interest and have policies and procedures to take certain actions to address

credit ratings that are influenced by a conflict of interest. 114 These requirements may facilitate

the alignment of incentives at both the NRSRO and individual NRSRO employee level to

ultimately promote the production of unbiased credit ratings. At the NRSRO level, for example,

sales and marketing considerations may influence the NRSRO’s production of credit ratings.

Consequently, there is a new requirement that prohibits an NRSRO from issuing or maintaining

a credit rating where a person within the NRSRO who participates in determining or monitoring

111

This requirement is discussed below in section II.A.3. of this release.

112

This requirement is discussed below in section II.F.1. of this release.

113

See Griffin and Tang, Did Subjectivity Play a Role in CDO Credit Ratings?.

114

These requirements are discussed below in sections II.B. and II.C. of this release.

the credit rating, or developing or approving procedures or methodologies used for determining

the credit rating, including qualitative and quantitative models, also: (1) participates in sales or

marketing of a product or service of the NRSRO or a product or service of an affiliate of the

NRSRO; or (2) is influenced by sales or marketing considerations. 115 This absolute prohibition

should result in internal policies, procedures, and organizational solutions that isolate the

analytical function from sales and marketing considerations within the NRSRO. To the extent

that the absolute prohibition prevents credit analysts that participate in the determination of

credit ratings from being influenced by sales and marketing considerations, this should curb

potential conflicts of interest related to “rating catering” practices that have been suggested by

anecdotal evidence 116 and academic literature. 117 Isolating the production of credit ratings and

the development of procedures and methodologies for determining credit ratings from sales and

marketing considerations should promote the integrity and quality of credit ratings to the benefit

of their users.

At the individual level, an analyst’s incentives may be distorted by the prospect of future

employment at an issuer or underwriter, which could influence the analyst in determining a

credit rating for that issuer or underwriter. Consequently, there is a new requirement that an

115

This requirement is discussed below in section II.B.1. of this release.

116

See Coffee Testimony I, pp. 2-3.

117

See John M. Griffin, Jordan Nickerson, Dragon Yongjun Tang, Rating Shopping or Catering? An

Examination of the Response to Competitive Pressure for CDO Credit Ratings, REV. FIN. ST. 2270-2310

(2013). The authors draw a distinction between rating shopping and rating catering. “Rating shopping”

refers to a situation in which issuers solicit ratings from multiple credit rating agencies and then hire the

credit rating agencies that will issue the most favorable credit ratings (Skreta and Veldkamp, 2009). Even

though rating agencies adhere to their rating procedures and methodologies and issue unbiased ratings,

credit rating inflation is a natural consequence of the rating shopping process and is not driven by the rating

agencies. “Rating catering” refers to a situation in which issuers solicit credit ratings from multiple credit

rating agencies and the credit rating agencies may not strictly adhere to their procedures and methodologies

for determining credit ratings in order to issue more favorable credit ratings. The authors argue that under

pressure from investment banks, the credit rating agency with a more stringent procedure or methodology

for determining credit ratings stretches the procedure or methodology to match more lenient competitors

(Bolton, Freixas, and Shapiro, 2012).

NRSRO must have policies and procedures that address instances in which this conflict of

interest influenced a credit rating that are reasonably designed to ensure that the NRSRO

promptly determines whether the current credit rating must be revised so that it no longer is

influenced by a conflict of interest and is solely a product of the documented procedures and

methodologies the NRSRO uses to determine credit ratings and to promptly publish a revised

credit rating, an affirmation of the credit rating, or potentially place the credit rating on watch or

review and in each case include certain disclosures about the existence of the conflict. 118 This

provision is designed to require the NRSRO to promptly address a conflicted credit rating, and it

will likely limit the potential risk that users of credit ratings may make investment decisions

using biased or inaccurate information. The disclosures also should provide information to

investors and other users of credit ratings that they can use to scrutinize an NRSRO, thereby

promoting accountability to the market for failing to appropriately manage this conflict of

interest.

In terms of accountability, the Commission is finalizing a rule amendment pursuant to

which an NRSRO could have its registration suspended or revoked for violating a rule governing

conflicts of interest. 119 In addition, the Commission is amending Form NRSRO to provide

notice to an NRSRO or a credit rating agency applying for registration as an NRSRO that an

NRSRO is subject to applicable fines, penalties, and other sanctions under the Exchange Act. 120

This may serve as a reminder to the NRSRO or applicant of the potential consequences of failing

to comply with federal laws and regulations. Taken together, these accountability measures may

have incremental effects on the integrity of an NRSRO’s activities and credit ratings by

118

This requirement is discussed below in section II.C.1. of this release.

119

This requirement is discussed below in section II.B.3. of this release.

120

This requirement is discussed below in section II.D.1. of this release.

promoting compliance with the Commission’s rules.

There are new requirements applicable to NRSROs pursuant to which they must

establish, maintain, enforce, and document policies and procedures that are reasonably designed

to ensure that: (1) the procedures and methodologies, including qualitative and quantitative data

and models, the NRSRO uses to determine credit ratings are developed and modified in

accordance with the policies and procedures of the NRSRO; and (2) material changes to the

procedures and methodologies, including changes to qualitative and quantitative data and

models, that the NRSRO uses to determine credit ratings are applied consistently to all current

and future credit ratings to which the changed procedures or methodologies apply and, to the

extent that the changes are to surveillance or monitoring procedures and methodologies, applied

to current credit ratings to which the changed procedures or methodologies apply within a

reasonable period of time, taking into consideration the number of credit ratings impacted, the

complexity of the procedures and methodologies used to determine the credit ratings, and the

type of obligor, security, or money market instrument being rated. 121 To the extent that these

policies and procedures are effectively implemented and enforced, their application may enhance

the integrity of how NRSROs determine credit ratings.

