Capital Requirements for Brokers or Dealers Under the Securities Exchange Act of 1934

SECURITIES AND EXCHANGE COMMISSION

17 CFR Part 240

[Release No. 34-39457; File No. S7-33-97]

RIN 3235-AH28

Capital Requirements for Brokers or Dealers Under the Securities

Exchange Act of 1934

AGENCY: Securities and Exchange Commission.

ACTION: Proposed rule.

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SUMMARY: The Securities and Exchange Commission (``Commission'') is

proposing for comment amendments to Rule 15c3-1 under the Securities

Exchange Act of 1934. The proposed amendments would define the term

``nationally recognized statistical rating organization'' (``NRSRO'').

The proposed definition sets forth a list of attributes to be

considered by the Commission in designating rating organizations as

NRSROs and the process for applying for NRSRO designation.

DATES: Comments must be received on or before March 2, 1998.

ADDRESSES: Persons wishing to submit written comments should file three

copies with Jonathan G. Katz, Secretary, Securities and Exchange

Commission, 450 Fifth Street, N.W., Stop 6-9, Washington, D.C. 20549.

Comments also may be submitted electronically at the following E-mail

address: [email protected]. All comment letters should refer to

File No. S7-33-97. This file number should be included on the subject

line if E-mail is used. All comments received will be available for

public inspection and copying in the Commission's Public Reference

Room, 450 Fifth Street, N.W., Washington, D.C., 20549. Electronically

submitted comment letters will be posted on the Commission's Internet

web site (http://www.sec.gov).

FOR FURTHER INFORMATION CONTACT: Michael A. Macchiaroli, Associate

Director, 202/942-0131, Peter R. Geraghty, Assistant Director, 202/942-

0177, Louis A. Randazzo, Special Counsel, 202/942-0191, or Michael E.

Greene, Staff Attorney, 202/942-4169, Division of Market Regulation,

Securities and Exchange Commission, 450 Fifth Street, N.W., Washington,

D.C. 20549.

SUPPLEMENTARY INFORMATION:

I. Introduction

R INFORMATION CONTACT: Michael A. Macchiaroli, Associate

Director, 202/942-0131, Peter R. Geraghty, Assistant Director, 202/942-

0177, Louis A. Randazzo, Special Counsel, 202/942-0191, or Michael E.

Greene, Staff Attorney, 202/942-4169, Division of Market Regulation,

Securities and Exchange Commission, 450 Fifth Street, N.W., Washington,

D.C. 20549.

SUPPLEMENTARY INFORMATION:

I. Introduction

A. The Commission's Concept Release

In August 1994, the Commission issued a concept release soliciting

public comment on the Commission's role in using the ratings of

NRSROs.1 In the Concept Release, the Commission specifically

solicited comments on: (1) Whether it should continue to use the NRSRO

concept, and, if so, whether it should define the term ``NRSRO''; and

(2) whether the current no-action letter process for designating a

rating organization an NRSRO is satisfactory, and, if not, whether the

Commission should establish an alternative procedure. The Commission is

now

proposing to amend the net capital rule to provide a definition of the

term ``NRSRO'' that sets forth the criteria that a rating organization

must satisfy to be an NRSRO.

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\1\ Securities Exchange Act Release No. 34616 (August 31 1994),

59 FR 46314 (September 7, 1994) (``Concept Release'').

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B. Summary of the Comments

The Commission received 25 comment letters in response to the

Concept Release. The comments generally supported the continued use of

the NRSRO concept, but recommended that the Commission adopt a

formalized process for designating NRSROs. A few commenters set forth

criteria that the Commission should consider to determine whether a

rating organization is an NRSRO. In addition, commenters generally

opposed formal regulatory oversight of NRSROs. These issues are

discussed in greater detail in Sections III and IV below.

e of

the NRSRO concept, but recommended that the Commission adopt a

formalized process for designating NRSROs. A few commenters set forth

criteria that the Commission should consider to determine whether a

rating organization is an NRSRO. In addition, commenters generally

opposed formal regulatory oversight of NRSROs. These issues are

discussed in greater detail in Sections III and IV below.

C. The Development and Expanded Use of the NRSRO Concept

The term ``NRSRO'' was initially adopted by the Commission in 1975

for the narrow purpose of distinguishing different grades of debt

securities under the Commission's net capital rule, Rule 15c3-

1.2 Rule 15c3-1 requires a broker-dealer to reduce the value

of the securities positions that it owns by specified percentages

(``haircuts'') when calculating its net capital. Broker-dealers that

own commercial paper, nonconvertible debt securities, and

nonconvertible preferred stock are allowed to reduce their haircuts for

these instruments when calculating net capital if the instruments are

rated investment grade by at least two NRSROs.3

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\2\ 17 CFR 240.15c3-1.

\3\ See 17 CFR 240.15c3-1(c)(2)(vi)(E) (haircuts applicable to

commercial paper that has been rated in one of the three highest

categories by at least two NRSROs); 17 CFR 240.15c3-1(c)(2)(vi)(F)

(haircuts applicable to nonconvertible debt securities that are

rated in one of the four highest rating categories by at least two

NRSROs); 17 CFR 240.15c3-1(c)(2)(vi)(H) (haircuts applicable to

cumulative, nonconvertible preferred stock rated in one of the four

highest rating categories by at least two NRSROs).

