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17 CFR Parts 240 and 249b

[Release No. 34-59342; File No. S7-13-08]

RIN 3235-AK14

Amendments to Rules for Nationally Recognized Statistical Rating Organizations

AGENCY: Securities and Exchange Commission (“Commission”).

ACTION: Final rule.

SUMMARY: The Commission is adopting rule amendments that impose additional

requirements on nationally recognized statistical rating organizations (“NRSROs”) in

order to address concerns about the integrity of their credit rating procedures and

methodologies.

DATES:

Effective Date: April 10, 2009

Compliance Date: April 10, 2009, except that the compliance date for the

amendment to § 240.17g-2(d) is August 10, 2009.

FOR FURTHER INFORMATION CONTACT: Michael A. Macchiaroli, Associate

Director, at (202) 551-5525; Thomas K. McGowan, Assistant Director, at (202) 5515521; Randall W. Roy, Branch Chief, at (202) 551-5522; Joseph I. Levinson, Special

Counsel, at (202) 551-5598; Carrie A. O’Brien, Special Counsel, at (202) 551-5640;

Sheila D. Swartz, Special Counsel, at (202) 551-5545; Rose Russo Wells, Special

Counsel, at (202) 551-5527; Division of Trading and Markets, Securities and Exchange

Commission, 100 F Street, NE, Washington, DC 20549-6628

SUPPLEMENTARY INFORMATION:

BACKGROUND

On June 16, 2008, the Commission, in the first of three related actions, proposed a

series of amendments to its existing rules governing the conduct of NRSROs.1 The

proposed amendments were designed to address concerns about the integrity of the

process by which NRSROs rate structured finance products, particularly mortgage related

securities.2 Today, the Commission is adopting, with revisions, a majority of the rule

amendments proposed in the first action.3 These new requirements are designed to

address practices identified, in part, by the Commission staff during its examination of

the three largest NRSROs.4 In particular, the requirements are intended to increase the

transparency of the NRSROs’ rating methodologies, strengthen the NRSROs’ disclosure

Proposed Rules for Nationally Recognized Statistical Rating Organizations, Exchange Act Release

No. 57967 (June 16, 2008), 73 FR 36212 (June 25, 2008) (“June 16, 2008 Proposing Release”).

The existing NRSRO rules were adopted by the Commission in 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) (“June 5, 2007 Adopting

Release”). The second action taken by the Commission (also on June 16, 2008) was to propose a

new rule that would require NRSROs to distinguish their ratings for structured finance products

from other classes of credit ratings by publishing a report with the rating or using a different rating

symbol. See June 16, 2008 Proposing Release. The third action taken by the Commission was to

propose a series of amendments to rules under the Exchange Act, Securities Act of 1933

(“Securities Act”), and Investment Company Act of 1940 (“Investment Company Act”) that would

end the use of NRSRO credit ratings in the rules. See References to Ratings of Nationally

Recognized Statistical Rating Organizations, Exchange Act Release No. 58070 (July 1, 2008), 73

FR 40088 (July 11, 2008); Securities Ratings, Securities Act Release No. 8940 (July 1, 2008), 73

FR40106 (July 11, 2008); References to Ratings of Nationally Recognized Statistical Rating

Organizations, Investment Company Act Release No. 28327 (July 1, 2008), 73 FR 40124 (July 11,

2008). The second and third actions are not being finalized in this release.

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, but

is not limited to, asset-backed securities such as residential mortgage-backed securities (“RMBS”)

and to other types of structured debt instruments such as collateralized debt obligations (“CDOs”),

including synthetic and hybrid CDOs.

The June 16, 2008 Proposing Release included amendments to paragraphs (a) and (b) of Rule 17g5 that are not being adopted today. Instead, in part, in response to the many comments received on

these proposed amendments identifying substantial issues as to how they would operate in

practice, the Commission today is re-proposing these amendments in a separate release. In

addition, the Commission is also proposing potential additional requirements to the final

amendment to paragraph (d) of Rule 17g-2 being adopted today.

See June 16, 2008 Proposing Release, 73 FR at 36213; Summary Report of Issues Identified in the

Staff’s Examinations of Select Credit Rating Agencies (July 2008). The report can be accessed at

http://www.sec.gov/news/studies/2008/craexamination070808.pdf

of ratings performance, prohibit the NRSROs from engaging in certain practices that

create conflicts of interest, and enhance the NRSROs’ recordkeeping and reporting

obligations to assist the Commission in performing its regulatory and oversight

functions.5 The Commission received 61 comment letters on the amendments as

proposed.6 Many commenters expressed general support for the proposals and the ends

The June 16, 2008 Proposing Release contains a detailed discussion of concerns the final rules are

intended to address, particularly with respect to the NRSROs’ role in the credit market turmoil.

See June 16, 2008 Proposing Release, 73 FR at 36213-36218.

Letter dated June 10, 2008 from Deborah A. Cunningham and Boyce I. Greer, Co-Chairs

Company, Co-Chairs, SIFMA Credit Rating Agency Task Force (“First SIFMA Letter”); letter

dated June 12, 2008 from G. Brooks Euler (“Euler Letter”); letter dated June 19, 2008 from Rupert

Schoder, Financial Engineer, Socit Gnrale, France (“SGF Letter”); letter dated July 8, 2008 from

William Morris, Principal, The Morris Group (“Morris Letter”); letter dated July 8, 2008 from

Elaine Wieche (“Wieche Letter”); letter dated July 13, 2008 from Walter C. Hamscher, Member,

XBRL International Board of Directors (“Hamscher Letter”); letter dated July 14, 2008 from

Robert Dobilas, President, CEO, Realpoint LLC (“Realpoint Letter”); letter dated July 21, 2008

from Dottie Cunningham, Chief Executive Officer, Commercial Mortgage Securities Association

(“CMSA Letter”); letter dated July 21, 2008 from Bruce Goldstein, SunTrust Robinson Humphrey

(“STRH Letter”); letter dated July 21, 2008 from Raymond E. Petersen, President, Inland

Mortgage Capital Corporation (“Inland Letter”); letter dated July 21, 2008 from Leonard W.

Cotton, Vice Chairman, Centerline Capital Group (“Centerline Letter”); letter dated July 21, 2008

from Gregg Rademacher, Chief Executive Officer, Los Angeles County Employees Retirement

Association (“LACERA Letter”); letter dated July 22, 2008 from Kevin Kohler, VP - Levered

Finance, Capmark Investments LP (“Capmark Letter”); letter dated July 22, 2008 from Richard

Metcalf, Director, Corporate Affairs Department, Laborers' International Union of North America

(“LIUNA Letter”); letter dated July 22, 2008 from Mary A. Downing, Director -Surveillance and

Due Diligence, Hillenbrand Partners (“Hillenbrand Letter”); letter dated July 23, 2008 from Kent

Wideman, Group Managing Director, Policy & Rating Committee and Mary Keogh, Managing

Director, Policy & Regulatory Affairs, DBRS (“DBRS Letter”); letter dated July 24, 2008 from

Takefumi Emori, Managing Director, Japan Credit Rating Agency, Ltd. (“JCR Letter”); letter

dated July 24, 2008 from J. Douglas Adamson, Executive Vice President, Technical Services,

American Bankers Association (“ABA Letter”); letter dated July 24, 2008 from Amy Borrus,

Deputy Director, Council of Institutional Investors (“Council Letter”); letter dated July 24, 2008

from Joseph A. Hall and Michael Kaplan, Davis Polk, and Wardwell (“DPW Letter”); letter dated

July 24, 2008 from Vickie A. Tillman, Executive Vice President, Standard & Poor’s Ratings

Services (“S&P Letter”); letter dated July 24, 2008 from Deborah A. Cunningham and Boyce I.

Greer, Co-Chairs Company, Co-Chairs, SIFMA Credit Rating Agency Task Force (“Second

SIFMA Letter”); letter dated July 24, 2008 from Alex J. Pollock, Resident Fellow, American

Enterprise Institute (“Pollock Letter”); letter dated July 25, 2008 from Sally Scutt, Managing

Director, and Pierre de Lauzun, Chairman, Financial Markets Working Group, International

Banking Federation (“IBFED Letter”); letter dated July 25, 2008 from Eric Sanitas, President,

Association federative internationale des porteurs d'emprunts russe (“AFIPER Letter”); letter

dated July 25, 2008 from Denise L. Nappier, Treasurer, State of Connecticut (“Nappier Letter”);

letter dated July 25, 2008 from Suzanne C. Hutchinson, Mortgage Insurance Companies of

America (“MICA Letter”); letter dated July 25, 2008 from Kieran P. Quinn, Chairman, Mortgage

Bankers Association (“MBA Letter”); letter dated July 25, 2008 from Sean J. Egan, President,

Egan–Jones Ratings Co. (“Egan-Jones Letter”); letter dated July 25, 2008 from Frank Chin,

Chairman, Municipal Securities Rulemaking Board (“MSRB Letter”); letter dated July 25, 2008

they were designed to achieve.7 At the same time, commenters raised concerns about the

practicality and costs of the proposals.8 The rules being adopted today incorporate many

aspects of the rules as proposed, but also include significant revisions based on the

from Charles D. Brown, General Counsel, Fitch Ratings (“Fitch Letter”); letter dated July 25,

2008 from Bill Lockyer, State Treasurer, California (“Lockyer Letter”); letter dated July 25, 2008

from Jeremy Reifsnyder and Richard Johns, Co-Chairs, American Securitization Forum Credit

Rating Agency Task Force (“ASF Letter”); letter dated July 25, 2008 from Annemarie G. DiCola,

Chief Executive Officer, Trepp, LLC (“Trepp Letter”); letter dated July 25, 2008 from Francisco

Paez, Metropolitan Life Insurance Company (“MetLife Letter”); letter dated July 25, 2008 from

Cate Long, Multiple-Markets (“Multiple-Markets Letter”); letter dated July 25, 2008 from Kurt N.

Schacht, Executive Director and Linda L. Rittenhouse, Senior Policy Analyst, CFA Institute

Centre for Financial Market Integrity (“CFA Institute Letter”); letter dated July 25, 2008 from

Lawrence J. White, Professor of Economics, Stern School of Business, New York University

(“White Letter”); letter dated July 25, 2008 from Jack Davis, Head of Fixed Income Research,

Schroder Investment Management North America Inc. (“Schroders Letter”); letter dated July 25,

2008 from Karrie McMillan, General Counsel, Investment Company Institute (“ICI Letter”); letter

dated July 25, 2008 from Michael Decker, Co-Chief Executive Officer and Mike Nicholas, CoChief Executive Officer, Regional Bond Dealers Association (“RBDA Letter”); letter dated July

25, 2008 from Richard M. Whiting, Executive Director and General Counsel, Financial Services

Roundtable (“Roundtable Letter”); letter dated July 25, 2008 from James H. Gellert, Chairman and

CEO and Dr. Patrick J. Caragata, Founder and Executive Vice Chairman, Rapid Ratings

International Inc.(“Rapid Ratings Letter”); letter dated July 25, 2008 from Alan P. Kress, Counsel,

Principal Global Investors, LLC (“Principal Global Letter”); letter dated July 25, 2008 from James

A. Kaitz, President and CEO, Association for Financial Professionals (“AFP Letter”); letter dated

July 25, 2008 from Gregory W. Smith, General Counsel, Colorado Public Employees’ Retirement

Association (“Colorado PERA Letter”); letter dated July 25, 2008 from Cleary Gottlieb Steen &

Hamilton LLP, “CGSH Letter”); letter dated July 25, 2008 from Keith A. Styrcula, Chairman,

Structured Products Association (“SPA Letter”); letter dated July 25, 2008 from Yasuhiro Harada,

Chairman and Co-CEO, Rating and Investment Information, Inc. (“R&I Letter”); letter dated July

28, 2008 from Michel Madelain, Chief Operating Officer, Moody’s Investors Service (“Moody’s

Letter”); letter dated July 28, 2008 from Keith F. Higgins, Chair, Committee on Federal

Regulation of Securities and Vicki O. Tucker, Chair, Committee on Securitization and Structured

Finance, American Bar Association (“ABA Business Law Committees Letter”); letter dated July

28, 2008 from Morris C. Foutch (“Foutch Letter”); letter dated July 29, 2008 from Glenn

Reynolds, CEO and Peter Petas, President CreditSights, Inc. (“CreditSights Letter”); letter dated

July 31, 2008 from Robert S. Khuzami Managing Director and General Counsel, Deutsche Bank

Americas (“DBA Letter”); letter dated August 5, 2008 from John Taylor, President and CEO,

National Community Reinvestment Coalition (“NCRC Letter”); letter dated August 8, 2008 from

Jeffrey A. Perlowitz, Managing Director and Co-Head of Global Securitized Markets, and

Myongsu Kong, Director and Counsel, Citigroup Global Markets Inc. (“Citi Letter”); letter dated

August 12, 2008 from John J. Niebuhr, Managing Director, Lehman Brothers, Inc. (“Lehman

Letter”); letter dated August 15, 2008 from Steve Linehan, Executive Vice-President and

Treasurer, Capital One Financial Corporation (“Capital One Letter”); letter dated August 17, 2008

from Olivier Raingeard, Ph.D (“Raingeard Letter”); letter dated August 22, 2008 from Robert

Dobilas, CEO and President, Realpoint LLC (“Second Realpoint Letter”); letter dated August 27,

2008 from Larry G. Mayewski, Executive Vice President & Chief Rating Officer, A.M. Best

Company (“A.M. Best Letter”).

See, e.g., LACERA Letter; LIUNA Letter; Council Letter; Second SIFMA Letter; Nappier Letter;

RBDA Letter; Colorado PERA Letter; CGSH Letter; SPA Letter; R&I Letter; Moody’s Letter;

CreditSights Letter; DBA Letter; NCRC Letter; Lehman Letter; Capital One Letter.

See, e.g., White Letter; Roundtable Letter; Rapid Ratings Letter; ABA Business Law Committees

Letter; Raingeard Letter.

comments received.9 The revisions seek to address practical impediments identified by

commenters while at the same time continuing to promote the substantive goals of the

proposed rules (increasing transparency and disclosure, diminishing conflicts, and

strengthening oversight) and of the Credit Rating Agency Reform Act of 2006 (“Rating

Agency Act”).10

In summary, the rule amendments require: (1) an NRSRO to provide enhanced

disclosure of performance measurements statistics and the procedures and methodologies

used by the NRSRO in determining credit ratings for structured finance products and

other debt securities on Form NRSRO;11 (2) an NRSRO to make, keep and preserve

additional records under Rule 17g-2;12 (3) an NRSRO to make publicly available on its

Internet Web site in XBRL format a random sample of 10% of the ratings histories of

credit ratings paid for by the obligor being rated or by the issuer, underwriter, or sponsor

of the security being rated (“issuer-paid credit ratings”) in each class of credit ratings for

which it is registered and has issued 500 or more issuer-paid credit ratings, with each new

ratings action to be reflected in such histories no later than six months after they are

taken;13 and (4) an NRSRO to furnish the Commission with an additional annual report.14

II.

THE FINAL RULE AMENDMENTS

Amendments to the Instructions for Form NRSRO

These comments are available on the Commission’s Internet Web site, located at

http://www.sec.gov/comments/s7-13-08/s71308.shtml, and in the Commission’s Public Reference

Room in its Washington DC headquarters.

See Report of the Senate Committee on Banking, Housing, and Urban Affairs to Accompany S.

3850, Credit Rating Agency Reform Act of 2006, S. Report No. 109-326, 109th Cong., 2d Sess.

(Sept. 6, 2006) (“Senate Report”), p. 2.

See amendments to Form NRSRO.

17 CFR 240.17g-2.

See Rule 17g-2(a)(8) and (d).

See Rule 17g-3(a)(6).

Form NRSRO contains 8 line items and requires 13 Exhibits. The line items elicit

information about the applicant credit rating agency or NRSRO such as: its address;

corporate form; credit rating affiliates that would be, or are, a part of its registration; the

classes of credit ratings for which it is seeking, or is, registered as an NRSRO; the

number of credit ratings it has issued in each class and the date it began issuing credit

ratings in each class; and whether it or a person associated with it has committed or

omitted any act, been convicted of any crime, or is subject to any order identified in

Section 15(d) of the Exchange Act. The 13 Exhibits to Form NRSRO elicit the

information required under Sections 15E(a)(1)(B)(i) through (ix) of the Exchange Act

and additional information the Commission prescribed under authority in Section

15E(a)(1)(B)(x) of the Exchange Act.15

The Commission proposed amending the instructions to Form NRSRO to enhance

the disclosures NRSROs make in Exhibits 1 and 2. As discussed below, the Commission

is adopting the changes with certain modifications that respond, in part, to points raised

by commenters.