There are new requirements applicable to NRSROs pursuant to which they must

establish, maintain, enforce, and document standards of training, experience, and competence for

the individuals they employ to participate in the determination of credit ratings that are

reasonably designed to achieve the objective that the NRSRO produces accurate credit ratings in

the classes of credit ratings for which the NRSRO is registered. At a minimum, these standards

must include: (1) a requirement for periodic testing of the individuals employed by the NRSRO

121

This requirement is discussed below in section II.F.1. of this release.

to participate in the determination of credit ratings on their knowledge of the procedures and

methodologies used by the NRSRO to determine credit ratings in the classes and subclasses of

credit ratings for which the individual participates in determining credit ratings; and (2) a

requirement that at least one individual with an appropriate level of experience in performing

credit analysis, but not less than three years, participates in the determination of a credit rating. 122

These requirements may increase the level of competence and experience of the credit analysts

employed by the NRSRO to participate in the production of credit ratings with possible positive

effects on the integrity and quality of credit ratings. 123

There are new requirements applicable to NRSROs pursuant to which they must have

reasonably designed policies and procedures relating to: (1) assessing the probability that an

issuer of a security or money market instrument will default, fail to make timely payments, or

otherwise not make payments in accordance with the terms of the security or money market

instrument; (2) clearly defining each symbol, number, or score in the rating scale used by the

NRSRO and including the definitions in Exhibit 1 to Form NRSRO; and (3) applying any

symbol, number, or score in the rating scale used by the NRSRO in a manner that is consistent

for all types of obligors, securities, and money market instruments for which the symbol,

number, or score is used. 124 Compliance with these policies and procedures may increase the

likelihood that NRSROs apply rating symbols, numbers, or scores consistently across classes of

credit ratings to the benefit of the users of credit ratings and obligors and issuers that are subject

122

See section II.I.1. of this release (providing a more detailed discussion of the requirements of this

paragraph).

123

See Cesare Fracassi, Stefan Petry, and Geoffrey Tate, Are Credit Ratings Subjective? The Role of Credit

Analysts in Determining Ratings (2014), available at

http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2230915. The authors find that the identity of the

credit analysts covering a firm significantly affects the firm’s credit rating, comparing credit ratings for the

same firm at the same time across credit rating agencies. Analyst effects account for 30% of the variation

within credit ratings. In addition, the quality of credit ratings varies with observable analyst characteristics.

124

These requirements are discussed below in section II.J. of this release.

to credit ratings.

Finally, there are new requirements applicable to NRSROs pursuant to which they must

retain records of certain internal controls, policies, procedures and standards they are required to

document. 125 These record retention requirements should facilitate Commission oversight of

NRSROs to the benefit of users of credit ratings. Similarly, the Exchange Act requires an annual

report of the NRSRO’s designated compliance officer to be filed on a confidential basis with the

Commission. 126 The new requirement should facilitate Commission oversight as well.

There will be costs associated with the amendments and new rules being adopted today

related to governance of NRSROs. 127 These costs will be primarily incurred by NRSROs. 128

Initial and ongoing direct costs, including compliance costs, may vary among the NRSROs

depending on the size and complexity of their business activities (for example, number of credit

ratings outstanding, number of analysts, or number of classes of credit ratings). Among other

costs, NRSROs also may incur training costs in order to make their personnel aware of the

changes in internal controls, policies, and procedures required by the amendments and new rules.

These costs are difficult to quantify because they depend significantly on how the required

changes differ from the internal policies and procedures currently in place within each NRSRO.

In addition, they depend on factors such as the NRSRO’s size and business complexity. For

example, an NRSRO may need to train its credit analysts and sales and marketing staff in the

updated policies and procedures related to the sales and marketing conflict requirements.

125

These requirements are discussed below in sections II.A.2., II.C.2., II.F.2., II.I.2., and II.J.2. of this release.

126

This requirement is discussed below in section II.K. of this release.

127

A detailed analysis of the economic costs, including compliance costs that can potentially result from each

amendment and/or rule is presented in the focused economic analyses in section II of this release. See

sections II.A.4., II.B.4., II.C.3., II.D.2., II.E.4., II.F.3., II.G.6., II.H.4., II.I.3., II.J.3., II.K.2., II.L.2., and

II.M.5. of this release.

128

NRSROs may be able to pass some of the incremental costs to their clients.

Among other factors, this cost will likely vary significantly with the degree of the existing

separation between the functions of analytical staff and sales and marketing personnel. 129

Keeping all other factors constant, the costs associated with establishing, maintaining,

enforcing, and documenting internal policies and procedures may be higher for structured

finance products because the inherent conflict of interest that credit rating agencies face in rating

these products is more acute than it is with respect to rating other types of securities. 130 In

addition, keeping all other factors constant, NRSROs operating under a business model that

combines the issuer-pay and subscriber-pay models may face greater direct costs, given that the

two models may entail different internal policies and procedures to prevent different sources of

potential conflicts of interest. A component of these costs may also be fixed, which may have a

disproportionate impact on smaller NRSROs that may find it more difficult to bear the costs. If

NRSROs are not able to readily pass the overall additional costs to clients, there may be adverse

effects, particularly on smaller NRSROs.