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i)(F)

(haircuts applicable to nonconvertible debt securities that are

rated in one of the four highest rating categories by at least two

NRSROs); 17 CFR 240.15c3-1(c)(2)(vi)(H) (haircuts applicable to

cumulative, nonconvertible preferred stock rated in one of the four

highest rating categories by at least two NRSROs).

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Since its adoption in 1975, the NRSRO concept has expanded beyond

its originally intended use under the net capital rule. For example,

Congress, in certain mortgage related legislation,4 and the

Commission, in its regulations pursuant to the Securities Act of

1933,5 the Securities Exchange Act of 1934 (``Exchange

Act''),6 and the Investment Company Act of 1940,7

use the ratings of NRSROs as proxies to distinguish ``investment

grade'' from ``non-investment grade'' debt securities. These references

are to an NRSRO as that term is used in Rule 15c3-1; however, the term

``NRSRO'' has not been defined for purposes of the federal securities

laws.

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\4\ Pub. L. 98-440, Section 101, 98 Stat. 1689 (1984). See 15

U.S.C. 78c(a)(41).

\5\ See, e.g., Regulation S-K (17 CFR 229.10) (a registrant may

include NRSRO ratings in its registration statements and periodic

reports); Rule 436 (17 CFR 230.436) (rating assigned to a security

by an NRSRO shall not be considered part of the registration

statement prepared or certified by a person within the meaning of

sections 7 and 11 of the Securities Act of 1933); Form S-3 (17 CFR

239.13) (Form S-3 may be used in primary offerings of non-

convertible securities and asset-backed securities which are rated

investment grade by at least one NRSRO); Forms F-2 and F-3 (17 CFR

239.32, 239.33) (non-convertible securities for purposes of Forms F-

2 and F-3 are investment grade securities if, at the time of sale,

at least one NRSRO has rated the security in one of its generic

rating categories that signifie

d in primary offerings of non-

convertible securities and asset-backed securities which are rated

investment grade by at least one NRSRO); Forms F-2 and F-3 (17 CFR

239.32, 239.33) (non-convertible securities for purposes of Forms F-

2 and F-3 are investment grade securities if, at the time of sale,

at least one NRSRO has rated the security in one of its generic

rating categories that signifies investment grade).

\6\ See, e.g., Rule 101 (17 CFR 242.101) and Rule 102 (17 CFR

242.102) (non-convertible debt securities, nonconvertible preferred

securities and asset-backed securities which are rated investment

grade by at least one NRSRO are exempt from the provisions of Rule

101 and Rule 102). See also Form 17-H (17 CFR 249.328T) (for each

Material Associated Person of a broker-dealer, the broker-dealer

must include the name of the NRSRO which has rated a Material

Associated Person's commercial paper).

\7\ See, e.g., Rule 2a-7(a)(9) (17 CFR 270.2a-7(a)(9)) (an

``eligible security'' is, among other things, a security that has

received a short-term rating by the requisite NRSROs in one of the

two highest short-term rating categories); Rule 10f-3 (17 CFR

270.10f-3) (municipal securities rated investment grade by at least

one NRSRO are exempt from section 10-f of the Investment Company Act

of 1940, which prohibits registered investment companies from

purchasing certain securities); and Rule 3a-7 (17 CFR 270.3a-7)

(issuers of asset-backed securities may not be deemed investment

companies for purposes of the Investment Company Act of 1940 if,

among other things, fixed-income securities sold by the issuer are

rated in one of the four highest categories by at least one NRSRO).

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D. Current Process for Determining Whether an Entity is an NRSRO

of asset-backed securities may not be deemed investment

companies for purposes of the Investment Company Act of 1940 if,

among other things, fixed-income securities sold by the issuer are

rated in one of the four highest categories by at least one NRSRO).

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D. Current Process for Determining Whether an Entity is an NRSRO

Currently, to determine whether a rating organization is an NRSRO,

the Division of Market Regulation (``Division'') staff first reviews

the rating organization's operations, position in the marketplace, and

other criteria. If the Division staff determines that a rating

organization may properly be labelled an NRSRO, the staff issues a

letter stating that it will not recommend enforcement action to the

Commission if the rating organization is considered by registered

broker-dealers to be an NRSRO for purposes of applying the relevant

portions of the net capital rule.

In determining whether a rating organization may be considered an

NRSRO for purposes of the Commission's rules, the staff considers a

number of criteria. The single most important criterion is that the

rating organization is nationally recognized, which means the rating

organization is recognized in the United States as an issuer of

credible and reliable ratings by the predominant users of securities

ratings. The Division also examines the operational capability and

reliability of each rating organization in conjunction with this

standard of national recognition. Included within this assessment are:

anization is nationally recognized, which means the rating

organization is recognized in the United States as an issuer of

credible and reliable ratings by the predominant users of securities

ratings. The Division also examines the operational capability and

reliability of each rating organization in conjunction with this

standard of national recognition. Included within this assessment are:

(1) The organizational structure of the rating organization; (2) the

rating organization's financial resources (to determine, among other

things, whether it is able to operate independently of economic

pressures or control from the companies it rates); (3) the size and

quality of the rating organization's staff (to determine if the entity

is capable of thoroughly and competently evaluating an issuer's

credit); (4) the rating organization's independence from the companies

it rates; (5) the rating organization's rating procedures (to determine

whether it has systematic procedures designed to produce credible and

accurate ratings); and (6) whether the rating organization has internal

procedures to prevent the misuse of non-public information and whether

those procedures are followed.