Enhanced Ratings Performance Measurement Statistics on

Form NRSRO

Exhibit 1 to Form NRSRO elicits the information required by Section

15E(a)(1)(B)(i) of the Exchange Act: credit ratings performance measurement statistics

over short-term, mid-term, and long-term periods (as applicable) of the credit rating

agency.16 The instructions for the Exhibit provide that an applicant and NRSRO must

include in the Exhibit definitions of the credit ratings (i.e., an explanation of each

15 U.S.C. 78o-7(a)(1)(B)(i) – (x).

15 U.S.C. 78o-7(a)(1)(B)(i).

category and notch) and explanations of the performance measurement statistics,

including the metrics used to derive the statistics.

The first proposed amendment to the Exhibit 1 instructions would enhance the

disclosure by requiring separate sets of default and transition statistics for different

classes of credit ratings. Specifically, as proposed, the instructions would require

separate sets of statistics for each class of credit rating for which an applicant is seeking

registration as an NRSRO or an NRSRO is registered as well as for any other broad class

of credit ratings issued by the NRSRO.

The Commission received eight comment letters on this amendment.17 One

commenter noted that separating performance measurements by classes of credit ratings

would help market participants make informed decisions.18 Commenters suggested that

the Commission refine the classes of credit ratings and raised concerns about how to

interpret the catchall phrase in the rule “any other broad class of credit rating.” For

example, one commenter argued that such a category “would capture a variety of

operational and qualitative scales, such as servicer and bank support ratings, for which

default and/or transition studies are of limited or no value.”19 The same commenter

suggested that the single category encompassing government securities, municipal

securities and foreign government securities be divided into three separate classes

(sovereigns, United States public finance, and international public finance) to account for

the different types of investors each such class of securities attracts as well as the

potential for the much greater amount of data on public finance issuance in the United

See Second SIFMA Letter; Fitch Letter; Lockyer Letter; Multiple-Markets Letter; ICI Letter; AFP

Letter; ABA Business Law Committees Letter; Raingeard Letter.

See AFP Letter.

See Fitch Letter.

States to overwhelm the sovereign and international public finance data, thus making the

statistics less useful to investors.20

In response to commenters’ concerns, the Commission is adopting the proposed

amendments to the instructions but not adopting the “catchall” requirement to which

commenters objected. Eliminating the catchall will remove ambiguity in the rule. In

addition, the Commission is adding language to the instructions as amended that divide

government securities into three classes: sovereigns, United States public finance, and

international public finance. This will make the performance statistics for these classes

of credit ratings more meaningful, since the types of rated obligors and instruments in

each class will be more similar.

As proposed, the first amendment to the Exhibit 1 instructions also would require

an NRSRO registered in the class of credit ratings described in Section 3(a)(62)(B)(iv) of

the Rating Agency Act21 (or an applicant seeking registration in that class) when

generating the performance statistics for that class to include credit ratings of any security

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

mortgage-backed securities transaction. This was designed to include ratings actions for

credit ratings of structured finance products that do not meet the narrower statutory

definition of “issuers of asset-backed securities (as that term is defined is section 1101(c)

of part 229 of title 17, Code of Federal Regulations).”22 The Commission received no

comment on this aspect of the amendment and is adopting it as proposed.

This first amendment to the Exhibit 1 instructions, modified as described above,

will result in the generation of performance statistics that will make it easier for users of

Id.

15 U.S.C. 78c(a)(62)(B)(iv).

See id.

credit ratings to compare the accuracy of NRSRO credit ratings on a class-by-class basis.

For the reasons discussed, the Commission is adopting the amendment to the instructions

with the modifications described above.

As proposed, the second amendment to the Exhibit 1 instructions would require

that the class-by-class disclosures be broken out over 1, 3 and 10-year periods. Section

15E(a)(1)(B)(i) of the Exchange Act requires that the performance statistics be over

short, mid, and long-term periods, which is also the language currently used in Form

NRSRO.23 The purpose of this amendment was to prescribe periods in specific years so

that the performance statistics generated by the NRSROs are more easily comparable.

The Commission received 12 comments on the amendment.24 Most of the

commenters supported the amendment, including the 1, 3, and 10 year time frames.

These comments supported the Commission’s view that 1, 3, and 10 year periods are

reasonable definitions of the terms “short-term, mid-term, and long-term periods” as used

in Section 15E(a)(1)(B)(i) of the Exchange Act.25 Commenters believed the proposed

statistics would provide investors additional information to make informed investment

decisions.26 Several commenters asked that the Commission clarify whether the default

rates were for the most recent 1, 3, and 10 year periods or the average over multiple 1, 3,

and 10 year periods.27 The Commission intended the default statistics to be for the most

recent 1, 3, and 10 year periods. The Commission is adopting the amendment to the

instructions as proposed.

15 U.S.C. 78o-7(a)(1)(B)(i).

See LIUNA Letter; JCR Letter; Council Letter; S&P Letter; Second SIFMA Letter; Fitch Letter;

Multiple-Markets Letter; AFP Letter; Colorado PERA Letter; ABA Business Law Committees

Letter; NCRC Letter; Raingeard Letter.

15 U.S.C. 78o-7(a)(1)(B)(i).

See LIUNA Letter; AFP Letter.

See JCR Letter; S&P Letter.

As proposed, the third amendment to the Exhibit 1 instructions would clarify the

type of ratings actions that are required to be included in these performance measurement

statistics. Specifically, it would change the instruction requiring that the performance

statistics show “down-grade and default rates” with an instruction that they show “ratings

transition and default rates.” The switch to “ratings transition” rates from “downgrade”

rates was designed to clarify that upgrades (as well as downgrades) should be included

when generating the statistics. The Commission did not receive any comments on this

amendment to the instructions and is adopting it as proposed.

Finally, the Commission proposed an amendment to the instructions of Exhibit 1

that would specify that the default statistics required under the exhibit must show defaults

relative to the initial rating and incorporate defaults that occur after a credit rating is

withdrawn. The proposed amendment was designed to prevent an NRSRO from

manipulating the performance statistics by not including defaults when generating

statistics for a category of credit ratings (e.g., AA) because the defaults occur after the

rating is downgraded to a lower category (e.g., CC) or withdrawn.

Commenters raised a number of concerns about how this proposal would operate

in practice.28 Several commenters expressed concern that the requirement to include

defaults occurring after a rating is withdrawn could obligate an NRSRO to monitor

ratings for an indefinite period of time after the NRSRO stops rating such instruments,

and that an NRSRO may not be able to provide such statistics after a rating is

withdrawn.29 Two NRSROs noted that the ability to monitor ratings depends on the

ability of the NRSRO to obtain information that an event of default has occurred and that

See DBRS Letter; S&P Letter; Fitch Letter; Moody’s Letter.

See DBRS Letter; S&P Letter.

this may be impractical given limited access to information once a rating is withdrawn.30

Another NRSRO believed that the proposal was overbroad and outside the scope of the

Commission’s authority, asserting that it intrudes upon the substance of the NRSRO’s

rating procedures.31 The Commission agrees that, given the limited information

available to NRSROs following the withdrawal of a rating, requiring the inclusion in

these statistics of defaults occurring after a rating is withdrawn may be problematic.

Therefore, the Commission is not adopting this provision at this time. While the

instructions to Exhibit 1 will continue to require default statistics that are relative to

initial rating on a class-by-class basis, for the reasons discussed above, the amendment as

adopted does not require the inclusion of defaults that occur after a credit rating is

withdrawn in those statistics. As an alternative means of achieving the Commission’s

goals in proposing this amendment, the Commission notes that, as discussed below,

ratings withdrawals must be included among the ratings actions to be disclosed under the

Commission’s amendment to Rule 17g-3,32 which requires an annual report of all ratings

actions taken during the year within a class of credit ratings. This information will be

useful in determining whether the number of ratings actions in a given class is unusually

large and, if so, the need for a review of the causes of any significant changes to that

number – including, potentially, a disproportionate amount of ratings withdrawals.

Enhanced Disclosure of Ratings Methodologies

Exhibit 2 to Form NRSRO elicits the information required by Section

15E(a)(1)(B)(ii) of the Exchange Act: information regarding the procedures and

See S&P Letter; Fitch Letter.

See Moody’s Letter.

17 CFR 240.17g-3.

methodologies used by the credit rating agency to determine credit ratings.33 The

instructions for the Exhibit require a description of the procedures and methodologies

(not the submission and disclosure of each actual procedure and methodology). The

instructions further provide that the description must be sufficiently detailed to provide

users of credit ratings with an understanding of the processes the applicant or NRSRO

employs to determine credit ratings. The instructions also identify a number of areas that

must be addressed in the description to the extent they are applicable.34

The Commission proposed amending the instructions to Exhibit 2 to add three

additional areas that an applicant and a registered NRSRO would need to address in the

descriptions of its procedures and methodologies in Exhibit 2 to the extent they are

applicable. The three proposed areas that would need to be addressed by an applicant and

NRSRO were:

•

Whether and, if so, how information about verification performed on

assets underlying or referenced by a security or money market instrument

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

securities transaction is relied on in determining credit ratings;

15 U.S.C. 78o-7(a)(1)(B)(ii).

Specifically, the instructions require an NRSRO to provide descriptions of the following areas (as

applicable): “policies for determining whether to initiate a credit rating; a description of the public

and non-public sources of information used in determining credit ratings, including information

and analysis provided by third-party vendors; the quantitative and qualitative models and metrics

used to determine credit ratings; the methodologies by which credit ratings of other credit rating

agencies are treated to determine credit ratings for securities or money market instruments issued

by an asset pool or as part of any asset-backed or mortgaged-backed securities transaction; the

procedures for interacting with the management of a rated obligor or issuer of rated securities or

money market instruments; the structure and voting process of committees that review or approve

credit ratings; procedures for informing rated obligors or issuers of rated securities or money

market instruments about credit rating decisions and for appeals of final or pending credit rating

decisions; procedures for monitoring, reviewing, and updating credit ratings; and procedures to

withdraw, or suspend the maintenance of, a credit rating.” See Form NRSRO Instructions for

Exhibit 2.

•

Whether and, if so, how assessments of the quality of originators of assets

underlying or referenced by a security or money market instrument issued

by an asset pool or as part of any asset-backed or mortgage-backed

securities transaction play a part in the determination of credit ratings; and

•

How frequently credit ratings are reviewed, whether different models or

criteria are used for ratings surveillance than for determining initial

ratings, whether changes made to models and criteria for determining

initial ratings are applied retroactively to existing ratings, and whether

changes made to models and criteria for performing ratings surveillance

are incorporated into the models and criteria for determining initial

ratings.

The comments submitted on the first proposed amendment to the instructions to

Exhibit 2 were supportive of the proposal.35 Commenters generally supported the second

proposed amendment as well.36 Likewise, commenters were supportive of the third

proposed amendment. They stated that it would be particularly helpful to retail investors

and that all investors would benefit from knowing what ratings have undergone

surveillance by the NRSRO.37

The Commission is adopting the first amendment to the instructions to Exhibit 2

as proposed. This amendment requires an NRSRO to disclose whether and, if so, how

information about verification performed on the assets is relied on in determining credit

ratings for structured finance products. The Commission believes this disclosure will

benefit users of credit ratings by providing information about the potential accuracy of an

See NCRC Letter; Second SIFMA Letter; MICA Letter; ASF Letter.

See Second SIFMA Letter; ASF Letter.

See ASF Letter; Multiple-Markets Letter; NCRC Letter.

NRSRO’s credit ratings. NRSROs determine credit ratings for structured finance

products based on assumptions in their models as to how the assets underlying the

instruments will perform under varying levels of stress. These assumptions are based on

the characteristics of the assets (e.g., value of the property, income of the borrower) as

reported by the arranger of the structured finance product. If this information is

inaccurate, the capacity of the model to predict the potential future performance of the

assets may be significantly impaired. Consequently, information about whether an

NRSRO requires that some level of verification be performed or takes other steps to

account for the lack of verification or a low level of verification will be useful to users of

credit ratings in assessing the potential for an NRSRO’s credit ratings to be adversely

impacted by inaccurate information about the assets underlying a rated structured finance

product.

The Commission is adopting the second amendment to the instructions to Exhibit

2 as proposed. This amendment requires an NRSRO to disclose whether it considers

qualitative assessments of the originator of assets underlying a structured finance product

in the rating process for such products. The Commission believes that certain qualities of

an asset originator, such as its experience and underwriting standards, may impact the

quality of the loans it originates and the accuracy of the associated loan documentation.

This, in turn, could influence how the assets ultimately perform and the ability of the

NRSRO’s models to predict their performance. Consequently, the failure to perform any

assessment of the loan originators could increase the risk that an NRSRO’s credit ratings

may not be accurate. Therefore, disclosures as to whether the NRSRO performs any

qualitative assessments of the originators would be useful in comparing the efficacy of

the NRSROs’ procedures and methodologies.

The Commission is adopting the third amendment to the instructions to Exhibit 2

as proposed. This amendment requires an NRSRO to disclose the frequency of its

surveillance efforts and how changes to its quantitative and qualitative ratings models are

incorporated into the surveillance process. The Commission believes that users of credit

ratings will find information about these matters useful in comparing the ratings

methodologies of different NRSROs. For example, how often and with what models an

NRSRO monitors its credit ratings would be relevant to assessing the accuracy of the

ratings inasmuch as ratings based on stale information and outdated models may not be as

accurate as ratings of like products using newer data and models. Moreover, with respect

to new types of rated obligors and debt securities, the NRSROs refine their models as

more information about the performance of these obligors and debt securities is observed

and incorporated into their assumptions. Consequently, as the models evolve based on

more robust performance data, credit ratings of obligors or debt securities determined

using older models may be at greater risk for being inaccurate than the newer ratings.

Therefore, whether the NRSRO verifies the older ratings using the newer methodologies

would be useful to users of credit ratings in assessing the accuracy of the credit ratings.

The Commission notes that, unlike the prior two changes, this new instruction

applies to all classes of credit ratings for which the NRSRO determines credit ratings (not

solely to structured products). For the reasons noted above, the Commission is adopting

this amendment as proposed.

The Commission is adopting these amendments to the instructions to Exhibit 2 to

Form NRSRO, in part, under authority to require such additional information in the

application as it finds necessary or appropriate in the public interest or for the protection

of investors.38 The Commission believes the new disclosure requirements are necessary

and appropriate and in the public interest or for the protection of investors. Specifically,

they are designed to provide greater clarity around three areas of the NRSROs’ rating

processes where questions have been raised, particularly for structured finance products,

in the context of the credit market turmoil: namely, the verification performed on

information provided in loan documents; the quality of loan originators; and the

surveillance of existing ratings and how changes to models are applied to existing ratings.

The amendments are designed to enhance the disclosures NRSROs make in these areas

and, thereby, allow users of credit ratings to better evaluate the quality of their ratings

processes.

Amendments to Rule 17g-2

Rule 17g-2 requires an NRSRO to make and retain certain records relating to its

business and to retain certain other business records made in the normal course of

business operations.39 The rule also prescribes the time periods and manner in which

these records are required to be retained. The Commission is adopting amendments to

Rule 17g-2 to require NRSROs to make and retain certain additional records and to

require that a portion of these new records be made publicly available.

A Record of Rating Actions and the Requirement that they be

made Publicly Available

See Section 15E(a)(1)(B)(x) of the Exchange Act (15 U.S.C. 78o–7(a)(1)(B)(x)).

See 17 CFR 240.17g-2.

The Commission proposed an amendment that would require an NRSRO to make

and retain a record of the ratings history of each outstanding credit rating as well as an

amendment that would require the NRSRO to make the ratings histories contained in the

record publicly available on its corporate Web site in eXtensible Business Reporting

Language (“XBRL”) electronic format, with each new ratings action to be made public

no later than six months after the date of the rating action. The Commission is adopting

the amendment with substantial changes in part to address concerns raised by

commenters.

As adopted, paragraph (a)(8) to Rule 17g-2 requires an NRSRO to make and

retain a record for each outstanding credit rating it maintains showing all rating actions

(initial rating, upgrades, downgrades, placements on watch for upgrade or downgrade,

and withdrawals) and the date of such actions identified by the name of the security or

obligor rated and, if applicable, the CUSIP for the rated security or the Central Index Key

(CIK) number for the rated obligor. This full record of credit rating histories will be

maintained by the NRSRO as part of its internal records that are available to Commission

staff.