As a result of the amendments and new rules being adopted today, the number of credit

rating agencies registered with the Commission as NRSROs may decline if current registrants

believe that the cost of being registered and being subject to these new requirements outweighs

the benefit of registration. The barriers to entry for credit rating agencies to register as NRSROs

may rise, discouraging credit rating agencies from registering as NRSROs. Further, historically,

successful new entrants have established themselves by first specializing in a particular industry,

creating a track record in a particular rating class, and building the necessary reputational capital

129

This requirement is discussed below in section II.B.4. of this release.

130

See Amendments to Rules for Nationally Recognized Statistical Rating Organizations, 74 FR at 63844.

(“In the case of structured finance products, the Commission believes this ‘issuer/underwriter-pay’ conflict

is particularly acute because certain arrangers of structured finance products repeatedly bring ratings

business to the NRSROs. As sources of frequent, repeated deal-based revenue, some arrangers have the

potential to exert greater undue influence on an NRSRO than, for example, a corporate issuer that may

bring far less ratings business to the NRSRO.”) (footnotes omitted).

to achieve marketplace acceptance of their credit ratings. 131 Compliance costs may reduce the

incentive for an NRSRO to expand its rating business into new classes of credit ratings, with

adverse effects on competition in certain market segments. Also, if compliance costs

significantly erode profit margins for NRSROs, the barriers to exit from being registered as an

NRSRO in certain or all classes of credit ratings may lower. The risk for deregistration may

likely be higher for smaller NRSROs. As mentioned earlier, these costs also should depend on

the complexity of operations within the NRSRO. Further, given that the conflict of interest in

rating structured finance products is more acute, the competitive effects could be greater within

the markets for rating these products. These potential consequences could reduce competition

among NRSROs.

An amendment being adopted today provides a mechanism for a small NRSRO to seek

an exemption from the sales and marketing prohibition. 132 The exemption based on size may

decrease the burden on small NRSROs. However, this amendment could create adverse effects

on competition as exempted NRSROs may be able to draw business through rating catering. In

particular, exempted NRSROs may be able to more readily produce conflicted and inflated

ratings 133 or generate a greater stream of revenue from selling rating and ancillary services than

non-exempted NRSROs. Reputation, which is an important disciplinary mechanism in this

industry, may mitigate this risk to a certain extent. 134

131

See Commission, Report on the Role and Function of Credit Rating Agencies in the Operation of the

Securities Markets (Jan. 2003), p. 24.

132

This provision is discussed below in section II.B.3. of this release.

133

See Griffin, Nickerson, and Tang, Rating Shopping or Catering? An Examination of the Response to

Competitive Pressure for CDO Credit Ratings.

134

See Jerome Mathis, James McAndrews, and Jean-Charles Rochet, Rating the Raters: Are Reputation

Concerns Powerful Enough to Discipline Rating Agencies?, J. OF MONETARY ECONOMICS 657-674 (July

2009).

A number of credit rating agencies located in the United States have not registered as

NRSROs. 135 As U.S. regulatory agencies continue to remove references to NRSRO credit

ratings from the regulations they administer, market participants subject to these regulations may

choose to use unregistered credit rating agencies thereby diminishing the incentive to register as

an NRSRO. 136 On the other hand, users of credit ratings may choose to use NRSROs over

unregistered credit rating agencies because of the NRSRO registration and oversight program,

which is being enhanced by the amendments and new rules being adopted today.

To the extent that these amendments and new rules improve the quality of credit-related

information, they may have effects related to allocative efficiency and capital formation. As a

result of these amendments and new rules, users of credit ratings could make more efficient

investment decisions based on higher-quality information. Market efficiency also may improve

if credit ratings become more informative and the additional information is reflected in asset

prices. To the extent that the amendments and rules will be effective in enhancing the integrity

and quality of NRSRO credit ratings, users of these credit ratings may benefit from an enhanced

confidence in the quality of the creditworthiness assessments reflected in the credit ratings,

which may have positive effects on the willingness of investors to participate in the securities

markets and thereby enhance capital formation, as capital efficiently flows to more productive

uses. The benefits in terms of efficiency and capital formation arising from the rules enhancing

governance and the integrity of credit ratings are likely to be greater for asset-backed securities,

where the inherent conflict of interest in the issuer-pay model is more acute, and, as a result of

135

See, e.g., James H. Gellert, Chairman and CEO, Rapid Ratings International, Inc., Testimony Concerning:

Oversight of the Credit Rating Agencies Post Dodd-Frank (July 27, 2011) (testimony before the U.S.

House of Representatives, Committee on Financial Services, Subcommittee on Oversight and

Investigations), available at

http://www.rapidratings.com/images/custom/gellert_testimony_to_house_cfs_oversight_and_investigations

_july_27_2011_final_w_bio.pdf.

136

See Pub. L. No. 111-203, 939A.

the amendments and new rules, investors may become less reluctant to invest in asset-backed

securities.

Amendments and Rules Enhancing Disclosure and

Transparency of Credit Ratings

The requirements in the amendments and new rules being adopted today that are

primarily designed to enhance disclosure should have economic benefits, relative to the baseline

that existed before the amendments and rules were adopted, in terms of promoting the

transparency of credit ratings and NRSRO activities and, therefore, NRSRO accountability. This

should benefit users of credit ratings, including investors. The amendments and rules also should

enhance disclosure requirements with respect to asset-backed securities for the benefit of users of

credit ratings, including investors in these securities.