The Division's no-action position regarding NRSRO designation is

based on representations made to the staff by the rating organization

during the no-action process. The no-action letter directs the rating

organization to advise the Division of any material change in the facts

that serve as the basis for granting the no-action position. For

example, material changes in an NRSRO's organizational structure or

modifications of its rating practices could affect the NRSRO's standing

as a credible evaluator in the credit market. The Division may withdraw

a no-action letter designating a particular rating organization as an

NRSRO under certain circumstances

in the facts

that serve as the basis for granting the no-action position. For

example, material changes in an NRSRO's organizational structure or

modifications of its rating practices could affect the NRSRO's standing

as a credible evaluator in the credit market. The Division may withdraw

a no-action letter designating a particular rating organization as an

NRSRO under certain circumstances.

To date, the Commission regards five rating organizations as NRSROs

for purposes of the net capital rule: (1) Standard & Poor's Corporation

(``Standard & Poor's''); (2) Moody's Investors Service, Inc.

(``Moody's''); (3) Fitch IBCA, Inc. (``Fitch IBCA''); 8 (4)

Duff & Phelps Credit Rating Co. (``Duff & Phelps'');9 and

(5) Thomson BankWatch, Inc. (``Bankwatch'').10

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\8\ When the net capital rule became effective in 1975, Fitch

Investors Service, L.P. (``Fitch''), Standard & Poor's and Moody's

were designated as NRSROs by the Division for purposes of the net

capital rule. Subsequently, based on requests from rating

organizations, the Division provided no-action assurances to Duff &

Phelps, BankWatch, IBCA Limited and IBCA Inc. (IBCA Limited and IBCA

Inc. are collectively referred to as ``IBCA''). IBCA was designated

as an NRSRO for limited purposes. In November 1997, Fitch and IBCA

combined to create Fitch IBCA, a successor rating organization. By

letter dated November 4, 1997, the Division stated that it would not

recommend enforcement action to the Commission if Fitch IBCA

succeeded to the NRSRO designation of Fitch for the purposes of

applying paragraphs (c)(2)(vi) (E), (F), and (H) of the net capital

rule to all debt. Subsequent to the transfer of the ownership of

IBCA to Fitch IBCA, IBCA was no longer considered to be an NRSRO.

See Letter regarding Fitch IBCA Inc. (November 4, 1997).

\9\ See Letter regarding Duff & Phelps, Inc. (February 24,

1982).

\10\ See Letter regarding Thomson BankWatch, Inc. (August 6,

1991)

of

applying paragraphs (c)(2)(vi) (E), (F), and (H) of the net capital

rule to all debt. Subsequent to the transfer of the ownership of

IBCA to Fitch IBCA, IBCA was no longer considered to be an NRSRO.

See Letter regarding Fitch IBCA Inc. (November 4, 1997).

\9\ See Letter regarding Duff & Phelps, Inc. (February 24,

1982).

\10\ See Letter regarding Thomson BankWatch, Inc. (August 6,

1991). BankWatch is recognized as an NRSRO only for the purposes of

rating debt issued by banks, bank holding companies, non-bank banks,

thrifts, broker-dealers, and broker-dealers' parent companies.

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II. The NRSRO Concept Release

The Concept Release requested comment on whether the Commission

should continue to employ an NRSRO concept to distinguish various types

of debt and other securities for purposes of its rules. Thirteen

commenters discussed the NRSRO concept. Overall, the commenters

generally supported the continued use of the NRSRO concept in the net

capital and other Commission rules. For example, the Securities

Industry Association Capital Committee (``SIA'') believes that the

continued use of the NRSRO concept is an integral part of the net

capital rule. Additionally, the SIA commented that the use of NRSRO

ratings is a vital ingredient of the Commission's efforts to safeguard

the capital markets against risks arising from fluctuations in the

proprietary positions of securities firms.

Some commenters suggested that the Commission discontinue the use

of the NRSRO concept and instead employ statistical models or

historical spreads to determine the level of risk associated with a

particular instrument. As the SIA commented, however, continued use of

the NRSRO concept in the net capital rule would give broker-dealers an

objective, simple standard for determining the capital value of a debt

instrument under the rule. In contrast, a modelling approach involves a

possibly intricate statistical configuration

storical spreads to determine the level of risk associated with a

particular instrument. As the SIA commented, however, continued use of

the NRSRO concept in the net capital rule would give broker-dealers an

objective, simple standard for determining the capital value of a debt

instrument under the rule. In contrast, a modelling approach involves a

possibly intricate statistical configuration. It is also likely that

modelling will work only where there is a deep and liquid market for

the instrument because of the difficulty in obtaining prices. It would

not be adequate for debt issuers with no previously issued or very old

public debt. In order to assist the Commission in determining whether

statistical modelling may be appropriate in the future for purposes of

the NRSRO concept, the Commission invites comments on practical

approaches to the use of statistical models in the context of

determining the credit risk of individual financial instruments.

III. Description of the Proposed Amendments

As discussed in more detail below, the proposal would amend Rule

15c3-1 by adopting a new subparagraph (c)(13), which would define the

term ``NRSRO.'' As proposed, the definition of NRSRO will include

rating organizations designated as NRSROs by the Commission.