In addition, paragraph (d) to Rule 17g-2, as amended, requires that an NRSRO

make publicly available, on a six-month delayed basis, a random sample of 10% of the

issuer-paid credit ratings and their histories documented pursuant to paragraph (a)(8) for

each class of credit rating for which the NRSRO is registered and has issued 500 or more

ratings paid for by the obligor being rated or by the issuer, underwriter, or sponsor of the

security being rated. Consequently, the final rule only requires the disclosure of ratings

histories for a limited number of outstanding credit ratings and only if they are issuer-

paid credit ratings. Generally, NRSROs make their issuer-paid credit ratings publicly

available for free.

NRSROs also obtain revenues by selling subscriptions to their credit ratings.

Certain NRSROs derive their credit rating revenues solely or predominantly from selling

subscriptions to their credit ratings. These NRSROs determine credit ratings that are not

paid for by the obligor being rated or by the issuer, underwriter, or sponsor of the security

being rated (“subscriber-paid credit ratings”). Generally, NRSROs do not make their

subscriber-paid credit ratings publicly available for free.

The Commission believes it is appropriate at this time to adopt a rule that will

accomplish much of what the Commission sought to achieve in the proposal, mindful of

the many comments about the proposal’s potential impact. In addition, in a companion

release40, the Commission is proposing additional means of accomplishing even more of

the Commission’s objective of providing information to the marketplace in order to

gauge the accuracy of ratings over time. Both the rule adopted today and the re-proposal

are designed to foster accountability and comparability – and hence, competition –

among NRSROs.

As noted above, NRSROs generally make their issuer-paid credit ratings publicly

available for free. Currently, while these rating actions are made public free of charge, it

may be difficult to compile the actions and compare them across NRSROs. Therefore,

the Commission expects that making this information more accessible will advance the

Commission’s goal of fostering accountability and comparability among NRSROs with

respect to their issuer-paid credit ratings. Furthermore, the Commission notes that issuer-

See Re-proposed Rules for Nationally Recognized Statistical Rating Organizations, Exchange Act

Release No. 34-59343 (January 30, 2009) (“Companion Proposing Release”).

paid credit ratings account for over 98% of the outstanding credit ratings issued by

NRSROs, according to information furnished by NRSROs in Form NRSRO. Moreover,

seven of the ten registered NRSROs currently maintain 500 or more issuer-paid credit

ratings in at least one class of credit ratings for which they are registered. Consequently,

applying this rule to issuer-paid ratings should result in a substantial amount of new

information for users of credit ratings. It also will allow market observers to begin

analyzing the information and developing performance metrics based on it.

The Commission is mindful of the potential impact on NRSROs that determine

issuer-paid credit ratings. Therefore, the Commission has taken a number of steps to

minimize the impact on NRSROs and enable them to be able to continue to sell

downloads and data feeds of their current credit ratings. For example, an NRSRO subject

to the disclosure requirement would not be required to disclose a rating action taken with

respect to an outstanding credit rating until six months after the action occurs.

In addition, by requiring NRSROs to publicly disclose ratings action histories for

a limited percentage of their outstanding issuer-paid credit ratings, market participants,

academics and others should still be able to use the information to perform analysis

comparing how the NRSROs subject to the disclosure rule perform in the classes of credit

ratings for which they are registered. This process will be facilitated by the requirement

that the ratings actions data be provided in XBRL format, which will provide a uniform

standard format for presenting the information and allow users to dynamically search and

analyze the information. This should facilitate the processing of the information and

enhance the ability of users to compare information across different NRSROs subject to

the disclosure by ratings classes. The Commission believes the random 10% of ratings

histories and 500 ratings per class thresholds will result in the disclosure of a sample

suitable for performing statistical analyses of NRSRO performance generally with respect

to issuer-paid credit ratings.

NRSROs that sell subscriber-paid credit ratings have suggested that requiring all

the histories of these ratings to be publicly disclosed could reduce competition by putting

them out of business or adversely impacting their business.41 They stated that this would

be the case even with a substantial time lag between the date a rating action is taken and

the date the action must be publicly disclosed. An NRSRO that determines issuer-paid

credit ratings stated that ratings history data has substantial commercial value even after 6

months.42 The Commission wants further input on this issue before deciding on whether

the rule should also apply to subscriber-paid credit ratings. As noted above, the

Commission, in a separate release, is seeking comment on whether to impose additional

means of increasing the amount of information publicly available with respect to the

ratings histories of subscriber-paid credit ratings. The Commission wants to carefully

balance the commercial and competitive concerns expressed by NRSROs that determine

subscriber-paid credit ratings with the Commission’s objective of fostering accountability

and comparability among all NRSROs. Therefore, in that release, the Commission asks

detailed questions about the potential impact of applying the rule to subscriber-paid credit

ratings. The responses to those questions will inform the Commission’s deliberations as

to whether this rule ultimately should be expanded to cover subscriber-paid credit ratings.

The amended rule further provides that the information must be made public on

the NRSRO’s corporate Internet Web site in XBRL format. The rule provides that in

See Realpoint Letter; Rapid Ratings Letter.

See S&P Letter.

preparing the XBRL disclosure, an NRSRO must use the List of XBRL Tags for

NRSROs as specified on the Commission’s Web site. In order to allow NRSROs subject

to this requirement sufficient time to implement this new disclosure requirement and the

Commission time to develop the List of XBRL Tags for NRSROs, the compliance date of

the amendment to paragraph (d) is delayed until 180 days after publication in the Federal

The Commission is adopting these amendments, in part, under authority to require

NRSROs to make and keep for specified periods such records as the Commission

prescribes as necessary or appropriate in the public interest, for the protection of

investors, or otherwise in furtherance of the purposes of the Exchange Act.44 The

Commission believes the new recordkeeping and disclosure requirements are necessary

and appropriate in the public interest and for the protection of investors, or otherwise in

furtherance of the purposes of the Exchange Act. The internal record of the complete

ratings histories of each outstanding credit rating required under new paragraph (a)(8) of

Rule 17g-2 will be useful to the Commission in performing its examination and oversight

functions. The data could be analyzed to determine if NRSROs are following their own

methodologies in their ratings actions and whether additional disclosure is necessary.

This could provide valuable information that could be indicative of problems in the

ratings process unrelated to the analytical process, such as conflicts of interest. The

Commission notes that this recordkeeping requirement applies to all credit ratings

regardless of whether they are issuer-paid or subscriber-paid. The disclosure

The Commission notes that the ability of NRSROs to comply with the amended rule depends on

the availability of the List of XBRL Tags for NRSROs on the Commission’s Web page. If the

publication of those materials is delayed, the Commission will consider delaying compliance with

the rule.

See Section 17(a)(1) of the Exchange Act (15 U.S.C. 78q(a)(1)).

requirements will assist users of credit ratings to compare the relative performance of

NRSROs that determine issuer-paid credit ratings. This could enhance competition by

making it easier for smaller NRSROs to develop proven track records of determining

accurate credit ratings.

The Commission received numerous comments on the proposed amendments to

paragraphs (a)(8) and (d)to Rule 17g-2 as proposed.45 Many commenters expressed

support for the proposal, stating that the proposed rule would be a meaningful step in

furthering competition in the credit rating industry and could benefit the investor

community.46 One commenter suggested that the proposed rule should require the

sorting of records by classes of credit ratings and that the six month time lag should be

reduced.47 Other commenters suggested either reducing48 or lengthening49 the proposed

six month time lag.

One NRSRO supported the proposal but believed the record of ratings histories

should be limited to 10 years.50 The Commission notes that in order to make the

information more meaningful, users seeking to analyze NRSRO performance should be

able to review the entire history of a given rating. Imposing a time limit – and therefore

eliminating the ability to compare a current rating against the initial rating – would curtail

the usefulness of this information.

See Nappier Letter; ICI Letter; RBDA Letter; R&I Letter; Moody’s Letter; ABA Business Law

Committee Letter; Realpoint Letter; CMSA Letter; DBRS Letter; ABA Letter; Council Letter;

S&P Letter; Second SIFMA Letter; Pollock Letter; IBFED Letter; Egan Jones Letter; Fitch Letter;

ASF Letter; Multiple-Markets Letter; CFA Institute Letter; Rapid Ratings Letter; AFP Letter;

Colorado PERA Letter; R&I Letter; DBA Letter; NCRC Letter; Citi Letter; Raingeard Letter.

See, e.g., AFP Letter; Colorado PERA Letter.

See Second SIFMA Letter.

See Multiple-Markets Letter; CFA Institute Letter; ICI Letter; RBDA Letter; NCRC Letter.

See Realpoint Letter; S&P Letter; Pollock Letter; Multiple-Markets Letter.

See DBRS Letter.

A number of commenters raised substantial concerns with the proposal.51 For

example, NRSROs and others noted that NRSROs that determine subscriber-paid credit

ratings make the ratings available for a fee.52 These commenters argued that requiring

them to make all the ratings publicly available for free – even with a six month time lag –

could cause them to lose subscribers.

Commenters also raised concerns that requiring an NRSRO that determines

issuer-paid credit ratings to make all ratings actions available free of charge in a machine

readable format would cause them to lose revenues they derive from selling

downloadable packages of their credit ratings.53 These commenters also questioned

whether the requirement would be permitted under the US Constitution, arguing that it

could be considered a taking of private property without compensation.54

The Commission is adopting paragraph (a)(8) to Rule 17g-2, the recordkeeping

provision, substantially as proposed, but, as noted above, has made substantial changes to

paragraph (d), the public disclosure provision. Specifically, rather than disclose the

ratings history for each outstanding credit rating, an NRSRO must disclose, in XBRL

format and on a six-month delay, ratings action histories for a randomly selected sample

of 10% of the outstanding credit ratings for each rating class for which the NRSRO has

issued 500 or more ratings paid for by the obligor being rated or by the issuer,

underwriter, or sponsor of the security being rated.

See R&I Letter; ABA Business Law Committee Letter; DBRS Letter; S&P Letter; Fitch Letter;

ASF Letter; Multiple-Markets Letter; AFP Letter; Moody’s Letter.

See ABA Business Law Committee Letter; Realpoint Letter; Pollock Letter; Egan-Jones Letter;

Multiple-Markets Letter; Rapid Ratings Letter; AFP Letter; R&I Letter; Moody’s Letter.

See S&P Letter; Moody’s Letter.

See S&P Letter; Egan-Jones Letter; Fitch Letter; R&I Letter;

The Commission believes that by limiting the ratings actions histories that need to

be disclosed to a random selection of 10% of outstanding credit ratings, applying the

requirement to issuer-paid credit ratings only, and allowing for a six-month delay before

a ratings action is required to be disclosed, the amendment as adopted addresses the

concerns among commenters that the rule would cause them to lose revenue. With

respect to NRSROs that earn revenues from issuer-paid credit ratings but sell access to

packages of the ratings as well, the Commission believes that customers that are willing

to pay for full and immediate access to downloadable information for all of an NRSRO’s

ratings actions are unlikely to reconsider their purchase of that product due to the ability

to access ratings histories for 10% of the NRSRO’s outstanding issuer-paid credit ratings

selected on a random basis and disclosed with a six-month time lag. The 500 ratings

threshold and random selection are designed to provide a sufficient sample of data upon

which to draw reasonable inferences about the quality of ratings generally issued by

NRSROs. The random 10% sample of issuer-paid credit ratings and six month time lag

are designed to make it less likely that current purchasers of data about issuer-paid credit

ratings could reliably find the information they want, and so NRSROs could continue to

sell downloads and data feeds of the credit ratings. As such, the Commission believes

that the changes made to the amendment address the commenters’ concerns while still

facilitating greater accountability for issuer-paid NRSROs, enhanced third-party

development of performance measurement statistics for issuer-paid credit ratings, and

increased competition among all NRSROs.

The Commission has decided not to impose the same disclosure obligation on

subscriber-paid credit ratings at this time out of competitive concerns raised, but is still

considering how to make more information publicly available and accessible about the

performance of these ratings. The Commission believes that the rule as adopted will

address the concerns expressed by commenters and at the same time foster greater

accountability of NRSROs with respect to their issuer-paid credit ratings as well as

increase competition among NRSROs by making it easier for persons to analyze the

actual performance of their credit ratings.

The amendment as adopted also will require that the data be made available in

XBRL format, using the List of XBRL Tags for NRSROs as specified on the

Commission’s Web site. Several NRSROs provided information arguing that an XBRL

format could be particularly costly and that the burden on smaller NRSROs could be

particularly acute.55 They suggested that if the Commission adopted the rule as proposed,

that the Commission allow NRSROs sufficient time to develop the necessary systems to

implement the XBRL format or, in the alternative, to implement this required disclosure

as a pilot program.56

The Commission believes, however, that the XBRL format will benefit market

participants seeking to develop their own performance statistics using the ratings history

data to be made public by the NRSROs. Requiring NRSROs to make histories of ratings

actions for issuer-paid credit ratings publicly available using the interactive data format

rather than using other machine readable format will enable market participants,

academics and others to analyze this information more quickly, more accurately, and at a

lower cost. The Commission believes that this will enhance the ability of end-users to

See, e.g., DBRS Letter, Moody’s Letter.

See Fitch Letter; DBRS Letter; Multiple-Markers Letter; CFA Institute Letter; ICI Letter; R&I

Letter; Moody’s Letter.

compare the rating performance of different NRSROs, which will foster NRSRO

competition.

For purposes of the internal records required by new paragraph (a)(8), the

NRSRO will be required to keep its records up to date to reflect the complete ratings

history of each outstanding credit rating (including the current rating). However, for

purposes of the requirement to make publicly available ratings action histories for a

random sample of 10% of outstanding issuer-paid credit ratings in each class of credit

rating for which the NRSRO is registered and has 500 or more such credit ratings

outstanding, the NRSRO will be permitted to delay disclosure of a rating action for six

months. As noted above, this limited disclosure and the six month time lag is expected to

mitigate the concerns regarding the loss of revenues that NRSROs derive from selling

data feeds and downloadable packages of their current outstanding issuer-paid credit

ratings and histories of the ratings.

Because NRSROs withdraw ratings and rated instruments mature, the number of

ratings made public in a particular class may fall below the 10% threshold. In order to

continue to make a large sample of information publicly available, the Commission is

requiring NRSROs to replenish the sample when it falls below 10%. Consequently,

paragraph (d) of Rule 17g-2 provides that the NRSRO must replace a rating that rolls off

for these reasons with a new randomly selected rating from the impacted class of credit

ratings. In order to protect against the possibility of “cherry picking” ratings that may

make the performance of the NRSRO more favorable, the Commission believes it is

important that both the initial selection and any replenishment of ratings be randomly

selected. The Commission is not specifying how the NRSROs must randomly select the

initial ratings disclosed under paragraph (d) of Rule 17g-2 or how they must randomly

select ratings going forward to maintain the 10% sample. The Commission believes the

NRSROs should develop a selection process that they can demonstrate to be random.

Finally, the Commission is adopting amendments to the instructions to Exhibit 1

of Form NRSRO to require that NRSROs subject to the new requirements of Rule 17g2(d) as amended disclose the Web address where the XBRL Interactive Data File with the

required information can be accessed. The Commission did not receive any comments on

this aspect of the proposal and is adopting the requirement with modifications to reflect

the modifications to the final rule discussed above. This rule amendment is designed to

inform persons who use credit ratings where the sample of ratings histories for each class

of issuer-paid credit ratings for which the NRSRO is registered can be obtained.

A Record of Material Deviation from Model Output

The Commission proposed amending paragraph (a)(2) of Rule 17g-2 to require

NRSROs to make a record documenting the rationale when a final credit rating materially

deviates from the rating implied by a quantitative model used in the rating process if the

model was a substantial component of the rating process. Under this paragraph, as

amended, if a quantitative model was a substantial component in the process of

determining the credit rating of a security or money market instrument issued by an asset

pool or as part of any asset-backed or mortgage-backed securities transaction, the

NRSRO is required to make a record of the rationale for any material difference between

the credit rating implied by the model and the final credit rating issued. The purpose of

this rule is to enhance the recordkeeping process in order to enable Commission staff, as

well as an NRSRO’s internal auditors, to understand the methodologies through which

analysts developed the credit rating issued by the NRSRO.

The Commission is adopting this amendment, in part, under authority to require

NRSROs to make and keep for prescribed periods such records as the Commission

prescribes as necessary or appropriate in the public interest, for the protection of

investors, or otherwise in furtherance of the purposes of the Exchange Act.57 The

Commission believes this new recordkeeping requirement is necessary and appropriate in

the public interest and for the protection of investors, or otherwise in furtherance of the

purposes of the Exchange Act.