The amendments significantly enhance the existing requirements for NRSROs to produce

and disclose performance statistics to make the disclosures more comparable across NRSROs

and easier for users of credit ratings and others to understand. 137 Similarly, the existing

requirements for NRSROs to disclose rating histories are being enhanced to make the histories

more complete in terms of the scope of credit ratings that must be included in the histories and

more robust in terms of the information that must be disclosed with each rating action. 138 To the

extent that the new disclosures facilitate the evaluation of the performance of an NRSRO’s credit

ratings and the comparison of rating performance across all NRSROs – including direct

comparisons of the rating history of the same obligor or instrument across two or more NRSROs

– the rules may benefit users of credit ratings, including investors. In particular, the enhanced

disclosure may allow them to better assess the reliability of credit ratings from different

137

These amendments are discussed below in section II.E.1. of this release.

138

These amendments are discussed below in section II.E.3. of this release.

NRSROs and, in the case of issuer-paid credit ratings or subscriber-paid credit ratings, make

more informed decisions regarding whether to hire, or subscribe to the credit ratings of, a

particular NRSRO.

There are new requirements applicable to NRSROs pursuant to which they must publish

on their Internet websites: (1) material changes to the procedures and methodologies, including

to qualitative models or quantitative inputs, the NRSRO uses to determine credit ratings, the

reason for the changes, and the likelihood the changes will result in changes to any current credit

ratings; and (2) notice of the existence of a significant error identified in a procedure or

methodology, including a qualitative or quantitative model, the NRSRO uses to determine credit

ratings that may result in a change to current credit ratings. 139 These requirements may benefit

users of NRSRO credit ratings in terms of their ability to evaluate the procedures and

methodologies used by an NRSRO to determine credit ratings. In this way, they also may

promote the NRSROs’ accountability to the market and the issuance of quality credit ratings.

There are new requirements applicable to NRSROs pursuant to which they must publish

two items when taking a rating action: (1) a form containing certain quantitative and qualitative

information about the credit rating that is the result or subject of the rating action; and (2) any

certification of a third-party due diligence provider relating to the credit rating. 140 The required

disclosures may be used by investors and other users of credit ratings to better understand credit

ratings issued by NRSROs. Specifically, the forms and certifications will provide incremental

information about how a credit rating was produced (for example, disclosure about assumptions,

limitations, information relied on, version of the procedure or methodology used, potential

conflicts of interest) and the information content of the credit rating. The information disclosed

139

These amendments are discussed below in section II.F.1. of this release.

140

These amendments are discussed below in section II.G. of this release.

in the form, including information about the limitations of the credit rating and information

regarding due diligence, may discourage undue reliance on credit ratings by investors and other

users of credit ratings in making investment and other credit-based decisions.

There is a new requirement applicable to issuers and underwriters of asset-backed

securities pursuant to which they must disclose the findings and conclusions of any third-party

due diligence report they obtain. 141 The rule applies to both registered and unregistered offerings

of asset-backed securities. Additionally, there is a new requirement applicable to providers of

third-party due diligence services with respect to asset-backed securities pursuant to which they

must provide a written certification to any NRSRO that is producing a credit rating with respect

to the asset-backed security. 142 The certification must disclose information about the due

diligence performed, including a summary of the findings and conclusions of the third party, and

identification of any relevant NRSRO due diligence criteria that the third party intended to meet

in performing the due diligence.

As discussed above, the amendments and new rules are intended to reduce asymmetric

information in the asset-backed security market. NRSROs producing credit ratings for assetbacked securities may benefit from receiving the information in the certification. The

certification also will be signed by an individual who is duly authorized by the third-party due

diligence provider to make such a certification, promoting confidence in the accuracy of the

information disclosed. Importantly, issuers and underwriters can no longer select what part of

this information to provide to NRSROs, reducing the possibility of less favorable information

being withheld from NRSROs and reducing the risk that the credit ratings will be based on

imperfect or incomplete information (to the extent the NRSROs use information about due

141

These amendments are discussed below in section II.H.1. of this release.

142

These amendments are discussed below in sections II.H.2. and II.H.3. of this release.

diligence in producing their credit ratings). Further, making this information available to all

NRSROs (rather than just the NRSROs hired to rate the asset-backed security) could promote the

issuance of more credit ratings for a given asset-backed security, including credit ratings that

provide a more diverse range of views on the creditworthiness of the security. Users of credit

ratings, including investors and other participants in the asset-backed securities markets, may

benefit both directly and indirectly from the disclosures made by issuers, underwriters, and

providers of third-party due diligence services. To the extent that findings and conclusions of all

third-party due diligence reports were not previously disclosed to these persons, the amendments

and new rules should enhance information available to the public.

Finally, there are new requirements pursuant to which NRSROs must use the

Commission’s Electronic Data Gathering, Analysis, and Retrieval (“EDGAR”) system to

electronically submit Form NRSRO and required exhibits to the form to the Commission.143

Having all information available in an electronic format in EDGAR will provide a centralized

location and should make the information and the history of that information more easily

accessible, comparable, and searchable to users of credit ratings, including investors.

There will be costs associated with the amendments and new rules being adopted today

that are related to enhanced disclosure and transparency. 144 These costs will be primarily

incurred by NRSROs, 145 issuers and underwriters of asset-backed securities, and third-party due

diligence providers. Initial and ongoing direct costs, including compliance costs, may vary

among the affected parties depending on their size and the complexity of their business activities

143

See section II.L. of this release (providing a more detailed discussion of the amendments).

144

A detailed analysis of the economic costs, including compliance costs that can potentially result from each

rule is presented in the focused economic analyses in section II of this release. See sections II.A.4., II.B.4.,

II.C.3., II.D.2., II.E.4., II.F.3., II.G.6., II.H.4., II.I.3., II.J.3., II.K.2., II.L.2., and II.M.5. of this release.