Designation of such rating organizations as NRSROs would be based upon

written application filed with the Director of the Commission's

Division of Market Regulation in Washington, D.C.11 The

Commission would consider the attributes currently assessed by the

Division in the no-action letter process in determining whether a

rating organization is an NRSRO.

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ons as NRSROs would be based upon

written application filed with the Director of the Commission's

Division of Market Regulation in Washington, D.C.11 The

Commission would consider the attributes currently assessed by the

Division in the no-action letter process in determining whether a

rating organization is an NRSRO.

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\11\ The Commission understands that a rating organization's

application may contain commercial or financial information that is

confidential. It is the responsibility of the rating organization to

request confidentiality under the appropriate Commission rules. See

17 CFR 200.83. The Commission believes, however, that the cover

letter from the rating organization requesting NRSRO designation and

any response by the Commission would be publicly available.

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IV. Discussion of the Proposed Amendments

A. Proposed Definition of NRSRO in the Net Capital Rule

Having considered the comments received, the Commission proposes to

define NRSRO in the net capital rule to include a list of attributes

that will be considered by the Commission in designating rating

organizations as NRSROs. These attributes are described in more detail

below. Under the proposal, rating organizations that have received no-

action assurances from the Division will retain whatever NRSRO

designation status that they currently possess and will not be required

to reapply for NRSRO designation; however, the Commission will conduct

reviews of the current NRSROs to assure that they meet the requirements

in the proposed definition. In the event the Commission determines that

any such rating organization does not satisfy the requirements set

forth in the proposed rule, the Commission will act to revoke the NRSRO

designation

ess and will not be required

to reapply for NRSRO designation; however, the Commission will conduct

reviews of the current NRSROs to assure that they meet the requirements

in the proposed definition. In the event the Commission determines that

any such rating organization does not satisfy the requirements set

forth in the proposed rule, the Commission will act to revoke the NRSRO

designation.

The Commission believes that defining the term ``NRSRO'' in the net

capital rule should provide clarity and limit concerns regarding any

perceived arbitrariness in the current process of designating NRSRO

status.

B. Criteria in the Definition of NRSRO

Commenters generally recommended that the Commission adopt

procedures for designating NRSRO status that clearly identify the

criteria a rating organization must possess. Specifically, commenters

recommended that the Commission formalize the current no-action letter

criteria for designating NRSROs in a Commission rule. For example,

various rating organizations recommended including the requirement of

national recognition and market acceptance of the organizations'

ratings.

Consistent with the comment letters received, an NRSRO would

include any rating organization designated by the Commission after

considering a list of attributes similar to the criteria currently

considered by the Division in the no-action letter process. The rating

organization would have to meet each criterion in order to be

designated as an NRSRO. The Commission's designation would apply only

to a rating organization's opinion concerning the creditworthiness of

debt instruments. The Commission notes that other opinions and views of

the rating organization would be outside the scope of the NRSRO

designation

in the no-action letter process. The rating

organization would have to meet each criterion in order to be

designated as an NRSRO. The Commission's designation would apply only

to a rating organization's opinion concerning the creditworthiness of

debt instruments. The Commission notes that other opinions and views of

the rating organization would be outside the scope of the NRSRO

designation.

The attributes the Commission would consider are: (1) National

recognition, which means that the rating organization is recognized as

an issuer of credible and reliable ratings by the predominant users of

securities ratings in the United States; (2) adequate staffing,

financial resources, and organizational structure to ensure that it can

issue credible and reliable ratings of the debt of issuers, including

the ability to operate independently of economic pressures or control

by companies it rates and a sufficient number of staff members

qualified in terms of education and experience to thoroughly and

competently evaluate an issuer's credit; (3) use of systematic rating

procedures that are designed to ensure credible and accurate ratings;

12 (4) extent of contacts with the management of issuers,

including access to senior level management of the issuers;

13 and (5) internal procedures to prevent misuse of non-

public information and compliance with these procedures.14

In addition to

the attributes noted above, the proposal would require a rating

organization to be registered with the Commission as an investment

adviser under the Investment Advisers Act of 1940 (``Advisers Act'') in

order to be designated as an NRSRO.15

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non-

public information and compliance with these procedures.14

In addition to

the attributes noted above, the proposal would require a rating

organization to be registered with the Commission as an investment

adviser under the Investment Advisers Act of 1940 (``Advisers Act'') in

order to be designated as an NRSRO.15

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\12\ The Commission believes that a systematic rating procedure

should help to ensure that the same or similar analysis is conducted

for all issues rated. In addition, the ratings should be structured

in such a way that the different rating categories are easily

identifiable.

\13\ The Commission believes that rating organizations that have

access to senior management are better able to make subjective

opinions regarding the risks associated with the issue.

\14\ The Commission believes that maintaining these procedures

should help ensure that the issuer's management is comfortable with

providing the rating organization all information necessary for the

rating organization to make reliable subjective opinions about the

risks associated with the issue.

\15\ All currently designated NRSROs are registered with the

Commission under the Advisers Act. Although section 203A of the

Advisers Act prohibits investment advisers that have less than $25

million of assets under management to register with the Commission,

the Commission has exempted investment advisers that are designated

as NRSROs from this prohibition. See rule 203A-2 [17 CFR 275.203A-

2].