Specifically, the Commission believes that maintaining records identifying the

rationale for material divergences from the ratings implied by qualitative models used as

a substantial component in the ratings process will assist the Commission in evaluating

whether an NRSRO is adhering to its disclosed procedures for determining ratings. As

the Commission has noted, “books and records rules have proven integral to the

Commission’s investor protection function because the preserved records are the primary

means of monitoring compliance with applicable securities laws.”58 In the absence of

such a recordkeeping requirement, there may be no way to determine whether an NRSRO

adhered to its stated methodologies for obtaining a certain category of credit rating (e.g.

AAA) as indicated by the model results, that is, whether adjustments to the result implied

by the model were made by applying appropriate qualitative factors permitted under the

NRSRO’s documented procedures or because of undue influence from the person seeking

the credit rating or other inappropriate reasons such as those prohibited by Rule 17g-6,

See Section 17(a)(1) of the Exchange Act (15 U.S.C. 78q(a)(1)).

June 5, 2007 Adopting Release, 72 FR at 33582.

including the prohibition on issuing or modifying credit ratings for unfair, abusive or

coercive reasons. The new recordkeeping requirement will allow Commission staff to

review whether an NRSRO is adhering to its disclosed procedures for determining

structured finance ratings and complying with Rule 17g-6.59

The Commission received 18 comments addressing this proposal.60 Many

commenters strongly supported the proposal.61 NRSROs and others, however, expressed

concern over the possibility that the rule could lead to the regulation of the substance of

ratings and the overemphasis of quantitative models at the expense of applying

qualitative factors.62 These commenters argued that the model is just one tool in the

rating process and that the proposal may lead to generalizations of models in order to

avoid material differences.63 One commenter noted that this record may cause examiners

to ignore the role qualitative factors play in developing ratings.64 Another commenter

noted that models are not as integral to the process of rating commercial mortgagebacked securities.65

In part in response to these comments, the Commission has narrowed the

application of the rule to ratings of structured finance products. This will lessen the

recordkeeping burden on an NRSRO and address commenters’ concerns that the

17 CFR 240.17g-6. Rule 17g-6 prohibits an NRSRO from engaging in certain unfair, abusive or

coercive practices such as issuing 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 will purchase the credit rating. See 17 CRF 240.17g-6(a)(2).

See CMSA Letter; DBRS Letter; Council Letter; S&P Letter; Second SIFMA Letter; Fitch Letter;

Lockyer Letter; ASF Letter; Multiple-Markets Letter; CFA Institute Letter; Rapid Ratings Letter;

AFP Letter; Colorado PERA Letter; R&I Letter; Moody’s Letter; ABA Business Law Committee

Letter; DBA Letter; NCRC Letter.

See Council Letter; Second SIFMA Letter; CFA Institute Letter; AFP Letter; Colorado PERA

Letter; DBA Letter NCRC Letter.

See DBRS Letter; S&P Letter; Rapid Ratings Letter; R&I Letter; Moody’s Letter; ABA Business

Law Committee Letter.

See, e.g., DBRS Letter.

See Moody’s Letter.

See CMSA Letter.

requirement could have negative effects on the ratings process for other classes of credit

ratings where qualitative analysis is predominant and models have a more marginal role.

Further, the Commission does not believe that the requirement will cause

NRSROs to abandon qualitative analysis when determining credit ratings for structured

finance products. The Commission does not believe that the record-making required by

the amendment will be extensive. For example, if the NRSRO’s methodologies permit

an analyst to adjust required credit enhancement levels up or down for the various

tranches of a structured finance issuer based on certain qualitative factors, the NRSRO

could document the rationale for any material difference between the credit rating

implied by the model and the final rating by describing the qualitative factor or factors

that were relied on. In addition to benefiting the Commission’s regulatory and oversight

functions, this requirement may serve to assist analysts in ensuring that their use of

qualitative factors follows the procedures documented in the NRSRO’s methodologies.

The Commission also notes that the NRSROs will be responsible for making the

determination of when a model constitutes a “substantial component” of the rating

process as well as when a difference between the rating issued and the rating implied by

the model is “material.” NRSROs should document in their ratings methodologies the

models they deem to be substantial components of a ratings process for structured finance

products and the magnitude of deviation from the rating implied by the model and rating

issued that they deem material.66

For the foregoing reasons, the Commission is adopting the rule with the

modification discussed above.

For example, the Commission believes the expected loss and cash flow models used by the

NRSROs to rate RMBS and CDOs are substantial components of the rating process.

Records Concerning Third-Party Analyst Complaints

The Commission proposed adding a new paragraph (b)(8) to Rule 17g-2 requiring

NRSROs to retain records of any complaints about the performance of a credit analyst.

The Commission is adopting this amendment with the modifications discussed below.

Under this paragraph, an NRSRO is required to retain any written communications

received from persons not associated with the NRSRO that contain complaints about the

performance of a credit analyst in initiating, determining, maintaining, monitoring,

changing, or withdrawing a credit rating. The purpose of this rule is to allow

Commission examiners the opportunity to review external complaints and how the

NRSRO addressed them.

The Commission is adopting this amendment, in part, under authority to require

NRSROs to make and keep for prescribed periods such records as the Commission

prescribes as necessary or appropriate in the public interest, for the protection of

investors, or otherwise in the furtherance of the Exchange Act.67 The Commission

believes this requirement is necessary and appropriate in the public interest and for the

protection of investors, or otherwise in furtherance of the Exchange Act, because it will

assist Commission examiners in reviewing how NRSROs handle the conflicts inherent in

the issuer-pay and subscriber-pay models: namely, that clients have an economic interest

in the ratings issued by the NRSRO and may seek to influence the rating process by

complaining about an analyst who does not issue ratings favorable to that interest.

Commission examiners will be able to review the complaint file and follow-up with the

relevant persons within the NRSRO as to how a particular complaint was handled. The

See Section 17(a)(1) of the Exchange Act (15 U.S.C. 78q(a)(1)).

potential for such a review by Commission examiners could reduce the willingness of an

NRSRO to re-assign or terminate a credit analyst to placate a client that desires a

different rating.

Commenters generally supported the proposal.68 Some commenters requested

clarification that rule does not require the retention of oral communications.69 The

Commission did not intend the rule to apply to oral communications. Consequently, the

rule text has been modified to clarify that it only applies to “written” communications.

One NRSRO expressed concern that privacy and labor laws in some non-U.S.

jurisdictions would prevent monitoring of an employee’s electronic communications.70

The Commission intended the rule to apply to communications received by the NRSRO

from outside parties such as subscribers or persons who pay to obtain credit ratings. The

amendment was not intended to require the retention of complaints sent internally

between, for example, employees of the NRSRO. The Commission has clarified the

rule’s scope in this regard by specifying that it only applies to complaints from persons

not associated with the NRSRO.

For the foregoing reasons, the Commission is adopting the proposed rule with the

modifications discussed above.

Clarifying Amendment to Rule 17g-2(b)(7)

Paragraph (b)(7) of Rule 17g-2 currently requires an NRSRO to retain all internal

and external communications that relate to “initiating, determining, maintaining,

See Council Letter; S&P Letter; MBA Letter; Fitch Letter; CFA Institute Letter; Rapid Ratings

Letter; AFP Letter; Colorado PERA Letter; Moody’s Letter.

See Moody’s Letter; S&P Letter.

See S&P Letter.

changing, or withdrawing a credit rating.”71 The Commission proposed to add the word

“monitoring” to this list. The intent was to clarify that NRSRO recordkeeping rules

extend to all aspects of the credit rating surveillance process as well as the initial rating

process. This was the intent when the Commission originally adopted the rule as

indicated by the use of the term “maintaining.” The Commission believes that adding the

term “monitoring” – a term of art in the credit rating industry – will better clarify this

requirement. The Commission received 5 comments on this proposed amendment, all of

which were supportive of the change.72 The Commission is adopting this amendment as

proposed.

Amendment to Rule 17g-3 (Report of Credit Rating Actions)

Rule 17g-3 requires an NRSRO to furnish the Commission on an annual basis the

following reports: audited financial statements; unaudited consolidated financial

statements of the parent of the NRSRO, if applicable; an unaudited report concerning

revenue categories of the NRSRO; an unaudited report concerning compensation of the

NRSRO’s credit analysts; and an unaudited report listing the largest customers of the

NRSRO. The rule further requires an NRSRO to furnish the Commission these reports

within 90 days of the end of its fiscal year. The Commission proposed amending the rule

to require a report showing the number of rating actions taken by the NRSRO during the

fiscal year in each class of credit rating for which the NRSRO is registered. In the June

16, 2008 Proposing Release, the Commission indicated that a “credit rating action”

17 CFR 240.17g-2(b)(7).

See S&P Letter; Multiple-Markets Letter; CFA Institute Letter; Rapid Ratings Letter; Moody’s

Letter.

includes upgrades, downgrades, or placements of the rating on watch for an upgrade or

downgrade.73

The Commission received 10 comments on this proposal.74 Commenters were

generally supportive of the proposal. One commenter recommended that the final rule

should make clear what is meant by “class of credit rating” and establish a measurement

period.75 The Commission notes that the rule requires the report to cover each of the

classes of credit rating identified in Section 3(a)(62)(B)(iv) of the Rating Agency Act76

for which the NRSRO is applying for registration or is registered. Further, as discussed

below, the note to the paragraph clarifies that for the purposes of this requirement, the

asset-backed securities class must include all structured finance products. The

Commission further notes that the measurement period is on a fiscal year basis.

One commenter believed that the proposal is unclear or overbroad regarding the

scope of a report on “credit rating actions.” This commenter also noted its belief that the

proposed rule was inappropriate because ratings changes are not financial statements, and

stated that the proposed requirement should be relocated to Rule 17g-2.77 In response,

the Commission notes that it is adopting this requirement, in part, under authority to

require an NRSRO to “make and disseminate such reports as the Commission, by rule,

prescribes as necessary or appropriate in the public interest, for the protection of

investors, or otherwise in furtherance of the purposes of [the Exchange Act].”78

June 16, 2008 Proposing Release, 73 FR at 36234.

See S&P Letter; Fitch Letter; Multiple-Markets Letter; ICI Letter; Rapid Ratings Letter; AFP

Letter; Moody’s Letter; ABA Business Law Committee Letter; NCRC Letter; Raingeard Letter.

See Fitch Letter.

15 U.S.C. 78c(a)(62)(B)(iv).

See Moody’s Letter.

See Section 17(a)(1) of the Exchange Act (15 U.S.C. 78q(a)(1)).

The Commission is adopting this amendment by adding paragraph (a)(6) to Rule

17g-3. Paragraph (a)(6) requires an NRSRO to provide the Commission with an

unaudited report of the number of credit rating actions (upgrades, downgrades,

placements on credit watch, and withdrawals) during the fiscal year in each class of credit

rating for which the NRSRO is registered with the Commission. As proposed, the

Commission did not identify the types of credit rating actions that should be used to

generate the report. Instead, it identified them in the preamble as being upgrades of

credit ratings, downgrades of credit ratings, placements of credit ratings on watch for an

upgrade or downgrade. The final rule text identifies the types of ratings actions that

should be included in order to provide greater clarity. In addition, the Commission is

adding “withdrawals” to the types of credit rating actions that must be included in the

“credit ratings actions” reported by the NRSRO. The Commission views a withdrawal as

a “credit rating action” since ceasing to monitor a credit rating is a significant change to

the rating and, as such, is comparable to a downgrade, upgrade and placement on watch

in terms of the potential impact on the rated obligor or security. Moreover, the inclusion

of withdrawals in the report addresses the concerns that led the Commission to propose

requiring that withdrawals be included in the default statistics generated for Exhibit 1 to

Form NRSRO. As discussed above, NRSROs raised substantial compliance concerns

with the proposal to require withdrawals in the performance statistics. This change is

intended to address their concerns regarding that proposed amendment while at the same

time ensuring that any disproportionate amount of ratings withdrawals in a class of

ratings will be captured in the ratings action information provided to the Commission for

examination and oversight purposes.

The new rule includes a note to paragraph (a)(6) clarifying that for the purposes of

reporting credit rating actions in the asset-backed security class of credit ratings described

in Section 3(a)(62)(B)(iv) of the Rating Agency Act79 an NRSRO must include credit

rating actions on any security or money market instrument issued by an asset pool or as

part of any asset-backed or mortgage-backed securities transaction. As discussed in the

June 16, 2008 Proposing Release, this note is designed to ensure the inclusion of

information about ratings actions for credit ratings of structured finance products that do

not meet the narrower statutory definition of “issuers of asset-backed securities (as that

term is defined is section 1101(c) of part 229 of title 17, Code of Federal Regulations).”80

The Commission also notes that the report required under paragraph (a)(6) to Rule 17g-3

will be furnished to the Commission on a confidential basis, to the extend permitted by

law, consistent with the other reports furnished to the Commission under Rule 17g-3.81

The Commission believes this amendment is necessary and appropriate in the

public interest, for the protection of investors, or otherwise in furtherance of the purposes

of the Exchange Act because it will assist the Commission in its examination function of

NRSROs. Large spikes in ratings actions within a class of credit ratings could indicate

the processes for determining the ratings may be compromised by inappropriate factors.

For example, a substantial increase in the number of downgrades in a particular class of

credit rating may be indicative of the fact that the initial ratings were higher than the

NRSRO’s procedures and methodologies would have implied because the NRSRO

sought to gain favor with issuers and underwriters by issuing higher ratings. A

15 U.S.C. 78c(a)(62)(B)(iv).

See June 16, 2008 Proposing Release, 73 FR at 36234.

17 CFR 240.17g-3; see also, June 5, 2007 Adopting Release, 72 FR at 33592.

substantial increase in upgrades also could be the result of the NRSRO attempting to gain

favor with issuers and underwriters.

As discussed in the June 16, 2008 Proposing Release, the Commission recognizes

that an increase in the number of ratings actions in a particular class of credit rating may

be the result of macroeconomic factors broadly impacting the rated obligors or

securities.82 In this case, the ratings actions are presumably the result of appropriate

credit analysis and not inappropriate extraneous factors. On the other hand, large

numbers of actions could be a signal that the process for rating and monitoring ratings in

the impacted class has been compromised by improper practices such as failing to adhere

to disclosed and internally documented ratings procedures and methodologies, having

prohibited conflicts, failing to establish reasonable procedures to manage conflicts, or

engaging in unfair, coercive, or abusive conduct. Consequently, the Commission expects

that the report will be a valuable tool to improve the focus of examination resources. For

these reasons, the Commission is adopting the amendment with the modifications

described above.

Amendments to Rule 17g-5

Rule 17g-5 identifies a series of conflicts arising from the business of determining

credit ratings. Under the rule, some of these conflicts must be disclosed and managed,

while others are prohibited outright. In the June 16, 2008 Proposing Release, the

Commission identified three additional conflicts that would be prohibited under

paragraph (c) of the rule.83 The Commission received a number of comments on the

See June 16, 2008 Proposing Release, 73 FR at 36235.

Id, 73 FR at 36226-36228. The Commission also proposed amendments to paragraphs (a) and (b)

of Rule 17g-5 that would require an NRSRO to manage the conflict of being repeatedly paid by

arrangers of structured finance products by prohibiting the NRSRO from rating such a product

proposed amendments.84 As discussed below, the Commission is adopting the

amendments but with revisions designed in part to address concerns raised by

commenters.

Rule 17g-5 Prohibition on Conflict of Interest Related to

Rating an Obligor or Debt Security where the Obligor or

Issuer Received Ratings Recommendations from the NRSRO

or Person Associated with the NRSRO

The Commission proposed adding a new paragraph (c)(5) to Rule 17g-5

prohibiting the conflict that arises when an NRSRO or its affiliate makes

recommendations on how to achieve a desired rating and then rates the obligor or debt

instrument that was the subject of the recommendations. The final rule being adopted

adds this new paragraph to Rule 17g-5. Under this paragraph, an NRSRO is prohibited

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 activities of the obligor or issuer of the security. The

purpose of this rule is to address the potential lack of impartiality that could arise when

an NRSRO determines a credit rating based on a corporate structure that was developed

after consultations with the NRSRO or its affiliate on how to achieve a desired credit

unless, among other things, information about the underlying assets was disseminated to persons

not involved in the rating process. Id, 73 FR at 36219-36226. The Commission received many

thoughtful comments on the proposal that identified substantial issues as to how the proposed

amendments would operate in practice. The Commission is re-proposing the amendments in a

separate release. See Companion Proposing Release.