145

NRSROs may be able to pass some of the incremental costs to their clients.

(for example, number of credit ratings outstanding, number of analysts, number of classes of

credit ratings, number of years issuing credit ratings, and number of historical credit ratings).

Keeping all other factors constant, NRSROs operating according to a subscriber-pay model may

face greater losses in revenue from the sale of access to historical ratings data, as more of this

data becomes publicly available, since they are likely to be more dependent on this source of

revenue than NRSROs operating according to the issuer-pay model. A component of these costs

may also be fixed, affecting more significantly smaller NRSROs that may find it more difficult

to bear the costs. If NRSROs are not able to readily pass the overall additional costs to clients,

there may be adverse effects, especially on smaller NRSROs.

Similar to the amendments and new rules relating to governance, the amendments and

new rules relating to disclosure and transparency could reduce the number of credit rating

agencies registered with the Commission as NRSROs to the extent that current registrants

believe the cost of being registered and subject to these new requirements outweighs the benefit

of registration. In addition, the barriers to entry for credit rating agencies to register as NRSROs

may rise, especially for smaller credit rating agencies. NRSROs may have a reduced incentive to

segments. Barriers to exit from registration as an NRSRO may lower due to the possible erosion

of profit margins, though an NRSRO’s decision to deregister from certain or all classes of credit

ratings may depend on whether users of credit ratings will favor NRSROs because of the

NRSRO registration and oversight program, which is being enhanced by the amendments and

new rules being adopted today. The risk for deregistration will likely be higher for smaller

NRSROs, given the fixed component of some compliance costs and the greater difficulty to pass

the increase in costs to their clients.

Also, the amendments and new rules may impact competition among third-party due

diligence providers. Although the Commission knows little about the characteristics of the

market for the services they provide, the certification requirement may increase the liability risk

for these providers, particularly for those who do not already bear expert liability under Rule

193. 146 If third-party due diligence providers are not able to charge more for performing the

asset review to account for the heightened risk of liability, some providers may exit the market or

some entities that otherwise would have entered the market may decide against doing so.

The amendments and new rules also may have positive effects on competition, efficiency

and capital formation. The enhanced standardization of the information content may facilitate

comparing performance statistics and rating histories across NRSROs. Clients of NRSROs (for

example, issuers, subscribers, and others) may use the performance statistics to inform their

hiring or subscribing decisions, increasingly promoting competition among NRSROs on the

basis of the quality of their credit ratings and the procedures and methodologies used to

determine credit ratings. To the extent that the adopted rules facilitate the external monitoring

and comparative analysis of NRSROs, they may allow users of credit ratings to develop more

refined views of NRSRO performance and thereby indirectly increase accountability and

encourage integrity in the production of credit ratings. This, in turn, may facilitate the ability of

NRSROs to establish and maintain reputations for issuing quality credit ratings to remain

competitive. More comparable performance data may also help relatively smaller and newer

146

See 17 CFR 230.193; 17 CFR 229.1111. Under Rule 193 and Item 1111 of Regulation AB, an issuer of a

registered asset-backed security is required to perform a review of the assets underlying the asset-backed

security and disclose the nature of the review. In meeting this requirement, an issuer may engage a third

party to perform the required review of the underlying assets. If the third party’s findings and conclusions

are to be attributed to it, the third-party must consent to being named in the issuer’s registration statement

as an “expert,” thus subjecting the third party to so-called “expert liability” under the Securities Act. If

third-party diligence providers are not subject to legal liability as experts, the issuer itself remains legally

accountable for the accuracy of the disclosures it makes to investors.

NRSROs, including subscriber-paid NRSROs, to attract attention to their rating performance,

enhancing their ability to develop a reputation for producing quality credit ratings. This may

allow them to better compete with more established competitors. Also, the ability of non-hired

NRSROs to obtain the information disclosed in the third-party due diligence certification may

provide them with an advantage in producing informative unsolicited credit ratings, relative to

unregistered credit rating agencies that cannot obtain this information.

The new disclosure requirements in the form and certifications that accompany a rating

action may reduce information asymmetries about how a credit rating was determined by

providing additional information about the rating process, such as assumptions, limitations,

version of the procedures or methodologies used, and, in the case of an asset-backed security, a

description of the findings and conclusions of a third-party due diligence provider, if such

services were employed. To the extent that the required disclosure does not diminish the content

and timeliness of the information conveyed with the rating actions, the enhanced information

may increase the ability of users of credit ratings to accurately interpret the information,

potentially resulting in more efficient investment decisions and higher overall market efficiency

to the benefit of those investors that use credit ratings. This, in turn, may increase investors’

participation in the securities markets with positive effects on capital formation. Because of the

higher degree of information asymmetry in the asset-backed security market, the benefits in

efficiency and capital formation resulting from the enhanced disclosure and transparency of

credit ratings are likely to be greater for these securities, with the result that investors may

become more willing to participate in this market.

II.

FINAL RULES AND RULE AMENDMENTS

As discussed in detail below, the Commission is adopting new rules and amendments to

existing rules to implement Title IX, Subtitle C of the Dodd-Frank Act and to enhance the

NRSRO registration and oversight program administered by the Commission. In designing rules

to implement Title IX, Subtitle C of the Dodd-Frank Act, the Commission has taken into account

section 15E(c)(2) of the Exchange Act. 147 This section provides, in pertinent part, that neither

the Commission nor any State (or political subdivision thereof) may regulate the substance of

credit ratings or the procedures and methodologies by which any NRSRO determines credit

ratings. 148 One way the Commission has sought to reconcile the rulemaking mandated by the

Exchange Act, as amended by the Dodd-Frank Act, with the limitation in section 15E(c)(2) is to

model rule text closely on statutory text.