As proposed, a rating organization must be registered as an

investment adviser under the Advisers Act and maintain such

registration as a condition of receiving and retaining its NRSRO

designation

f assets under management to register with the Commission,

the Commission has exempted investment advisers that are designated

as NRSROs from this prohibition. See rule 203A-2 [17 CFR 275.203A-

2].

As proposed, a rating organization must be registered as an

investment adviser under the Advisers Act and maintain such

registration as a condition of receiving and retaining its NRSRO

designation. A rating organization applying for designation as an

NRSRO that is not registered as an investment adviser, because, for

example, it does not have $25 million of assets under management,

would have to register under rule 203A-2(d) under the Advisers Act,

which permits an investment adviser that reasonably expects to be

eligible for Commission registration within 120 days of registering

with the Commission to register with the Commission even though it

may not otherwise meet the criteria for Commission registration

under section 203A of the Advisers Act. Once a rating organization

is registered as an investment adviser, it must maintain its

registration. Otherwise, its NRSRO designation will void

automatically.

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By specifying required criteria in the definition of NRSRO, the

Commission will be able to promulgate the characteristics that are

necessary for NRSRO designation, thereby assuring rating organizations

that if they possess such characteristics, they will likely be

designated, and will remain, NRSROs. Similar to the no-action letter

process, however, the Commission is reserving the ability to withdraw

designation if a rating organization fails to maintain the requisite

criteria. Accordingly, a rating organization designated as an NRSRO

would be required to notify the Commission when it experiences material

changes that may affect its ability to continue to meet any of the

requisite criteria

milar to the no-action letter

process, however, the Commission is reserving the ability to withdraw

designation if a rating organization fails to maintain the requisite

criteria. Accordingly, a rating organization designated as an NRSRO

would be required to notify the Commission when it experiences material

changes that may affect its ability to continue to meet any of the

requisite criteria. For example, material changes in an NRSRO's

organizational structure or modifications of its rating practices could

affect the NRSRO's standing in the credit market that could warrant

withdrawing NRSRO designation. Codifying the current NRSRO designation

would ensure that the process is transparent and applied consistently.

C. Application Process

A rating organization seeking NRSRO designation would be required

to file an application with the Director of the Commission's Division

of Market Regulation in Washington, D.C. The rating organization would

be required to include in the application detailed information

explaining how the rating organization satisfies the attributes

necessary for NRSRO designation. The rating organization also would be

required to file any additional information subsequently requested by

the Division.

D. Delegation of Authority to the Division

The Commission proposes to delegate authority to the Division to

examine rating organizations' applications and to designate a rating

organization as an NRSRO or to deny such designation.16

Under the proposed amendments, the Division would not have delegated

authority to revoke or withdraw any previously granted designation.

Delegating authority to the Division will allow rating organizations

that receive an adverse decision from the Division to seek Commission

review

g organizations' applications and to designate a rating

organization as an NRSRO or to deny such designation.16

Under the proposed amendments, the Division would not have delegated

authority to revoke or withdraw any previously granted designation.

Delegating authority to the Division will allow rating organizations

that receive an adverse decision from the Division to seek Commission

review. Pursuant to the Commission's Rules of Practice, any person

aggrieved by an action made by delegated authority may seek Commission

review of the action by filing a petition for review with the

Commission.17 The Commission may preside over or, if it so

orders, designate a hearing officer to preside over any proceeding

instituted to review a determination made pursuant to delegated

authority. The Commission may, at its discretion, designate an

administrative law judge as the hearing officer presiding over such

proceedings.18

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\16\ The Commission proposes to amend Rule 200.30-3, which

provides for delegation of authority to the Director of the Division

of Market Regulation, to include the designation of NRSROs. See 17

CFR 200.30-3.

\17\ See 17 CFR 201.430.

\18\ See 17 CFR 201.110.

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E. Charging Fees Based on the Size of the Transaction

In the Concept Release, the Commission requested comments on the

practice of NRSROs charging issuers for ratings and whether it is

appropriate for an NRSRO to charge an issuer fees based on the size of

the transaction being rated.

Fourteen commenters offered views on this practice. As a general

matter, they did not oppose NRSROs charging issuers for ratings.

Various commenters expressed concern, however, regarding charging fees

based upon the size of the transaction

tended results and possible manipulation of the NRSRO designation

process. A rating organization may meet the basic objective criteria

standard, but have no credibility in the marketplace. For example,

using the number of persons employed by a rating organization as one of

the criteria would not take into consideration qualifications of the

employees with respect to rating issuer's securities. On the other

hand, a rating organization may have a solid reputation for publishing

reliable ratings, but may not meet an objective criteria, such as a

minimum number of employees. The Commission, however, invites comment

on whether objective criteria should be used to determine NRSRO

designation and the types of objective criteria that should be

considered.

The Commission also invites comment on whether a specific time

period should be established for the Commission to act on an

application. If such a period is considered appropriate, the Commission

also seeks comment on whether a time period in the range of 180 to 365

calendar days would be appropriate.

In addition, concerns have been raised to the Commission about the

fact that some ratings may not be generally available to the public and

may be restricted only to subscribers. Because the Commission is

proposing to provide rating organizations with the NRSRO designation,

the Commission invites comment on whether NRSROs should be required to

provide their ratings to the public. The Commission also invites

interested persons to submit written data, views, arguments and/or

comments on the other aspects of the proposed amendments.