See MICA Letter; ICI Letter; Rapid Ratings Letter; ABA Business Law Committees Letter;

NCRC Letter; Nappier Letter; Egan-Jones Letter; Lockyer Letter; RBDA Letter; Moody’s Letter;

A.M. Best Letter; Euler Letter; Realpoint Letter; CMSA Letter; LIUNA Letter; DBRS Letter;

Council Letter; DPW Letter; S&P Letter; Second SIFMA Letter; IBFED Letter; MBA Letter;

Fitch Letter; ASF Letter; Trepp Letter; CFA Institute Letter; Roundtable Letter; Colorado PERA

Letter; CGSH Letter; SPA Letter; R&I Letter; CreditSights Letter; DBA Letter; Citi Letter;

Lehman Letter; Raingeard Letter; JCR Letter; Second Realpoint Letter.

rating. In simple terms, the rule prohibits an NRSRO from rating its own work or the

work of an affiliate.

The Commission is adopting this amendment to Rule 17g-5, in part, pursuant to

the authority in Section 15E(h)(2) of the Exchange Act.85 This section of the statute

provides the Commission with authority to prohibit, or require the management and

disclosure of, any potential conflict of interest relating to the issuance of credit ratings by

an NRSRO.86 The Commission believes this amendment is necessary and appropriate in

the public interest and for the protection of investors because it addresses a practice that

could impair the objectivity, and, correspondingly, the quality, of a credit rating. It has

been suggested that during the process of rating structured finance products the NRSROs

have recommended to arrangers how to structure a trust or complete an asset pool to

receive a desired credit rating and then rated the securities issued by the trust – in effect,

rating their own work.87 This amendment will prohibit this conduct based on the

Commission’s belief that it creates a conflict that cannot be effectively managed

insomuch as it would be very difficult for an NRSRO to remain objective when assessing

the creditworthiness of an obligor or debt security where the NRSRO or person

associated with the NRSRO made recommendations about steps the obligor or issuer of

the security could take to obtain a desired credit rating.

15 U.S.C. 78o-7(h)(2).

Id.

See e.g., Testimony of Professor John C. Coffee, Jr., Adolf A. Berle Professor of Law, Columbia

University Law School, before the U.S. Senate Committee on Banking, Housing, and Urban

Affairs (September 26, 2007), pp. 2-3.

The Commission received 33 comments addressing this proposal.88 Most of the

comments supported the proposal, although some commenters expressed concern that the

provision may limit appropriate dialogue between an NRSRO and a person seeking a

credit rating or subject to an existing rating.89 Several commenters asked that the

Commission clarify the type of communications that would be acceptable feedback

during the ratings process. As stated in the June 16, 2008 Proposing Release, it is not the

Commission’s intent to prohibit the flow of information between an NRSRO and the

obligor, issuer, underwriter, or sponsor during the rating process.90 For example, the

Commission does not view an explanation by an NRSRO of the assumptions and

rationales it uses to arrive at ratings decisions and how they apply to a given rating

transaction as a recommendation. Consequently, in the case of a residential mortgagebacked security, an NRSRO, after putting the underlying assets through an expected loss

model run, may communicate the results to the sponsor and discuss how loan

characteristics such as FICO scores, geographic concentrations, or loan-to-value ratios

may have driven the results.

The Commission recognizes that providing this type of information during the

rating process allows the person seeking the rating to make adjustments in response to the

information provided by the NRSRO. However, the free flow of information between

the NRSRO and the person increases the transparency of the rating process. Moreover,

See Realpoint Letter; CMSA Letter; LIUNA Letter; DBRS Letter; JCR Letter; Council Letter;

DPW Letter; S&P Letter; Second SIFMA Letter; IBFED Letter; Nappier Letter; MBA Letter;

Fitch Letter; Lockyer Letter; ASF Letter; Multiple-Markets Letter; CFA Institute Letter; ICI

Letter; RBDA Letter; Roundtable Letter; Rapid Ratings Letter; AFP Letter; Colorado PERA

Letter; CGSH Letter; SPA Letter; R&I Letter; Moody’s Letter; ABA Business Law Committees

Letter; DBA Letter; NCRC Letter; Raingeard Letter; A.M. Best Letter.

See, e.g., CMSA Letter; LIUNA Letter; DBRS Letter; JCR Letter; Second SIFMA Letter; IBFED

Letter; MBA Letter; Fitch Letter; Roundtable Letter; AFP Letter.

June 16, 2008 Proposing Release, 73 FR at 36226.

NRSROs generally make their models available to persons seeking ratings. Sponsors of

structured finance securities can run potential asset pools through the models before

bringing the transactions to the NRSRO to be rated. This gives them an understanding of

the rating that the NRSRO likely will determine, particularly with respect to more

standardized structured finance products. The Commission believes this level of

transparency before and during the rating process benefits the credit markets by allowing

participants to gain an understanding and, ultimately, to assess the methodologies used by

the NRSROs. The alternative – restricting the flow of information – would make the

rating process more opaque.

The Commission notes, however, that if the feedback process turns into

recommendations by the NRSRO about changes to the structure, assets, liabilities or

activities of the obligor or security that the person seeking the rating potentially could

make to obtain a desired credit rating, the NRSRO would be in violation of the new rule.

For example, in the case of a residential mortgage-backed security, the NRSRO would

not be prohibited from informing the sponsor that the expected loss model indicated that

the underlying loan pool was too concentrated in a certain geographic region to receive

the desired rating given the level of credit enhancement proposed. On the other hand, if

an analyst recommends how to change the composition of the loans in the pool to achieve

the desired rating, the NRSRO would be making a recommendation about the assets of

the issuer and, consequently violate the rule. The sponsor must take the model results

from the NRSRO and decide independently how to adjust the asset pool to achieve the

desired rating. If changes are made, the NRSRO will run the new pool through the model

as if it were a new transaction and report the results to the sponsor.

Some argue that even this process of providing sponsors with information they

can use to make adjustments during the rating process should be prohibited. The

Commission disagrees because locking down the structure prior to the rating process

could have serious adverse consequences. Investors seek securities with specific credit

ratings. If sponsors cannot make adjustments to obtain those ratings, then the securities

ultimately issued and rated may not be marketable.

The Commission understands that NRSROs are concerned about how to draw the

line between permissible and unlawful communication of information.91 In response, the

Commission notes that NRSROs who provide the greatest clarity to the marketplace

about their ratings methodologies will need to provide less explanation during the ratings

process. Thus, NRSROs can mitigate the risk that communications during the rating

process will violate the rule by enhancing their disclosures about their ratings

methodologies, including about the qualitative factors they consider and the quantitative

models and the assumptions underlying those models they employ. For these reasons, the

Commission believes the new prohibition creates a strong incentive for NRSROs to

improve their disclosures, which, in turn, will benefit the users of credit ratings and, by

extension, the credit markets.

Some commenters stated that this conflict should not be prohibited but, instead,

included among the conflicts that must be disclosed and managed.92 Several commenters

also suggested that the conflict should not be prohibited when the affiliate (as opposed to

the NRSRO) makes the recommendation. The commenters suggested that measures such

as information barriers could address the conflict adequately without the need to prohibit

See, e.g., Fitch Letter, JCR Letter.

See, e.g., Realpoint Letter; DPW Letter; S&P Letter; ICI Letter; Colorado PERA Letter; R&I

Letter; Moody’s Letter.

it outright.93 The Commission believes that an NRSRO cannot remain objective when

rating its own work or that of an affiliate. As stated in the June 16, 2008 Proposing

Release, the Commission believes it would be difficult for the NRSRO to remain

objective if an affiliate were providing advice to obligors, issuers and sponsors about how

to obtain desired credit ratings because the financial success of the affiliate would depend

on issuers getting the ratings they sought after taking steps recommended by the

affiliate.94 This may create undue pressure on the NRSRO’s credit analysts to determine

credit ratings that favored the affiliate. The Commission believes this pressure may

undermine protective measures such as information barriers between the NRSRO and the

affiliate as they both would be under the common control of a group that benefited from

the affiliate’s financial success.

Finally, several commenters requested that the Commission clarify whether this

conflict applies only to structured finance ratings or whether it applies to all ratings

classes.95 The Commission intends that this prohibited conflict would apply across all

ratings classes.

For the reasons discussed above, the Commission is adopting the amendment as

proposed.

Rule 17g-5 Prohibition on Conflict of Interest Related to the

Participation of Certain Personnel in Fee Discussions

The Commission proposed prohibiting the conflict that arises when persons

within an NRSRO responsible for determining credit ratings or developing

methodologies for determining credit ratings participate in fee discussions. The final rule

See, e.g., Fitch Letter; Moody’s Letter.

See June 16, 2008 Proposing Release, 73 FR at 36226.

See, e.g., Lockyer Letter, RBDA Letter, A.M. Best Letter.

being adopted adds a new paragraph (c)(6) to Rule 17g-5.96 Under this paragraph, an

NRSRO is prohibited from issuing or maintaining a credit rating where the fee paid for

the rating was negotiated, discussed, or arranged by a person within the NRSRO who has

responsibility for participating in determining or approving credit ratings or for

developing or approving procedures or methodologies used for determining credit

ratings, including qualitative and quantitative models. The purpose of this rule is to

remove the persons most directly involved in making the judgments that credit ratings are

based on from fee negotiations and, thereby, insulate them from a process that could

make them more or less favorably disposed toward a client or class of clients.

As proposed, the rule did not explicitly mention persons involved in approving

credit ratings, although it implicitly included them by including persons involved in

“determining” credit ratings.97 The Commission notes that both determiners and

approvers engage in analysis that results in a final rating, and the Commission intends

them both to be covered by prohibitions aimed at protecting the integrity of this process.

Therefore, the Commission is clarifying today that for the purposes of Rule 17g-5, the

terms “determine,” “determined,” and “determining” include both persons who develop

credit ratings and persons who approve credit ratings. This clarification reflects the

Commission’s intent when it proposed the rule and is designed to remove any potential

ambiguity that could arise if some of the Rule 17g-5 prohibitions cover persons who

determine and approve credit ratings and others only cover persons who determine credit

ratings.

17 CFR 240.17g-5.

June 16, 2008 Proposing Release, 73 FR at 36226-36228.

The Commission is adopting this amendment to Rule 17g-5, in part, pursuant to

the authority in Section 15E(h)(2) of the Exchange Act.98 This section of the statute

provides the Commission with authority to prohibit, or require the management and

disclosure of, any potential conflict of interest relating to the issuance of credit ratings by

an NRSRO.99 The Commission believes this amendment is necessary and appropriate in

the public interest or for the protection of investors because it addresses a potential

practice that could impair the objectivity, and, correspondingly, the quality, of a credit

rating. This amendment is designed to effectuate the separation within the NRSRO of

persons involved in fee discussions from persons involved in the credit rating analytical

process. While the incentives of the persons discussing fees could be based primarily on

generating revenues for the NRSRO; the incentives of the persons involved in the

analytical process should be based on determining accurate credit ratings. There is a

significant potential for these distinct incentive structures to conflict with one another

when persons within the NRSRO are engaged in both activities.

The potential consequences are that a credit analyst or person responsible for

approving credit ratings or credit rating methodologies could, in the context of

negotiating fees, let business considerations undermine the objectivity of rating process.

For example, an individual involved in a fee negotiation with an issuer might not be

impartial when it comes to rating the issuer’s securities. In addition, persons involved in

approving the methodologies and processes used to determine credit ratings could be

reluctant to adjust a model to make it more conservative if doing so would make it more

15 U.S.C. 78o-7(h)(2).

Id.

difficult to negotiate fees with issuers. For these reasons, the Commission believes that

this conflict should be prohibited.

The Commission received 19 comments addressing this proposal, most of which

supported its goal.100 NRSROs, while agreeing in principle with the rule, raised a

number of questions. First, several NRSROs suggested that the Commission revise the

language of the amendment to conform to the International Organization of Securities

Commissions’ “Code of Conduct Fundamentals for Credit Rating Agencies” (the

“IOSCO Code”).101 The IOSCO Code provides that credit rating agencies “should not

have employees who are directly involved in the rating process initiate, or participate in,

discussions regarding fees or payments with any entity they rate.” The Commission

believes, however, that the IOSCO Code provision would be insufficient to accomplish

the goal of fully effectuating the separation within NRSROs of persons involved in fee

discussions from persons involved in the credit rating analytical process. In particular,

the IOSCO Code’s language would allow persons involved in approving the

methodologies and processes used to determine credit ratings to negotiate ratings fees,

which could make them reluctant to adjust a model to make it more conservative if doing

so would make it more difficult to negotiate fees with issuers.

In addition, other commenters, including the NRSROs, asked that the

Commission clarify that the prohibition does not apply to internal communications.102

They stated that senior managers (some of whom may be covered by the prohibition)

100

101

102

See Realpoint Letter; CMSA Letter; LIUNA Letter; DBRS Letter; S&P Letter; Nappier Letter;

Fitch Letter; ASF Letter; Multiple-Markets Letter; CFA Institute Letter; ICI Letter; Rapid Ratings

Letter; AFP Letter; Colorado PERA Letter; Moody’s Letter; ABA Business Law Committees

Letter; NCRC Letter; Raingeard Letter; A.M. Best Letter.

See, e.g., S&P Letter; Fitch Letter; A.M Best Letter. A copy of the IOSCO code is available at

www.iosco.org.

See, e.g., S&P Letter; Fitch Letter; A.M. Best Letter.

participate in internal discussions relating to fees to ensure that a fee charged is in

proportion to the work performed by the NRSRO. The Commission recognizes that

credit analysts may need to provide information on expected staffing and resource

requirements to the persons involved in fee discussions so the latter can factor such

information into the fees charged.

Some commenters stated that this conflict should be subject to the requirement to

disclose and manage, as opposed to being prohibited.103 The Commission disagrees for

several reasons. There does not appear to be a compelling reason for credit analysts and

model developers to participate in fee discussions. Furthermore, their involvement in that

process creates greater risk that they will develop a favorable or negative view of the

client or a class of clients based on how the negotiations proceed. This could influence

the judgment they exercise in determining credit ratings or developing credit rating

methodologies.

Several commenters noted that small NRSROs may need to have some analysts or

model developers participate in fee discussions given their staffing levels.104 These

commenters suggested that the rule should include an exemption for such NRSROs.105

The Commission agrees that the rule could potentially raise difficulties in certain

circumstances for an NRSRO with a small staff. Consequently, the Commission will

review requests by small NRSROs for exemptions from the rule under Section 36 of the

Exchange Act based on their specific circumstances. The Commission notes that it has

103

104

105

See, e.g., DBRS Letter; ASF Letter; Multiple-Markets Letter; Moody’s Letter.

See, e.g., DBRS Letter; Multiple-Markets Letter; CFA Institute Letter; Colorado PERA Letter;

ABA Business Law Committees Letter.

See, e.g., Fitch Letter; Rapid Ratings Letter; Moody’s Letter.

provided two small NRSROs with temporary exemptive relief from the prohibition in

Rule 17g-5 against receiving 10% or more of their net revenues from a single client.106

For the reasons discussed, the Commission is adopting the amendment as

proposed and clarifies, as noted above, that persons responsible for “approving” credit

ratings are covered by the prohibition as well as the provisions of Rule 17g-5 as a whole.

Rule 17g-5 Prohibition of Conflict of Interest Related to

Receipt of Gifts

The Commission proposed adding a new paragraph (c)(7) to Rule 17g-5107

prohibiting the conflict that arises when persons responsible for determining or approving

credit ratings receive gifts from the persons being rated or the sponsors of the persons

being rated.108 The final rule being adopted includes this new paragraph. Under this

paragraph, an NRSRO is prohibited from issuing or maintaining a credit rating where a

credit analyst who participated in determining or monitoring the credit rating, or a person

responsible for approving the credit rating received gifts, including entertainment, from

the obligor being rated, or from the issuer, underwriter, or sponsor of the securities being

rated, other than items provided in the context of normal business activities such as

meetings that have an aggregate value of no more than $25. The purpose of this rule is to

eliminate the potential undue influence that gifts can have on those responsible for

determining credit ratings.

106

107

108

See Order Granting Temporary Exemption of LACE Financial Corp. from the Conflict

of Interest Prohibition in Rule 17a-5(c)(1) of the Securities Exchange Act of 1934, Exchange Act

Release No. 57301 (February 11, 2008); Order Granting Temporary Exemption of Realpoint LLC

from the Conflict of Interest Prohibition in Rule 17a-5(c)(1) under the Securities Exchange Act of

1934, Exchange Act Release No. 58001 (June 23, 2008).

17 CFR 240.17g-5.

See June 16, 2008 Proposing Release, 73 FR at 36227-36228.