INTERNAL CONTROL STRUCTURE

Section 932(a)(2)(B) of the Dodd-Frank Act added paragraph (3) to section 15E(c) of the

Exchange Act. 149 Section 15E(c)(3)(A) requires 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 (“internal control

structure”), taking into consideration such factors as the Commission may prescribe, by rule. 150

While section 15E(c)(3)(A) provides that the Commission “may” prescribe factors an NRSRO

would need to take into consideration when establishing, maintaining, enforcing, and

documenting the internal control structure, the requirement that an NRSRO “establish, maintain,

enforce, and document an effective internal control structure” is self-executing. 151

147

15 U.S.C. 78o-7(c)(2).

148

See 15 U.S.C. 78o-7(c)(2).

149

See Pub. L. No. 111-203, 932(a)(2)(B); 15 U.S.C. 78o-7(c)(3)(A).

150

See 15 U.S.C. 78o-7(c)(3)(A).

151

See id.

Consequently, an NRSRO must adhere to this provision irrespective of whether the Commission

prescribes factors pursuant to section 15E(c)(3)(A).

Section 15E(c)(3)(B) of the Exchange Act provides that the Commission “shall

prescribe” rules requiring each NRSRO to submit an annual internal controls report to the

Commission, which shall contain: (1) a description of the responsibility of the management of

the NRSRO in establishing and maintaining an effective internal control structure; (2) an

assessment of the effectiveness of the internal control structure; and (3) the attestation of the

chief executive officer (“CEO”), or equivalent individual, of the NRSRO. 152

In the proposing release, the Commission: (1) deferred prescribing factors the NRSRO

must take into consideration in establishing, maintaining, enforcing, and documenting an

effective internal control structure; (2) proposed amending the NRSRO recordkeeping rule (Rule

17g-2) to require that the documentation of the internal control structure be subject to the rule’s

record retention requirements; and (3) proposed amending the NRSRO annual reporting rule

(Rule 17g-3) to require an NRSRO to file an unaudited annual internal controls report with the

Commission.153

Prescribing Factors

In the proposing release, the Commission stated that it was deferring prescribing factors

an NRSRO must take into consideration when establishing, maintaining, enforcing, and

documenting an effective internal control structure to provide the Commission with an

opportunity – through the NRSRO examination process and the submission of annual reports by

the NRSROs on the effectiveness of their internal control structures – to review how NRSROs

have complied with the self-executing requirement in section 15E(c)(3)(A) of the Exchange Act

152

See 15 U.S.C. 78o-7(c)(3)(B)(i) through (iii).

153

See Nationally Recognized Statistical Rating Organizations, 76 FR at 33421-33425.

to establish, maintain, enforce, and document an effective internal control structure. 154 However,

the Commission sought comment on whether it would be appropriate as part of this rulemaking

to prescribe factors and on potential factors the Commission could prescribe. 155 In particular, the

Commission identified factors relating to: (1) the establishment of an internal control structure;

(2) the maintenance of an internal control structure; and (3) the enforcement of an internal

control structure. 156

In terms of establishing an internal control structure, the Commission requested comment

on the following factors:

•

Controls reasonably designed to ensure that a newly developed methodology or proposed

update to an in-use methodology for determining credit ratings is subject to an

appropriate review process (for example, by persons who are independent from the

persons that developed the methodology or methodology update) and to management

approval prior to the new or updated methodology being employed by the NRSRO to

determine credit ratings; 157

•

Controls reasonably designed to ensure that a newly developed methodology or update to

an in-use methodology for determining credit ratings is disclosed to the public for

consultation prior to the new or updated methodology being employed by the NRSRO to

determine credit ratings, that the NRSRO makes comments received as part of the

consultation publicly available, and that the NRSRO considers the comments before

implementing the methodology;

•

Controls reasonably designed to ensure that in-use methodologies for determining credit

ratings are periodically reviewed (for example, by persons who are independent from the

persons who developed and/or use the methodology) in order to analyze whether the

methodology should be updated;

154

Id. at 33421-33423.

155

Id.

156

Id. at 33422-33423.

157

Section 15E(t)(3)(A) of the Exchange Act contains a self-executing provision requiring that the board of

directors of the NRSRO shall “oversee” the “establishment, maintenance, and enforcement of policies and

procedures for determining credit ratings.” See 15 U.S.C. 78o-7(t)(3)(A). At the same time, section 15E(r)

of the Exchange Act requires the Commission to adopt rules “to ensure that credit ratings are determined

using procedures and methodologies, including qualitative and quantitative data and models” that are

approved by the board of the NRSRO. See 15 U.S.C. 78o-7(r)(1)(A).