VI. Costs and Benefits of the Proposed Amendments and Their Effects on

Competition

e rating organizations with the NRSRO designation,

the Commission invites comment on whether NRSROs should be required to

provide their ratings to the public. The Commission also invites

interested persons to submit written data, views, arguments and/or

comments on the other aspects of the proposed amendments.

VI. Costs and Benefits of the Proposed Amendments and Their Effects on

Competition

To assist the Commission in its evaluation of the costs and

benefits that may result from the proposed rule amendments, commenters

are requested to provide analyses and data relating to the costs and

benefits associated with any of the proposals herein. The Commission

believes the benefit of the proposed definition will be to make its

current practice of designating NRSROs more transparent and formalized.

The Commission preliminarily believes that the proposed amendments will

benefit all market participants by clarifying the basis for designating

NRSROs and making the designation process more transparent. The

amendments also will provide an appeal process for rating organizations

that have been denied NRSRO designation. The amendments will impose no

additional compliance burdens on broker-dealers and will not impede

efficiency, competition, and capital formation, because they merely

codify the current criteria a credit rating organization must meet in

order to be designated as an NRSRO. The costs associated with the rule

proposal would not differ significantly from those incurred under the

current no-action letter process.19 The proposed amendments

would not change the basis by which broker-dealers determine the

deductions applicable to their proprietary securities. Section 23(a) of

the Exchange Act, 15 U.S.C. 78w(a)(2), requires the Commission, in

adopting rules under the Exchange Act, to consider the anti-competitive

effect of the rule, if any

y from those incurred under the

current no-action letter process.19 The proposed amendments

would not change the basis by which broker-dealers determine the

deductions applicable to their proprietary securities. Section 23(a) of

the Exchange Act, 15 U.S.C. 78w(a)(2), requires the Commission, in

adopting rules under the Exchange Act, to consider the anti-competitive

effect of the rule, if any. The Commission has considered the proposed

amendments in light of this standard and believes, preliminarily, that

if adopted, they would not likely impose any significant burden on

competition that is not necessary or appropriate in furtherance of the

Exchange Act. The Commission solicits comment on this preliminary view.

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\19\ The average time to complete an application is estimated to

be 100 hours. See infra section VIII D.

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VII. Summary of Initial Regulatory Flexibility Analysis

In accordance with 5 U.S.C. 603, the Commission has prepared an

Initial Regulatory Flexibility Analysis (``IRFA'') concerning the

proposed amendments. The IRFA notes that the purpose of the proposed

amendments is to make the NRSRO designation process open and

transparent by defining the term ``NRSRO'' for purposes of the net

capital rule to provide a list of attributes that would be considered

by the Commission in designating rating organizations as NRSROs. The

IRFA indicates that the proposed amendments would apply to all credit

rating organizations that request NRSRO designation.

The IRFA further indicates that in the past, the Commission has

only designated seven credit rating organizations as NRSROs. In

addition, only seven other credit rating organizations have requested

designation as an NRSRO

n designating rating organizations as NRSROs. The

IRFA indicates that the proposed amendments would apply to all credit

rating organizations that request NRSRO designation.

The IRFA further indicates that in the past, the Commission has

only designated seven credit rating organizations as NRSROs. In

addition, only seven other credit rating organizations have requested

designation as an NRSRO. Because the Commission cannot determine the

number of entities that may request NRSRO designation in the future, it

is difficult to estimate the number of small entities that may be

subject to the proposed amendments. However, due to the fact that only

seven credit rating organizations have been designated as NRSROs and

only seven other entities have requested NRSRO designation, the IRFA

adds that it appears that very few small entities, if any, as

contemplated by the Regulatory Flexibility Act 20, will be

subject to the proposed amendments. In addition, the IRFA states that

the proposed amendments require the filing of an application and

notification of any material changes in the NRSROs business and that no

federal rules duplicate, overlap, or conflict with, the proposed

amendments. Furthermore, the IRFA states that the Commission does not

believe that any less burdensome alternatives are available to

accomplish the objectives of the proposed amendments.

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ification of any material changes in the NRSROs business and that no

federal rules duplicate, overlap, or conflict with, the proposed

amendments. Furthermore, the IRFA states that the Commission does not

believe that any less burdensome alternatives are available to

accomplish the objectives of the proposed amendments.

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\20\ 5 U.S.C. 601 et seq. The Regulatory Flexibility Act states

that the term ``small entity'' shall have the same meaning as the

term ``small business'' under the Regulatory Flexibility Act.

According to section 601(3) under the Regulatory Flexibility Act,

``the term `small business' has the same meaning as the term `small

business concern'' under section 3 of the Small Business Act (15

U.S.C. 632), unless an agency, after consultation with the Small

Business Administration and after opportunity for public comment,

establishes one or more definitions of such term which are

appropriate to the activities of the agency and publishes such

definition(s) in the Federal Register''. If the agency has not

defined the term for a particular purpose, the Small Business Act

states that ``a small business concern, * * *, shall be deemed to be

one which is independently owned and operated and which is not

dominant in its field of operation.'' Because the Commission has not

defined the term ``small entity'' in the context of NRSROs for

purposes of the Regulatory Flexibility Act, for purposes of this

rulemaking, the Commission is using the broader definition of

``small business concern'' as defined in the Small Business Act.