The Commission is adopting this amendment to Rule 17g-5, in part, pursuant to

the authority in Section 15E(h)(2) of the Exchange Act.109 This section of the statute

provides the Commission with authority to prohibit, or require the management and

disclosure of, any potential conflict of interest relating to the issuance of credit ratings by

an NRSRO as the Commission deems necessary or appropriate in the public interest or

for the protection of investors.110 The Commission believes the amendment is necessary

and appropriate in the public interest or for the protection of investors because it

addresses a potential practice that could impair the objectivity, and, correspondingly, the

quality, of a credit rating.

The Commission received 18 comments on the proposed amendment, most of

which agreed in principle with the proposal.111 One commenter suggested that this

conflict should be disclosed and managed instead of prohibited.112 The Commission

disagrees because other than in the most obvious cases it would be very difficult to

determine whether an analyst was swayed by gifts to adjust a rating. Persons seeking

credit ratings for an obligor or debt security could use gifts in an attempt to gain favor

with the analyst. In the case of a substantial gift, the potential to impact the analyst’s

objectivity could be immediate. With smaller gifts, the danger is that over time the

cumulative effect of repeated gifts can impact the analyst’s objectivity. In either case,

there is little ability to “manage” the analyst’s motivations. Therefore, the Commission

109

110

111

112

15 U.S.C. 78o-7(h)(2).

Id.

See S&P Letter; Nappier Letter; Lockyer Letter; ASF Letter; Multiple-Markets Letter; CFA

Institute Letter; ICI Letter; Roundtable Letter; Rapid Ratings Letter; AFP Letter; R&I Letter;

Moody’s Letter; ABA Business Law Committees Letter; Foutch Letter; DBA Letter; NCRC

Letter; Raingeard Letter; A.M. Best Letter.

See Moody’s Letter.

believes that an absolute prohibition on gifts, with the exception of minor incidentals

such as those provided in business meetings, is appropriate.

Several NRSROs noted the potential for cultural misunderstandings over the

proposed gift limit, noting that issuers from other countries may be embarrassed or

offended by the prohibition. One NRSRO suggested in response that the Commission

include an exemption or higher dollar threshold for gifts from foreign issuers, while

another cited such potential misunderstandings in support of its suggestion that the

conflict be disclosed and managed instead of prohibited.113 The Commission recognizes

that a prohibition may pose initial difficulties with certain foreign issuers but believes

that over time, and given the uniformity of the rule across NRSROs, such issuers will

come to understand and accept the prohibition.

Several commenters asked that the Commission clarify how the $25 limit would

operate114 and some suggested a higher limit such as $50 or $100.115 The $25 limit is not

designed to be an exception to the prohibition on giving gifts. Rather, it is intended to

permit the exchange of items that are incidental to routine business interactions such as

meetings. For example, if an analyst meets with an issuer to discuss a credit rating, the

issuer could provide the analyst with note pads, pens and light refreshments, provided

they did not have an aggregate value exceeding $25. The Commission notes that the rule

is not intended to allow an analyst to accept a gift, regardless of its value, that has no use

in conducting the meeting. In addition, the Commission wishes to clarify that the $25

limit is per analyst and per interaction and not a one-time or annual limit.

113

114

115

See, e.g., S&P Letter, Moody’s Letter.

See, e.g., S&P Letter; Roundtable Letter; R&I Letter; Moody’s Letter.

See, e.g., S&P Letter; CFA Institute Letter; Roundtable Letter; ABA Business Law Committees

Letter; A.M. Best Letter.

The Commission also intends that the rule be prospective. Therefore, the fact that

an analyst received a gift from a person seeking a credit rating prior to the rule’s effective

date will not preclude the NRSRO from issuing a credit rating determined by the analyst.

Finally, a few commenters asked the Commission to clarify whether this

amendment applied only to structured finance ratings or whether it applied to all ratings

classes.116 The Commission believes that there is no reason to limit this prohibition to

structured finance ratings: any person seeking a credit rating could attempt to gain favor

with an analyst responsible for determining the credit rating by using gifts. Therefore,

this prohibition applies across all classes of credit ratings.

For the reasons discussed, the Commission is adopting the amendment as

proposed.

III.

PAPERWORK REDUCTION ACT

Certain provisions of the rule amendments contain a “collection of information”

within the meaning of the Paperwork Reduction Act of 1995 (“PRA”).117 The

Commission published a notice requesting comment on the collection of information

requirements in the June 16, 2008 Proposing Release and submitted the proposed

amendments to the Office of Management and Budget (“OMB”) for review in accordance

with the PRA.118 An agency may not conduct or sponsor, and a person is not required to

comply with, a collection of information unless it displays a currently valid control

number. The titles for the collections of information are:

(1)

116

117

118

Rule 17g-1, Application for registration as a nationally recognized

statistical rating agency; Form NRSRO and the Instructions for Form

NRSRO (OMB Control Number 3235-0625);

See, e.g., Lockyer Letter.

44 U.S.C. 3501 et seq.; 5 CFR 1320.11.

See June 16, 2008 Proposing Release, 73 FR at 36236-36241.

(2)

Rule 17g-2, Records to be made and retained by national recognized

statistical rating organizations (OMB Control Number 3235-0628);

and

(3)

Rule 17g-3, Annual reports to be furnished by nationally recognized

statistical rating organizations (OMB Control Number 3235-0626).

Collections of Information under the Amended Rules

The Commission is adopting rule amendments to prescribe additional

requirements for NRSROs to address concerns that have arisen with respect to their role

in the credit market turmoil. These amendments modify rules the Commission adopted in

2007 to implement registration, recordkeeping, financial reporting, and oversight rules

under the Rating Agency Act. Certain of the amendments contain recordkeeping and

disclosure requirements that will be subject to the PRA. The collection of information

obligations imposed by the amendments is mandatory. The amendments, however, will

apply only to credit rating agencies that are registered with the Commission as NRSROs.

Such registration is voluntary.119

In summary, the rule amendments require: (1) an NRSRO to provide enhanced

disclosure of performance measurements statistics and the procedures and methodologies

used by the NRSRO in determining credit ratings for structured finance products and

other debt securities on Form NRSRO;120 (2) an NRSRO to make, keep and preserve

additional records under Rule 17g-2;121 (3) an NRSRO to make publicly available on its

Internet Web site in XBRL format a random sample of 10% of the ratings histories in

each ratings class for which it is registered and has issued 500 or more ratings paid for by

the obligor being rated or by the issuer, underwriter, or sponsor of the security being

119

120

121

See Section 15E of the Exchange Act (15 U.S.C. 78o-7).

See amendments to Form NRSRO.

17 CFR 240.17g-2.

rated, with each new ratings action to be reflected in such histories no later than six

months after they are taken;122 and (4) an NRSRO to furnish the Commission with an

additional annual report.123

Proposed Use of Information

The amendments enhance the framework for Commission oversight of NRSROs,

in part in response to the recent credit market turmoil.124 The collections of information

in the rule amendments are designed to further assist the Commission in effectively

monitoring, through its examination function, whether an NRSRO is conducting its

activities in accordance with Section 15E of the Exchange Act125 and the rules

thereunder. In addition, these rule amendments are designed to further assist users of

credit ratings by requiring the disclosure of additional information with respect to an

NRSRO that could be used to compare the credit ratings quality of different NRSROs,

particularly with respect to structured finance products. The Commission believes that the

information that NRSROs will be required to make public as a result of the amendments

will advance one of the primary objectives of the Rating Agency Act, as noted in the

accompanying Senate Report, to “facilitate informed decisions by giving investors the

opportunity to compare ratings quality of different firms.”126

Respondents

In adopting the final rules under the Rating Agency Act, the Commission

estimated that approximately 30 credit rating agencies would be registered as

122

123

124

125

126

See Rule 17g-2(a)(8) and (d).

See Rule 17g-3(a)(6).

See 17 CFR 17g-1 through 17g-6, and Form NRSRO.

15 U.S.C. 78o-7.

See Senate Report, p. 8.

NRSROs.127 The Commission believes that this estimate continues to be appropriate for

identifying the number of respondents for purposes of the amendments. Since the initial

set of rules under the Rating Agency Act became effective in June 2007, ten credit rating

agencies have registered with the Commission as NRSROs.128 The registration program

has been in effect for over a year; consequently, the Commission expects additional

entities will register. While 20 more entities may not ultimately register, the Commission

believes the estimate is within reasonable bounds and appropriate given that it adds an

element of conservatism to its paperwork burden estimates as well as cost estimates.

The Commission requested comment on all aspects of the proposed estimate for

the number of respondents. The Commission did not receive any comments in response

to the proposed estimate. As discussed above, the Commission continues to estimate, for

purposes of this PRA, that approximately 30 credit rating agencies will be registered as

NRSROs and thus will be required to comply.

Total Annual Recordkeeping and Reporting Burden

As discussed in further detail below, the Commission estimates the total

recordkeeping burden resulting from the amendments will be approximately 820 hours on

an annual basis129 and 4,560 hours on a one-time basis.130

The total annual and one-time hour burden estimates described below are

averages across all types of NRSROs expected to be impacted by the rule amendments.

The size and complexity of NRSROs range from small entities to entities that are part of

127

128

129

130

See June 5, 2007 Adopting Release, 72 FR at 33607.

A.M. Best Company, Inc.; DBRS Ltd.; Fitch.; Japan Credit Rating Agency, Ltd.; Moody’s; Rating

and Investment Information, Inc.; S&P; LACE Financial Corp.; Egan-Jones Rating Company; and

Realpoint LLC.

This total is derived from the total annual hours set forth in the order that the totals appear in the

text: 750 + 70 + 1000 = 1,820.

This total is derived from the total one-time hours set forth in the order that the totals appear in the

text: 3,000 + 1,350 + 210 = 4,560.

complex global organizations employing thousands of credit analysts. Consequently, the

burden hour estimates represent the average time across all NRSROs. The Commission

further notes that, given the significant variance in size between the largest NRSROs and

the smallest NRSROs, the burden estimates, as averages across all NRSROs, are skewed

higher because the largest firms currently predominate in the industry.

Amendments to Form NRSRO

The amendments to Form NRSRO change the instructions for the Form to require

that NRSROs provide more detailed credit ratings performance statistics in Exhibit 1 and

disclose with greater specificity information about the procedures and methodologies used

to determine structured finance and other credit ratings in Exhibit 2.131 The total annual

burden hours currently approved by OMB is 2,100, and the total one-time burden hours is

10,000. In the June 16, 2008 Proposing Release, the Commission stated that it expected

that the proposed amendments would not have a material effect on the respondents’ hour

burden because the additional disclosures would be included within the overall preparation

of the initial Form NRSRO for new applicants.132 Additionally, in that release, the

Commission stated it believed that the NRSROs currently registered would be required to

prepare and furnish an amended Form NRSRO to update their registration applications as

a result of the adoption of the proposed amendments (i.e., as of today that would be ten

amended Form NRSROs).133 However, the Commission stated that it believed these

potential furnishings of Form NRSRO were accounted for in the currently approved PRA

collection for Rule 17g-1, which includes an estimate that each NRSRO would file two

amendments to Form NRSRO per year.

131

132

133

17 CFR 240.17g-1 and Form NRSRO.

June 16, 2008 Proposing Release, 73 FR at 36237-36238.

Id.

The Commission requested comment on all aspects of the burden estimates for

Rule 17g-1 and Form NRSRO, as amended.134 One commenter disagreed with the

Commission that there would be no additional one-time or ongoing collection of

information burdens for NRSROs to provide the additional information required in Exhibit

2 to Form NRSRO.135 The commenter stated that it would need to conduct a survey of its

practices, synthesize and summarize the results of the survey, and incorporate the results

into Exhibit 2 of Form NRSRO.136 The commenter estimated that it would take at least

100 hours to complete a global survey, involving compliance personnel, as well as senior

analysts and their supervisors. In addition, the commenter estimated that it would take at

least 24 hours per year on average to collect information and another 12 hours per year to

incorporate descriptions of changes into Form NRSRO, as well as an additional 24 hours

per year conducting compliance assessments.137 The commenter noted, however, that it

did not consider such one-time and ongoing compliance burdens to be excessive.138

As adopted, the amendments to the instructions to Exhibit 2 to Form NRSRO add

three additional areas that an applicant and a registered NRSRO must address in the

descriptions of its procedures and methodologies in Exhibit 2 to the extent they are

applicable.139 Because the additional requirements, as adopted, require only a description

134

135

136

137

138

139

Id.

See Moody’s Letter.

Id.

These additional areas are: whether and, if so, how information about verification performed on

assets underlying or referenced by a security or money market instrument issued by an asset pool

or as part of any asset-backed or mortgage-backed securities transaction is relied on in determining

credit ratings; whether and, if so, how assessments of the quality of originators of assets

underlying or referenced by a security or money market instrument issued by an asset pool or as

part of any asset-backed or mortgage-backed securities transaction play a part in the determination

of credit ratings; and how frequently credit ratings are reviewed, whether different models or

criteria are used for ratings surveillance than for determining initial ratings, whether changes made

to models and criteria for determining initial ratings are applied retroactively to existing ratings,

of the procedures and methodologies, the Commission believes that there may have been

some misinterpretation with respect to the actual requirements regarding the amendments

to Exhibit 2. As stated above, the Commission notes that the instructions for Exhibit 2 to

Form NRSRO require only a description of the procedures and methodologies that the

NRSRO actually employs and it does not require an NRSRO to adopt specific

procedures. In addition, it only requires a description of the NRSRO’s general ratings

procedures and methodologies as opposed to the submission and disclosure of the actual

procedures and methodologies used to determine credit ratings.140

Based on clarifications discussed above, the Commission believes that the actual

time expenditures of NRSROs in complying with the rules will be less than the

commenter’s estimates. Nonetheless, the Commission is revising the one-time hourly

burden estimate upward in response to the comment. The Commission, based on the

comment received and staff experience, estimates that the average time necessary for an

applicant or NRSRO to gather the information on a one-time basis in order to complete

the additional disclosures required by the amendments to Exhibit 2 to Form NRSRO will

be 100 hours per NRSRO, which would be a one-time hour burden to the industry of

3,000 hours.141 The Commission is not revising its annual burden because it believes that

once an NRSRO has updated Exhibit 2 to Form NRSRO to include descriptions of these

aspects of its methodologies, any further updates would be incremental and the time

140

141

and whether changes made to models and criteria for performing ratings surveillance are

incorporated into the models and criteria for determining initial ratings.

The instructions further provide that the description must be sufficiently detailed to provide users

of credit ratings with an understanding of the processes the applicant or NRSRO employs to

determine credit ratings.

100 hours x 30 NRSROs = 3,000 hours.

burdens associated with completing the updates are reflected in the current annual

burdens discussed above.

Amendments to Rule 17g-2

Rule 17g-2 requires an NRSRO to make and keep current certain records relating

to its business and requires an NRSRO to preserve those and other records for certain

prescribed time periods.142 The amendments to Rule 17g-2 require an NRSRO to make

and retain two additional records and to retain a third type of record. The records to be

made and retained are: (1) a record of the rationale for any material difference between

the credit rating implied by the model and the final credit rating issued, if a quantitative

model is a substantial component in the process of determining a credit rating of a

security or money market instrument issued by an asset pool or as part of any assetbacked or mortgage-backed securities transaction;143 and (2) a record showing the history

and dates of all previous rating actions with respect to each outstanding credit rating.144

The amendments to Rule 17g-2 also require an NRSRO to make public, in XBRL format

and with a six-month grace period, the ratings action information required under new

paragraph (a)(8) for a random sample of 10% of the issuer paid credit ratings for each

ratings class for which it has issued 500 or more issuer-paid credit ratings.145 In addition,

the amendments require an NRSRO to retain communications from persons not

associated with the NRSRO that contain any complaints by an obligor, issuer,

underwriter, or sponsor about the performance of a credit analyst.146

142

143

144

145

146

17 CFR 240.17g-2.

Paragraph (a)(2)(iii) of Rule 17g-2.

Paragraph (a)(8) of Rule 17g-2.

Amendment to Rule 17g-2(d).

Paragraph (b)(8) of Rule 17g-2.