158

•

Controls reasonably designed to ensure that market participants have an opportunity to

provide comment on whether in-use methodologies for determining credit ratings should

be updated, that the NRSRO makes any such comments received publicly available, and

that the NRSRO considers the comments;

•

Controls reasonably designed to ensure that newly developed or updated quantitative

models proposed to be incorporated into a credit rating methodology are evaluated and

validated prior to being put into use;

•

Controls reasonably designed to ensure that quantitative models incorporated into in-use

credit rating methodologies are periodically reviewed and back-tested;

•

Controls reasonably designed to ensure that an NRSRO engages in analysis before

commencing the rating of a class of obligors, securities, or money market instruments the

NRSRO has not previously rated to determine whether the NRSRO has sufficient

competency, access to necessary information, and resources to rate the type of obligor,

security, or money market instrument;

•

Controls reasonably designed to ensure that an NRSRO engages in analysis before

commencing the rating of an “exotic” or “bespoke” type of obligor, security, or money

market instrument to review the feasibility of determining a credit rating;

•

Controls reasonably designed to ensure that measures (for example, statistics) are used to

evaluate the performance of credit ratings as part of the review of in-use methodologies

for determining credit ratings to analyze whether the methodologies should be updated or

the work of the analysts employing the methodologies should be reviewed;

•

Controls reasonably designed to ensure that, with respect to determining credit ratings,

the work and conclusions of the lead credit analyst developing an initial credit rating or

conducting surveillance on an existing credit rating is reviewed by other analysts,

supervisors, or senior managers before a rating action is formally taken (for example,

having the work reviewed through a rating committee process);

•

Controls reasonably designed to ensure that a credit analyst documents the steps taken in

developing an initial credit rating or conducting surveillance on an existing credit rating

with sufficient detail to permit an after-the-fact review or internal audit of the rating file

to analyze whether the analyst adhered to the NRSRO’s procedures and methodologies

for determining credit ratings; and

•

Controls reasonably designed to ensure that the NRSRO conducts periodic reviews or

internal audits of rating files to analyze whether analysts adhere to the NRSRO’s

procedures and methodologies for determining credit ratings. 158

See Nationally Recognized Statistical Rating Organizations, 76 FR at 33422.

In terms of maintaining an internal control structure, the Commission requested comment

on the following factors:

•

Controls reasonably designed to ensure that the NRSRO conducts periodic reviews of

whether it has devoted sufficient resources to implement and operate the documented

internal control structure as designed;

•

Controls reasonably designed to ensure that the NRSRO conducts periodic reviews or

ongoing monitoring to evaluate the effectiveness of the internal control structure and

whether it should be updated; and

•

Controls designed to ensure that any identified deficiencies in the internal control

structure are assessed and addressed on a timely basis. 159

In terms of enforcing an internal control structure, the Commission requested comment

on the following factors:

•

Controls designed to ensure that additional training is provided or discipline taken with

respect to employees who fail to adhere to requirements imposed by the internal control

structure; and



Controls designed to ensure that a process is in place for employees to report failures to

adhere to the internal control structure. 160

In terms of documenting the internal control structure, the Commission asked for

comment on whether there should be a factor relating to the level of written detail about the

internal control structure that should be documented. 161

A number of commenters addressed whether the Commission should prescribe factors as

part of this rulemaking and, if so, the type of factors the Commission should prescribe. 162

NRSROs urged the Commission to defer rulemaking and stated that the Commission should not

159

Id.

160

Id. at 33422-33423.

161

Id.

162

See AFSCME Letter; A.M. Best Letter; Better Markets Letter; CFA/AFR Letter; CFA II Letter; COPERA

Letter; DBRS Letter; Kroll Letter; Levin Letter; Morningstar Letter; S&P Letter; TradeMetrics Letter.

prescribe factors. 163 For example, one NRSRO stated that the Commission should defer

rulemaking until it has the opportunity to determine through the examination process and its

review of the NRSROs’ annual reports the “best practices utilized” by NRSROs to comply with

the self-executing requirement in section 15E(c)(3)(A) and that the Commission’s “examination

feedback regarding best practices related to internal controls will be an important element for the

adequate design and monitoring of internal controls.” 164 Another NRSRO stated that it “strongly

agrees” with the Commission’s proposal to defer rulemaking but that, if the Commission

proceeds with rulemaking, it should “exercise caution” because attempting to create a "one-size

fits all" rule in “such a short timeframe could result in the creation of an anti-competitive

environment and the attendant unintended consequences.” 165 A third NRSRO stated that

“NRSROs should have the flexibility to implement whatever control structure suits their size and

particular business operations.” 166

In contrast, several other commenters stated that the Commission should not defer

rulemaking. 167 For example, one commenter stated that the Commission “already has significant

information about the weak internal controls at the NRSROs and has already identified a number

of factors critical to an effective internal control system” and that “[p]ostponing the issuance of

any standards will result in the NRSROs developing different internal control structures, making

oversight and the implementation of minimum standards more difficult, time consuming, and

163

See A.M. Best Letter; DBRS Letter; Kroll Letter; Morningstar Letter; S&P Letter.

164

See Morningstar Letter.

165

See A.M. Best Letter (“prescribing specific factors implies that all NRSROs are the same, which they are

not. NRSROs vary in size, ownership, business plans, and management. ‘Specific factors’ would

undoubtedly be designed to apply to the largest NRSROs – this scenario would create a disproportionate

impact on smaller NRSROs, whose internal control structure would be best served by designing and

implementing policies and procedures that apply the law to the specific characteristics of the NRSRO.”).

166

See DBRS Letter.