Furthermore, based on this broader definition, it appears that none

of the current NRSROs would be considered small entities for

purposes of the Regulatory Flexibility Act.

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or purposes of this

rulemaking, the Commission is using the broader definition of

``small business concern'' as defined in the Small Business Act.

Furthermore, based on this broader definition, it appears that none

of the current NRSROs would be considered small entities for

purposes of the Regulatory Flexibility Act.

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The Commission encourages the submission of comments with respect

to any aspect of the IRFA. Comment specifically is requested on the

number of small entities that would be affected by the proposed rules.

Such comments will be considered in the preparation of the Final

Regulatory Flexibility Analysis, if the proposed rules are adopted, and

will be placed in the same public file as comments on the proposed

rules themselves. Comment letters should be submitted in triplicate to

Jonathan G. Katz, Secretary, Securities and Exchange Commission, 450

Fifth Street, N.W., Stop 6-9, Washington, D.C. 20549. Comments also may

be submitted electronically at the following E-Mail address: rule-

[email protected]. All comment letters should refer to File No. S7-33-

97. This file number should be included on the subject line if E-mail

is used. All comments received will be available for public inspection

and copying in the Commission's Public Reference Room, 450 Fifth

Street, N.W., Washington, D.C., 20549. Electronically submitted comment

letters will be posted on the Commission's Internet web site (http://

www.sec.gov). A copy of the IRFA may be obtained by contacting Michael

E. Greene, Securities and Exchange Commission, 450 Fifth Street, N.W.,

Mail Stop 2-2, Washington, D.C. 20549.

For purposes of the Small Business Regulatory Enforcement Fairness

Act of 1996 (``SBREFA''), the Commission is also requesting information

regarding the potential impact of the proposed rule on the economy on

an annual basis

). A copy of the IRFA may be obtained by contacting Michael

E. Greene, Securities and Exchange Commission, 450 Fifth Street, N.W.,

Mail Stop 2-2, Washington, D.C. 20549.

For purposes of the Small Business Regulatory Enforcement Fairness

Act of 1996 (``SBREFA''), the Commission is also requesting information

regarding the potential impact of the proposed rule on the economy on

an annual basis. The Commission preliminarily believes that the

proposed amendments do not constitute a ``major rule'' for purposes of

SBREFA based on the criteria used to determine what constitutes a

``major rule'' under SBREFA. Commenters should provide empirical data

to support their views.

VIII. Paperwork Reduction Act

Certain provisions of the proposed amendments contain ``collection

of information'' requirements within the meaning of the Paperwork

Reduction Act of 1995 (``PRA''),21 and the Commission has

submitted them to the Office of Management and Budget for review in

accordance with 44 U.S.C. 3507(d) and 5 CFR 1320.11. The title for the

collection of information is: ``Net Capital Requirements for Brokers or

Dealers: Definitions: NRSRO.''

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\21\ 44 U.S.C. 3501 et seq.

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A. Collection of Information Under Proposed Amendments

The proposed amendments would require credit rating organizations

that desire designation as NRSROs to submit certain information to the

Commission in order to obtain such designation and to report to the

Commission in the event of any material change in their status.

B. Proposed Use of Information

--------------------------------------

A. Collection of Information Under Proposed Amendments

The proposed amendments would require credit rating organizations

that desire designation as NRSROs to submit certain information to the

Commission in order to obtain such designation and to report to the

Commission in the event of any material change in their status.

B. Proposed Use of Information

The information collected pursuant to the proposed amendments would

be used only by the Commission. No other governmental agency or third

party would regularly receive any of the information described above.

The Commission would use the information required by the proposed

amendments in determining whether to designate a credit rating

organization as an NRSRO.

C. Respondents

The proposed amendments would apply to those credit rating

organizations that desire designation as an NRSRO by the Commission.

D. Total Annual Reporting and Recordkeeping Burden

The proposed amendments require a one-time application process,

which includes any amendments to the initial application. Therefore,

there is no recurring reporting or recordkeeping requirement and thus

no annual reporting or recordkeeping requirement. However, it is

estimated that on an annual basis there will be ten respondents to this

collection of information. It is also estimated that the time to

complete the proposed collection of information is 100 hours.

E. General Information About the Collection of Information

,

there is no recurring reporting or recordkeeping requirement and thus

no annual reporting or recordkeeping requirement. However, it is

estimated that on an annual basis there will be ten respondents to this

collection of information. It is also estimated that the time to

complete the proposed collection of information is 100 hours.

E. General Information About the Collection of Information

The collection of information under the proposed amendments would

be required in order to obtain NRSRO designation. There would be no

obligation on the NRSRO to retain the information submitted to the

Commission to obtain NRSRO designation. Any information received by the

Commission pursuant to the proposed amendments would be kept

confidential (except the cover letter), subject to the provisions of

the Freedom of Information Act, 5 U.S.C. 552 and the Commission's

regulations thereunder (17 CFR 200.80). The proposed amendments do not

mandate a time period for retaining the information submitted to the

Commission by credit rating organizations applying for NRSRO

designation. Seeking the NRSRO designation is voluntary; however, for

rating organizations that desire the NRSRO designation, the obligation

to respond to the collection of information is mandatory. Persons

should be aware that the Commission may not conduct or sponsor, and a

person is not required to respond to, a collection of information

unless it displays a currently valid control number.