The Commission requested comment in the June 16, 2008 Proposing Release on

the burdens that would result from the proposed amendments to Rule 17g-2.147 The

Commission received one comment regarding the PRA estimate for Rule 17g-2.148 This

commenter, a large NRSRO, stated that the Commission has significantly underestimated

the initial and ongoing recordkeeping burdens associated with its proposed changes to

NRSROs’ recordkeeping requirements.149

The same large NRSRO submitted comments specific to the proposed amendment

to Rule 17g-2(d) which would have required disclosure of the histories of rating actions

for outstanding credit ratings in an XBRL format. The commenter stated that developing

and agreeing upon the taxonomy and tags for an XBRL data file would take at least

several hundred hours over several months or even longer and that ongoing maintenance

of the database could easily exceed two months per year.150 The Commission notes that

the amendment as adopted specifies that in making the required information available on

its Web site, an NRSRO will use the List of XBRL Tags for NRSROs as specified on the

Commission’s Web site, thus eliminating the need for an NRSRO to develop its own

taxonomy and tags. In addition, as adopted, the amendment to Rule 17g-2(d) limits the

requirement to the disclosure of a random sample of 10% of the issuer-paid credit rating

histories for each ratings class for which an NRSRO has issued 500 or more issuer-paid

credit ratings. This is a substantial reduction from the amount of information that would

have been required by the amendment as proposed. Consequently, the amount of time

required to comply with the amendment to Rule 17g-2(d), as adopted, will be

147

148

149

150

See June 16, 2008 Proposing Release, 73 FR at 36238-36239.

See Moody’s Letter.

Id.

significantly reduced for what would have been required under the proposal. Finally, the

Commission notes that, in order to allow NRSROs sufficient time to implement the new

disclosure requirement of Rule 17g-2(d), as amended, the compliance date for that

amendment will be 180 days after publication in the Federal Register.

In addition to its comments on the XBRL portion of the proposed amendments to

Rule 17g-2, the same large NRSRO submitted comments on the proposed amendment to

Rule 17g-2 regarding records of material deviation from model output and the recording

of complaints relating to analysts. With respect to the record of material deviation from

model output, the commenter stated it would take analysts, supervisors, and senior

management more than 150 hours to determine which quantitative models were a

“substantial component” in determining ratings; 200 hours for compliance, legal and IT

staff to develop policies, amend schedules and modify systems to comply with the rule;

and 1,500 hours to develop compliance procedures and training materials. On an

ongoing basis, the commenter estimated that it would take approximately 60-90 minutes

to create, approve and file each record related to this amendment. Finally, the commenter

estimated that, on an annual basis, it would spend 40 to 80 hours per year on compliance

reviews and 200 hours per year on training.151 In response to comments on the proposed

rule language, the Commission narrowed the application of Rule 17g-2(a)(2)(iii) to

ratings of structured finance products only. This will lessen the recordkeeping burden on

an NRSRO and be responsive to commenters’ concerns that the requirement could have

negative effects on the ratings process for other classes of credit ratings where qualitative

analysis is predominant and models have a more marginal role.

151

Id.

Finally, the same NRSRO commenter estimated that with respect to the records of

complaints about analysts under Rule 17g-2(b)(8), it would take approximately 100 hours

to implement the proposed rule, draft a policy, and change its systems to capture the

required records, as well as 1,500 hours to develop compliance procedures and a training

module. On an ongoing basis, the commenter estimated it would take approximately 10

to 100 hours to follow-up and document each complaint. Finally, on an annual basis, the

commenter estimated it would spend approximately 40 to 80 hours per year on

compliance reviews and 150 hours per year on training.152 With respect to this

requirement, the Commission notes that it intends the rule to apply only to

communications received by the NRSRO from outside parties such as subscribers or

entities that pay to obtain credit ratings. The amendment was not intended to require the

retention of complaints sent internally between, for example, employees of the NRSRO.

Further, the Commission has clarified that the rule does not apply to oral

communications.

Based on the modifications and clarifications discussed above, the Commission

believes that the actual time expenditures of NRSROs in complying with the rules will be

less than the commenter’s estimates. Nonetheless, the Commission is revising its hourly

burden estimates upward in response to the comment.

With respect to the amendments to Rule 17g-2, the Commission estimates, based

on staff information gained from the NRSRO examination process and in response to

comments received, that the total one-time and annual recordkeeping burdens will

increase approximately 15% and 10%, respectively. The Commission believes that the

one-time burden to set up and/or modify a recordkeeping system to comply with the

152

Id.

amendments would be greater than the ongoing annual burden. Once an NRSRO has set

up or modified its recordkeeping system to comply with the amendments, its annual hour

burden would be increased only to the extent it would be required to make and retain

additional records. In the June 16, 2008 Proposing Release, the Commission estimated

that the total one-time and annual recordkeeping burdens would increase approximately

10% and 5%, respectively.153 Thus, the Commission estimates that the one-time burden

that each NRSRO will spend implementing a recordkeeping system to comply with Rule

17g-2, as amended, will be approximately 345 hours,154 for a total one-time burden of

10,350 hours for 30 NRSROs,155 which represents an increase in the currently approved

PRA burden under Rule 17g-2 of 1,350 total one-time burden hours.156 The Commission

estimates that an NRSRO would spend an average of 279 hours per year157 to make and

retain records under Rule 17g-2 as amended, for a total annual hour burden under Rule

17g-2 of 8,370 hours.158 This estimate will result in an increase in the currently approved

PRA burden under Rule 17g-2 of 750 annual burden hours.159 As discussed above, the

increase in annual burden hours will result from the increase in the number of records an

NRSRO will be required to make and retain under the amendments to Rule 17g-2. The

Commission notes that the PRA estimates for Rule 17g-2 are averages across all types of

NRSROs expected to be affected by the rule amendments. The size and complexity of

NRSROs range from small entities to entities that are part of complex global

153

154

155

156

157

158

159

See June 16, 2008 Proposing Release, 73 FR at 36238-36239.

300 hours x 1.15 = 345 hours. This will result in an increase of approximately 45 hours per

NRSRO for the one-time hour burden.

345 hours x 30 respondents = 10,350 hours.

11,700 hours – 10,350 hours = 1,350 hours.

254 hours x 1.10 = 279 hours. The amendments would result in an increase of approximately 25

annual burden hours per NRSRO for Rule 17g-2.

279 hours x 30 respondents = 8,370 hours.

8,370 hours – 7,620 hours = 750 hours.

organizations employing thousands of credit analysts. Consequently, the burden hour

estimates for Rule 17g-2 represent the average time across all NRSROs.

In addition, the amendments to Rule 17g-2 require an NRSRO to make publicly

available on its Web site in XBRL format ratings action histories for a random sample of

10% of its outstanding issuer-paid credit ratings in each class of credit rating for which it

is registered and has determined 500 or more issuer-paid credit ratings.160 Based on

information furnished on Form NRSRO, seven of the ten currently registered NRSROs

issue 500 or more issuer-paid credit ratings in at least one of the classes of credit ratings

for which they are registered. The Commission believes that even as the number of

registered NRSROs expands to the 30 ultimately expected to register, this number will

remain relatively constant, as new entrants are likely to predominantly determine

subscriber-paid credit ratings, at least in the near future. In addition, the Commission

believes that each of the NRSROs affected by this new requirement already has, or will

have, an Internet Web site. As noted above, the amendment as adopted specifies that in

making the required information available on its Web site, an NRSRO will use the List of

XBRL Tags for NRSROs as specified on the Commission’s Web site, thus eliminating

the need for an NRSRO to develop its own taxonomy and tags and significantly reducing

the amount of time required to comply with the amendment.

Therefore, based on staff experience, the Commission estimates that, on average,

an NRSRO subject to the requirement will spend approximately 30 hours to publicly

disclose the required information in an XBRL format and, thereafter, 10 hours per year to

160

See amendment to Rule 17g-2(d).

update this information.161 Accordingly, the total aggregate one-time burden to the

industry to make the history of rating actions publicly available in an XBRL format will

be 210 hours,162 and the total aggregate annual burden hours will be 70 hours.163

Under the currently approved PRA collection for Rule 17g-2, the Commission

estimated that an NRSRO may need to purchase recordkeeping system software to

establish a recordkeeping system in conformance with Rule 17g-2.164 The Commission

estimated that the cost of the software would vary based on the size and complexity of the

NRSRO. Also, the Commission estimated that some NRSROs would not need such

software because they already have adequate recordkeeping systems or, given their small

size, such software would not be necessary. Based on these estimates, the Commission

estimated that the average cost for recordkeeping software across all NRSROs would be

approximately $1,000 per firm, with an aggregate one-time cost to the industry of

$30,000.165 In response to comments discussed above, the Commission estimates that the

amendments to Rule 17g-2 would alter this per firm estimate upward by approximately

$800.166 For example, in the PRA for the proposed rules requiring the submission of

risk/return summary information using interactive data, the Commission estimated that

software and consulting services would be used by mutual funds for an increase of

approximately $803 per mutual fund.167 The Commission believes that the requirement

161

162

163

164

165

166

167

The Commission also bases this estimate on the current one-time and annual burden hours for an

NRSRO to publicly disclose its Form NRSRO. No alternatives to these estimates as proposed

were suggested by commenters. See June 5, 2007 Adopting Release, 72 FR at 33609.

30 hours x 7 NRSROs = 210 hours.

10 hours x 7 NRSROs = 70 hours.

See June 5, 2007 Adopting Release, 72 FR at 33609, 33610.

Id.

See Interactive Data for Mutual Fund Risk/Return Summary, Securities Act Release No. 8929

(June 10, 2008), 73 FR 35442 (June 23, 2008).

Id.

to publicly disclose certain ratings action histories in an XBRL format would result in a

similar cost.

Amendment to Rule 17g-3

Rule 17g-3 requires an NRSRO to furnish certain financial reports to the

Commission on an annual basis, including audited financial statements as well as other

financial reports.168 The Commission is amending Rule 17g-3 to require an NRSRO to

furnish the Commission with an additional report: an unaudited report of the number of

credit ratings actions (upgrades, downgrades, placements on credit watch, and

withdrawals) taken during the fiscal year in each class of credit ratings identified in

section 3(a)(62)(B) of the Act (15 U.S.C. 78c(a)(62)(B)) for which the NRSRO is

registered with the Commission.169

The total annual burden currently approved by OMB for Rule 17g-3 is 6,000

hours, based on the fact that it will take an NRSRO, on average, approximately 200 hours

to prepare for and file the annual reports.170 In addition, the total annual cost burden

currently approved by OMB is $450,000 to engage the services of an independent public

accountant to conduct the annual audit as part of the preparation of the first report

required by Rule 17g-3.171 This estimate is based on 30 NRSROs hiring an independent

public accountant on an annual basis for an average of $15,000.172

The Commission requested comment in the June 16, 2008 Proposing Release on

the burdens that would result from the proposed amendments to Rule 17g-3.173 One

168

169

170

171

172

173

17 CFR 240.17g-3.

See Rule 17g-3(a)(6).

200 hours x 30 NRSROs = 6,000 hours. See June 5, 2007 Adopting Release, 72 FR at 33610.

Rule 17g-3 currently requires six reports. Only the first report – financial statements – need be

audited.

$15,000 x 30 NRSROs = $450,000. See June 5, 2007 Adopting Release, 72 FR at 33610.

See June 16, 2008 Proposing Release, 73 FR at 36239.

commenter, a large NRSRO, estimated that it would cost $300,000 to build and test a

system to comply with this amendment and that its ongoing costs would be $70,000 per

year.174 The commenter did not provide specific data and analysis to support the

estimates.175 The Commission believes that most NRSROs already will have the

information that it needs in order to comply with the amendment to Rule 17g-3 with

respect to each class of credit ratings for which it is registered. In addition, the

Commission emphasizes that this amendment does not prescribe a specific format for the

report. Consequently, the Commission believes that the actual time expenditures of

NRSROs in complying with the rule amendment will be less than the commenter’s

estimates. Nonetheless, the Commission is revising its PRA estimate for Rule 17g-3

upward in response to the comment.

The Commission, based on the comment received and staff experience, estimates

that the average time necessary for an applicant or NRSRO to establish an internal

process to conform its systems to generate a report in compliance with the amendment

will be 100 hours per NRSRO, for a total one-time hour burden to the industry of 3,000

hours.176 The Commission believes that once an NRSRO complies with the amendment

to Rule 17g-3 in the first year, that preparation of the new annual report will become

routine. To account for this one-time burden of 3,000 hours and the possibility that new

credit rating agencies will register as NRSROs, the Commission is averaging this burden

estimate over the three year approval period. Consequently, the Commission is

increasing the annual burden estimate by 1,000 hours for a total annual burden estimate

for Rule 17g-3 of 4,000 hours.

174

175

176

See S&P Letter.

Id.

100 hours x 30 NRSROs = 3,000 hours.

Collection of Information Is Mandatory

The recordkeeping requirements for the rule amendments are mandatory.

Confidentiality

The disclosures required under the amendments to Rule 17g-1 and Form NRSRO

will be made publicly available on Form NRSRO. The books and records information to

be collected under the amendments to Rule 17g-2 will be stored by the NRSRO and made

available to the Commission and its representatives as required in connection with

examinations, investigations, and enforcement proceedings. However, an NRSRO will

be required to make public, in XBRL format and with a six-month grace period, the

ratings action histories for a random sample of 10% of the issuer-paid credit ratings for

each ratings class for which it has issued 500 or more issuer-paid credit ratings.177 The

information collected under the amendment to Rule 17g-3 will be generated from the

internal records of the NRSRO and will be furnished to the Commission on a confidential

basis, to the extent permitted by law.178

IV.

COSTS AND BENEFITS OF THE AMENDED RULES

The Commission is sensitive to the costs and benefits that result from its rules.

The Commission identified certain costs and benefits arising from these amendments and

requested comment on all aspects of the cost-benefit analysis contained therein, including

identification and assessment of any costs and benefits not discussed in the analysis.179

177

178

179

Amendment to Rule 17g-2(d).

15 U.S.C. 78o-7(k).

For the purposes of this cost/benefit analysis, the Commission is using salary data from the

Securities Industry and Financial Markets Association (“SIFMA”) Report on Management and

Professional Earnings in the Securities Industry 2007, which provides base salary and bonus

information for middle-management and professional positions within the securities industry. The

Commission believes that the salaries for these securities industry positions would be comparable

to the salaries of similar positions in the credit rating industry. Finally, the salary costs derived

from the report and referenced in this cost benefit section, are modified to account for an 1800-

The Commission sought comment and data on the value of the benefits identified. The

Commission also requested comment on the accuracy of the cost estimates in each

section of the cost-benefit analysis, and requested those commenters to provide data so

the Commission could improve the cost estimates, including identification of statistics

relied on by commenters to reach conclusions on cost estimates. Finally, the

Commission requested estimates and views regarding the costs and benefits for particular

types of market participants, as well as any other costs or benefits that might result from

the adoption of the rule amendments.

Benefits

The purposes of the Rating Agency Act, as stated in the accompanying Senate

Report, are to improve ratings quality for the protection of investors and in the public

interest by fostering accountability, transparency, and competition in the credit rating

industry.180 As the Senate Report states, the Rating Agency Act establishes “fundamental

reform and improvement of the designation process” to further the belief that

“eliminating the artificial barrier to entry will enhance competition and provide investors

with more choices, higher quality ratings, and lower costs.”181

The Commission requested comment on all aspects of the benefits of the

amendments as proposed.182 In addition, the Commission requested specific comment on

available metrics to quantify these benefits and any other benefits the commenter may

180

181

182

hour work year and multiplied by 5.35 to account for bonuses, firm size, employee benefits and

overhead. The Commission used comparable assumptions in adopting the final rules

implementing the Rating Agency Act in 2007, requested comments on such assumptions, and

received no comments in response to its request. See June 5, 2007 Adopting Release, 72 FR at

33611, note 576. Hereinafter, references to data derived from the report as modified in the manner

described above will be cited as “SIFMA 2007 Report as Modified.”

Senate Report, p. 2.

Id, p. 7.

See June 16, 2008 Proposing Release, 73 FR at 36241-36243.

identify, including he identification of sources of empirical data that could be used for

such metrics.183 The Commission did not receive any comments in response to this

request.

The amendments are designed to further the goals of the Rating Agency Act,

including fostering transparency in the credit rating agency industry. Since the adoption

of the final rules implementing the Rating Agency Act in 2007,184 the Commission has

identified a number of areas where it is appropriate to enhance the current regulatory

program for NRSROs.

Consequently, the Commission is adopting amendments that enhance the

disclosure of credit ratings performance measurement statistics; increase the disclosure of

information about the assets underlying structured finance products; require more

information about the procedures and methodologies used to determine structured finance

ratings; and address conflicts of interest arising from the structured finance rating

process. As discussed below, the Commission believes that these amendments will

further the purpose of the Rating Agency Act to improve the quality of credit ratings by

fostering accountability, transparency, and competition in the credit rating industry,

particularly with respect to credit ratings for structured finance products.185

Rule 17g-1 prescribes a process for a credit rating agency to register with the

Commission as an NRSRO using Form NRSRO, 186 and requires that a credit rating

agency provide information required under Section 15E(a)(1)(B) of the Exchange Act

183

184

185

186

Id.