167

See AFR II Letter; AFSCME Letter; Better Markets Letter; CFA/AFR Letter; COPERA Letter; Levin

Letter.

expensive down the line.” 168 Another commenter stated that the proposed approach “will be

ineffective in reforming credit rating agency practices and will leave the Commission with little

if any ability to hold ratings agencies accountable if they adopt weak and ineffective controls.” 169

These commenters and others recommended that the Commission prescribe factors, 170 and one

of the commenters recommended that the Commission re-propose the rule to prescribe factors. 171

One commenter discussed factors that the commenter believed should be included in “a set of

mandatory minimum standards for an effective internal control system for credit ratings.” 172

Another commenter stated that “the criteria on which the Commission seeks comment are

precisely the sort of controls that ought to be in place if the system is operating effectively.” 173

A third commenter agreed that the rule should “incorporate all of these factors [as described in

the proposing release].” 174 Two commenters pointed to the internal control framework

developed by the Committee of Sponsoring Organizations of the Treadway Commission in 1992

as a model. 175 Two commenters stated that the rule should require that the documentation of the

internal control structure include specific elements, such as how the board of directors conducted

its oversight of the internal control structure. 176

168

See Levin Letter.

169

See CFA/AFR Letter. See also CFA II Letter.

170

See AFGI Letter; AFSCME Letter; Better Markets Letter; CFA/AFR Letter; COPERA Letter; Harrington

Letter; Levin Letter; TradeMetrics Letter.

171

See CFA II Letter

172

See Levin Letter.

173

See CFA/AFR Letter.

174

See Better Markets Letter.

175

See CFA/AFR Letter; AFSCME Letter.

176

See AFSCME Letter (stating that the NRSRO should be required to document: the control environment;

risk assessment; control activities; and information and communication within the NRSRO); CFA/AFR

Letter (stating that the NRSRO should be required to document: the design of the system of internal

The Commission believes it is critically important to investors and other users of credit

ratings that, as required by section 15E(c)(3)(A) of the Exchange Act, NRSROs establish,

maintain, enforce, and document an effective internal control structure governing the

implementation of and adherence to their policies, procedures, and methodologies for

determining credit ratings. 177 The Commission agrees that the requirements established by the

NRSROs to address the internal control structure should “provide the companies’ management

the ability to effectively administer their internal compliance measures, and instill confidence in

their investors and the public that the companies in fact are achieving the objectives of their

internal control rules and, in so doing, promoting ratings that are high-quality, objective,

independent, reliable, and free from influence by any conflicts of interest.” 178 This is one of the

reasons that the Commission previously has expressed concerns about – and has taken action to

address – the integrity of policies, procedures, and methodologies for determining credit ratings used

by certain NRSROs in light of the role these NRSROs played in determining credit ratings for

securities collateralized by or linked to subprime residential mortgages. 179

Moreover, the Commission staff conducts annual examinations of each NRSRO and

publishes a report summarizing the essential findings of the examinations, as required by section

15E(p)(3) of the Exchange Act. 180 The annual report attributes the essential findings, as

controls; the evidence obtained and conclusions reached during testing of the effectiveness of the internal

controls; material weaknesses identified and how they were remediated; how the board of directors

conducted its oversight; significant matters that arose in the design, operation, or monitoring of internal

controls and how they were resolved; and the basis for reports to the Commission on the effectiveness of

the internal control structure).

177

See 15 U.S.C. 78o-7(c)(3)(A).

178

See CFA II Letter.

179

See, e.g., Proposed Rules for Nationally Recognized Statistical Rating Organizations, 73 FR 36212;

Amendments to Rules for Nationally Recognized Statistical Rating Organizations, 74 FR 63832; 2008 Staff

Inspection Report.

180

See 15 U.S.C. 78o-7(p)(3).

applicable, to the “smaller” NRSROs or “larger” NRSROs, and describes for the public the

nature and extent of the deficiencies cited. The Commission staff, as part of the annual

examination of each NRSRO, reviews whether the internal control structure of the NRSRO is

effective as required by section 15E(c)(3)(A) of the Exchange Act. 181

For example, in the annual report published in December 2013, the Commission staff

noted that all NRSROs had “added or improved internal controls over the rating process” since

the examinations began in 2010 and generally improved adherence to their rating policies and

procedures, which “appear[ed] to be attributable, in part, to improvements in the internal control

structure at NRSROs.” 182 However, in several instances the staff found that an NRSRO did not

follow its policies and procedures and the staff recommended that the NRSRO improve its

internal controls to ensure compliance with the policies and procedures. 183 In particular, the

Commission staff cited section 15E(c)(3)(A) of the Exchange Act in its report and stated that

many NRSROs relied on a testing or internal audit program as an internal supervisory control. 184

The staff then described certain weaknesses it found in those controls, and recommended that

those NRSROs improve and better document their testing and audit programs. 185

Deficiencies in the internal control structure found by the examination staff are brought

to the attention of the NRSRO, and the staff monitors whether and how those deficiencies are

181

See 15 U.S.C. 78o-7(c)(3)(A). See also 15 U.S.C. 78o-7(p)(3)(B) (requiring the Commission to review,

among other things, whether the NRSRO conducts business in accordance with the policies, procedures,

and rating methodologies of the NRSRO, the internal supervisory controls of the NRSRO, and the

governance of the NRSRO).

182

See 2013 Annual Staff Inspection Report, p. 8.

183

See, e.g., 2013 Annual Staff Inspection Report, p. 10 (discussing Commission staff finding that an NRSRO

did not consistently follow its policies and procedures for rating criteria development).

184

See 2013 Annual Staff Inspection Report, p. 18.

185

See id.

addressed. If warranted, the examination staff also can refer an NRSRO to the enforcement staff

for potential violations of section 15E(c)(3)(A).

Given the importance of the NRSROs’ internal control structures, the Commission

believes that an NRSRO should be required to consider the factors identified in the proposing

release when establishing, maintaining, enforcing, and documenting an effective internal control

struct

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