See June 5, 2007 Adopting Release.

See Senate Report, p. 2.

See Rule 17g-1.

and certain additional information.187 Form NRSRO is also the means by which

NRSROs update the information they must publicly disclose. The amendments to the

instructions to Exhibit 1 to Form NRSRO will require NRSROs to provide more detailed

performance statistics and, thereby, make it easier for users of credit ratings to compare

the ratings performance of the NRSROs.188 In addition, these amendments will make it

easier for an NRSRO to demonstrate that it has a superior ratings methodology or

competence and, thereby, attract clients.

The amendments to the instructions to Exhibit 2 of Form NRSRO are designed to

provide greater clarity around three areas of the NRSROs’ rating processes that have

raised concerns in the context of the recent credit market turmoil: the level of verification

performed on information provided in loan documents; the quality of loan originators;

and the on-going surveillance of existing ratings and how changes made to a model used

for initial ratings are applied to existing ratings. The additional information provided by

the amendments will assist users of credit ratings in making more informed decisions

about the quality of an NRSRO’s ratings processes, particularly with regard to structured

finance products.

The Commission believes that these enhanced disclosures in the Exhibits to Form

NRSRO will make it easier for market participants to select the NRSROs that are

performing well and have the highest quality processes for determining credit ratings.

The Commission expects that providing market participants with enhanced disclosures

will lead to increased competition and the promotion of capital formation through a

restoration of confidence in credit ratings.

187

188

See Section 15E(a)(1)(B) of the Exchange Act. 15 U.S.C. 78o-7(a)(1)(B).

17 CFR 240.17g-1 and Form NRSRO.

The amendments to Rule 17g-2 are designed to provide greater documentation of

the ratings process to assist Commission staff in its examination function as well as to

provide greater information to users of issuer-paid credit ratings about the performance of

an NRSRO’s issuer-paid credit ratings. The additional records will be: (1) a record of the

rationale for any material difference between the credit rating implied by the model and

the final credit rating issued, if a quantitative model is a substantial component in the

process of determining a credit rating for a structured finance product;189 (2) a record

showing the history and dates of all previous rating actions with respect to each

outstanding credit rating; (3) a record, to be made publicly available, showing the history

and dates of a 10% random sample of issuer-paid credit ratings, for each ratings class for

which an NRSRO is registered and has issued 500 or more issuer-paid credit ratings, of

all previous rating actions with respect to each outstanding credit rating;190 and (4) any

written complaints regarding the performance of a credit analyst in determining credit

ratings.191 These records will assist the Commission in monitoring whether an NRSRO is

complying with provisions of Section 15E of the Exchange Act and the rules thereunder.

The Commission will be better able to monitor whether an NRSRO is operating

consistently with the methodologies and procedures it establishes (and discloses) to

determine credit ratings and its policies and procedures designed to ensure the

impartiality of its credit ratings, including its ratings of structured finance products.

In addition, the amendment to Rule 17g-2(d) will require an NRSRO to make

publicly available a random sample of 10% of the issuer-paid credit ratings actions

189

190

191

Paragraph (a)(2)(iii) of Rule 17g-2.

Paragraph (a)(8) of Rule 17g-2.

Paragraph (b)(8) of Rule 17g-2.

histories, in an XBRL format and with a six-month grace period, for each ratings class for

which it has issued 500 or more issuer-paid credit ratings. This XBRL disclosure

requirement will allow the marketplace to better compare the performance of different

NRSROs that determine issuer-paid credit ratings, since it will shift the source of data

formatting from end-users to NRSROs submitting interactive data, thus eliminating the

need for end-users to make interpretive decisions on how to compare data fields across

NRSROs’ reported rating histories. This additional disclosure also may make NRSROs

more accountable for their issuer-paid credit ratings by enhancing the transparency of

their ratings performance. The Commission believes the XBRL format will benefit

market participants seeking to develop their own performance statistics using the ratings

history data to be made public by the NRSROs because it will require them to present the

information in a standard format. Making the information available in an XBRL format

will facilitate the process of creating better and more useful means to analyze how a

given NRSRO performed in a certain class of issuer-paid credit ratings and compare that

broader performance across NRSROs subject to the public disclosure rule, increasing the

transparency of the results of their rating processes and encouraging competition within

the industry by making it easier for users of issuer-paid credit ratings to judge the output

of such NRSROs. As noted above, the Commission believes that the XBRL format will

increase access to information in the financial marketplace and transform the manner in

which individual investors, financial intermediaries, analysts, the financial media, and

others access, use, and ultimately understand the wealth of available data. Requiring

NRSROs to provide this disclosure in a single industry standard format will offer market

participants the benefits of simplification, increased transparency, and ease of

comparisons.

The amendment to Rule 17g-3 will require an NRSRO to furnish an additional

annual report to the Commission: an unaudited report of the number of credit ratings

actions (upgrades, downgrades, placements on credit watch, and withdrawals) taken

during the fiscal year in each class of credit ratings identified in section 3(a)(62)(B) of the

Act (15 U.S.C. 78c(a)(62)(B)) for which the NRSRO is registered with the

Commission..192 The new report is designed to enhance the Commission’s oversight of

NRSROs by providing the Commission with additional information to assist in the

monitoring of NRSROs for compliance with their stated policies and procedures. For

example, the proposed new report will allow examiners to target potential problem areas

in an NRSRO’s rating processes by highlighting spikes in rating actions within a

particular class of credit rating.

The amendments to Rule 17g-5 will prohibit an NRSRO from issuing or

maintaining a credit rating where the NRSRO or an affiliate provided recommendations

on the structure of the transaction being rated; a credit analyst or person involved in the

ratings process participated in fee negotiations; or a credit analyst or a person responsible

for approving a credit rating received gifts from the obligor being rated, or from the

issuer, underwriter, or sponsor of the securities being rated, other than items provided in

the context of normal business activities such as meetings that have an aggregate value of

no more than $25.193 The Commission believes that the amendments to Rule 17g-5 will

promote the disclosure and management of conflicts of interest and mitigate potential

192

193

See Rule 17g-3(a)(6).

See Rule 17 CFR 240.17g-5(c)(5)-(7).

undue influences on an NRSRO’s credit rating process, particularly with respect to credit

ratings for structured finance products.194 These amendments will, in turn, increase

confidence in the integrity of NRSRO ratings and, thereby, promote capital formation.

Costs

The cost of compliance to a given NRSRO will depend on its size and the

complexity of its business activities. The size and complexity of the ten NRSROs vary

significantly. For example, the three largest NRSROs account for approximately 98% of

all outstanding credit ratings as reported on their most recent Form NRSROs. In

addition, these three NRSROs also employ approximately 92% of the credit analysts

among the ten registered NRSROs. In the June 16, 2008 Proposing Release, the

Commission provided estimates of the average cost per NRSRO as a result of the

proposed amendments, taking into consideration the range in size and complexity of

NRSROs and the fact that many already may have established policies, procedures and

recordkeeping systems and processes that would comply substantially with the

amendments.195

The Commission also sought comment on its cost estimates and the assumptions

behind the estimates. One of the largest NRSROs provided cost data for the proposed

rules but, significantly, only in summary form.196 That is, the NRSRO provided

estimates for the total one-time and on-going costs to comply with each proposed rule but

did not identify the particular components of each total cost estimate. For example, the

NRSRO did not identify the amount of each cost estimate that would be due to internal

costs such as employee salaries and internal systems developments; nor the amount of

194

195

196

See 15 U.S.C. 78o-7(a)(1)(B)(vi) and (h).

See June 16, 2008 Proposing Release, 73 FR at 36243-36247.

See S&P Letter.

each cost that would be due to external costs such as the need to purchase software to

comply with a recordkeeping requirement in a rule. Nonetheless, the Commission

believes that the summary form cost estimates provided by the NRSRO do provide some

basis for revising the Commission’s earlier cost estimates because they reflect the

experience of a large highly complex NRSRO that has been subject to existing

Commission rules. However, the Commission does note that, because the cost estimates

were provided in summary form, the Commission cannot identify specific components of

the cost estimates that are linked to a recordkeeping requirement and, therefore, subject to

the PRA. Consequently, the Commission continued to analyze the PRA burden estimates

separately from these summary cost estimates.

For the reasons discussed above, the cost estimates below are calculated for two

categories of NRSROs. The first category is comprised of the three largest NRSROs in

terms of the number of credit ratings outstanding. As noted above, these three firms

account for 98% of the credit ratings outstanding. The second category is comprised of

the seven smaller NRSROs currently registered with the Commission. These NRSROs

account for the remaining 2% of credit ratings outstanding. The theory behind this

analysis is that the total cost to the NRSRO industry resulting from an amendment will be

incurred by each NRSRO in approximate proportion to the percentage of the total credit

ratings it issues. As discussed below, the Commission is determining a total cost to the

industry using the summary cost figures provided by the large NRSRO by estimating

that, since this firm accounts for 47% of the credit ratings outstanding, its summary cost

estimate is 47% of the total cost to the industry. Having derived a total cost to the

industry using this NRSRO’s summary cost estimates, the Commission allocates a

percentage of that total cost to the two different categories of NRSROs: 98% for the first

category and 2% for the second category. Further, the Commission estimates an average

cost per NRSRO by dividing the amount of the total cost allocated to the first category by

the three NRSROs in that category and the amount of the total cost allocated to the

second category of NRSROs by the seven NRSROs in that category.

The Commission continues to estimate that 30 NRSROs ultimately may register.

However, because the Commission assumes the total number of ratings extant would

remain stable, the total cost to the industry likely would remain stable and be reallocated

among new entrants. Therefore, for the purposes of cost estimates derived using this

analysis, the Commission is not including the potential 20 new entrants in either the first

or second categories of NRSROs for the purposes of determining the cost per NRSRO.

Additionally, the Commission notes that ten credit rating agencies are currently

registered with the Commission as NRSROs and subject to the statutory and regulatory

requirements for NRSROs. The cost of compliance to these firms will vary depending on

which classes of credit ratings an NRSRO issues. For example, NRSROs that issue credit

ratings for structured finance products – the focus of many of these new requirements –

will incur higher compliance costs than NRSROs that do not issue credit ratings or that

issue relatively few credit ratings in that class. The Commission notes that the bulk of

the structured finance credit ratings outstanding are issued by NRSROs in the first

category.

This method of calculating costs also differs from the one used in the June 16,

2008 Proposing Release in that it is not derived by multiplying the number of burden

hours estimated for purposes of the PRA by hourly costs of personnel expected to

undertake the responsibilities for complying with the amendment. As noted above, the

Commission received summary cost data from the NRSRO in its comments that did not

separate internal costs from external costs or paperwork burdens from other economic

impacts. Nonetheless, the Commission believes that using the summary cost information

provided by the NRSRO allows for a more robust method of estimating the total

economic impact of the amendments. The Commission believes that for purposes of the

cost-benefit analysis this methodology provides a more conservative method for

estimating costs because it is based on the experience of an NRSRO that has been subject

to existing Commission rules and it accounts for the substantial variance in size and

complexity of the 10 registered NRSROs. For example, the methodology provides a

basis for assessing the different cost impacts the rules will have on the largest NRSROs,

which skew the total costs to the industry.

Amendments to Form NRSRO

The Commission is amending the instructions to Exhibit 1 to Form NRSRO to

require the disclosure of more detailed performance statistics. Currently, the instructions

require the disclosure of performance measurement statistics of the credit ratings of the

“Applicant/NRSRO over the short-term, mid-term and long-term periods (as applicable)

through the most recent calendar year end.” The new amendments refine these

instructions to require the disclosure of separate sets of default and transition statistics for

each class of credit ratings. In addition, the class-by-class disclosures need to be broken

out over 1, 3 and 10 year periods.197

The Commission also is amending the instructions to Exhibit 2 to Form NRSRO

to require enhanced disclosures about the procedures and methodologies an NRSRO uses

197

See instructions to Exhibit 1, Form NRSRO.

to determine credit ratings, including whether and, if so, how information about

verification performed on assets underlying a structured finance transaction is relied on in

determining credit ratings; whether and, if so, how assessments of the quality of

originators of assets underlying a structured finance transaction factor into the

determination of credit ratings; and how frequently credit ratings are reviewed, whether

different models are used for ratings surveillance than for determining credit ratings, and

whether changes made to models and criteria for determining initial ratings are applied

retroactively to existing ratings.

In the June 16, 2008 Proposing Release, the Commission preliminarily stated that

it believed NRSROs may incur a cost of compliance in updating their performance metric

statistics to conform to the new requirements set forth in the proposed rule

amendments.198 Specifically, the Commission estimated that it would take each NRSRO

currently registered with the Commission approximately 50 hours to review its

performance measurement statistics and to develop and implement any changes necessary

to comply with the proposed amendment.199 For these reasons, the Commission

originally estimated that the average one-time cost to an NRSRO would be $12,740200

and the total aggregate cost to the currently registered NRSROs would be $114,660.201

The Commission received one comment on these proposed costs. The

commenter, a large NRSRO, estimated that it would have to build systems to comply

with each new amendment to Form NRSRO, resulting in a one-time cost to the NRSRO

198

199

200

201

See June 16, 2008 Proposing Release, 73 FR at 36244.

Id.

The Commission estimated that a Compliance Attorney (40 hours) and a Programmer Analyst (10

hours) would perform these responsibilities. The SIFMA 2007 Report as Modified indicates that

the average hourly rates for a Compliance Attorney and a Programmer Analyst are $270 and $194

per hour, respectively. Therefore, the average one-time cost to an NRSRO would be $12,740 [(40

hours x $270) + (10 hours x $194)].

$12,740 x 9 NRSROs = $114,660.

of $6,710,000.202 The commenter further estimated that its costs on an annual basis

would be $1,860,000.203 The commenter did not break down these cost estimates or

provide supporting data. Although the Commission believes existing systems could be

adjusted instead of rebuilt to comply with the new Exhibit instructions, the Commission

is taking into account the comment received regarding the cost and, therefore, is revising

its cost estimates.

The Commission believes the costs incurred by the NRSROs will be in

approximate proportion to the number of credit ratings they issue. The commenter that

provided cost estimates for this rule amendment is the largest NRSRO in terms of credit

ratings outstanding. As such, it accounts for approximately 47% of the total outstanding

credit ratings reported by all registered NRSROs on their most recent Form NRSROs.

The Commission estimates that this NRSRO will incur 47% of the total costs to the

NRSROs from this amendment. Consequently, the total one time cost to the industry will

be approximately $14,276,600204 and the total annual cost to the industry will be

$3,957,400.205 Furthermore, the three largest NRSROs constituting the first category

account for approximately 98% of the total credit ratings outstanding among all NRSROs

and, therefore, the Commission estimates they will incur approximately $13,991,100206 of

the total one-time cost to the industry and approximately $3,878,300207 of the total annual

cost to the industry. Consequently, the Commission estimates that they will incur

approximately $4,663,700208 per firm in one time costs and approximately $1,292,800209

202

203

204

205

206

207

208

See S&P Letter.

Id.

$6,710,000 x 100 = $671,000,000; $671,000,000/47 = $14,276,600.

$1,860,000 x 100 = $186,000,000; $186,000,000/47 = $3,957,400.

$14,276,600 x .98 = $13,991,100.

$3,957,400 x .98 = $3,878,300

$13,991,100/3 = $4,663,700.

per firm in annual costs. The seven remaining NRSROs account for 2% of the credit

ratings outstanding among all NRSROs and, therefore, the Commission estimates they

will incur approximately $285,500210 of the total one time costs to the industry and

approximately $79,100211 the total annual costs to the industry. Consequently, the

Commission estimates that they will incur approximately $40,790212 per firm in one time

costs and $11,300213 per firm in annual costs. The Commission further estimates that the

cost per NRSRO within each category will vary based on their relative sizes.

Finally, the Commission has made changes to the final amendments to Form

NRSRO that will minimize the burdens. Therefore, the Commission anticipates that the

costs could be lower than those estimated here for NRSROs in both the first and second

categories.

Amendments to Rule 17g-2

Rule 17g-2 requires an NRSRO to make and preserve specified records related to

its credit rating business as well as to make a portion of those records available

publicly.214 The amendments to Rule 17g-2 will require an NRSRO to make and retain

two additional records and retain a third type of record. The records to be made and

retained are: (1) a record of the rationale for any material difference between the credit

rating implied by the model and the final credit rating issued, if a quantitative model is a

substantial component in the process of determining a credit rating;215 and (2) a record

showing the history and dates of all previous rating actions with respect to each

209

210

211

212

213

214

215

$3,878

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