F. Request for Comment

Pursuant to 44 U.S.C. 3506(c)(2)(B), the Commission solicits

comments to:

re the NRSRO designation, the obligation

to respond to the collection of information is mandatory. Persons

should be aware that the Commission may not conduct or sponsor, and a

person is not required to respond to, a collection of information

unless it displays a currently valid control number.

F. Request for Comment

Pursuant to 44 U.S.C. 3506(c)(2)(B), the Commission solicits

comments to:

(i) evaluate whether the proposed collection of information is

necessary for the proposed performance of the functions of the agency,

including whether the information shall have practical utility;

(ii) evaluate the accuracy of the Commission's estimate of the

burden of the proposed collection of information;

(iii) enhance the quality, utility, and clarity of the information

to be collected; and

(iv) minimize the burden of collection of information on those who

are to respond, including through the use of automated collection

techniques or other forms of information technology.

Persons desiring to submit comments on the collection of

information requirements should direct them to the Office of Management

and Budget, Attention: Desk Officer for the Securities and Exchange

Commission, Office of Information and Regulatory Affairs, Washington,

D.C. 20503, and should also send a copy of their comments to Jonathan

G. Katz, Secretary, Securities and Exchange Commission, 450 Fifth

Street, N.W., Washington, D.C. 20549, and refer to File No. S7-33-97.

OMB is required to make a decision concerning the collections of

information between 30 and 60 days after publication of this release in

the Federal Register, so a comment to OMB is best assured of having its

full effect if OMB receives it within 30 days of this publication.

IX. Statutory Analysis

nge Commission, 450 Fifth

Street, N.W., Washington, D.C. 20549, and refer to File No. S7-33-97.

OMB is required to make a decision concerning the collections of

information between 30 and 60 days after publication of this release in

the Federal Register, so a comment to OMB is best assured of having its

full effect if OMB receives it within 30 days of this publication.

IX. Statutory Analysis

Pursuant to the Securities Exchange Act of 1934 and particularly

Sections 3(b), 15(c)(3), 17, and 23 thereof, 15 U.S.C. 78c(b),

78o(c)(3), 78q, and 78w, the Commission proposes to amend 240.15c3-1 of

Title 17 of the Code of Federal Regulations in the manner set forth

below.

X. List of Subjects in 17 CFR Part 240

Reporting and recordkeeping requirements, Securities.

XI. Text of the Proposed Rule Amendments

In accordance with the foregoing, Title 17, Chapter II of the Code

of Federal Regulation is proposed to be amended as follows:

PART 240--GENERAL RULES AND REGULATIONS, SECURITIES EXCHANGE ACT OF

1934

1. The authority citation for Part 240 continues to read in part as

follows:

Authority: 15 U.S.C. 77c, 77d, 77g, 77j, 77s, 77z-2, 77eee,

77ggg, 77nnn, 77sss, 77ttt, 78c, 78d, 78i, 78j, 78k, 78k-1, 78l,

78m, 78n, 78o, 78p, 78q, 78s, 78u-5, 78w, 78x, 78ll(d), 79q, 79t,

80a-20, 80a-23, 80a-29, 80a-37, 80b-3, 80b-4 and 80b-11, unless

otherwise noted.

* * * * *

2. Section 240.15c3-1 is amended by adding paragraph (c)(13) to

read as follows:

Sec. 240.15c3-1 Net capital requirements for brokers or dealers.

* * * * *

77z-2, 77eee,

77ggg, 77nnn, 77sss, 77ttt, 78c, 78d, 78i, 78j, 78k, 78k-1, 78l,

78m, 78n, 78o, 78p, 78q, 78s, 78u-5, 78w, 78x, 78ll(d), 79q, 79t,

80a-20, 80a-23, 80a-29, 80a-37, 80b-3, 80b-4 and 80b-11, unless

otherwise noted.

* * * * *

2. Section 240.15c3-1 is amended by adding paragraph (c)(13) to

read as follows:

Sec. 240.15c3-1 Net capital requirements for brokers or dealers.

* * * * *

(c) * * *

* * * * *

(13)(i) The term nationally recognized statistical rating

organization (``NRSRO'') means any entity that:

(A) Issues ratings which are current assessments of the

creditworthiness of obligors with respect to specific securities or

money market instruments and that is registered under the Investment

Advisers Act of 1940 (15 U.S.C. 80b-1 et seq.) and

(B) Is designated as an NRSRO by the Commission.

(ii) The Commission will consider the following attributes in

determining whether to grant NRSRO status:

(A) Recognition of the rating organization in the United States as

an issuer of credible and reliable ratings by users of securities

ratings;

(B) Adequate staffing, financial resources, and organizational

structure to ensure that it can issue credible and reliable ratings of

the debt of issuers, including a sufficient number of qualified staff

members and the ability to operate independently of economic pressures

or control by companies that it rates;

(C) Use of systematic rating procedures that are designed to ensure

credible and accurate ratings;

(D) Extent of contacts with the management of issuers, including

access to senior level management of issuers; and

(E) Internal procedures to prevent misuse of non-public information

and compliance with these procedures.

ndependently of economic pressures

or control by companies that it rates;

(C) Use of systematic rating procedures that are designed to ensure

credible and accurate ratings;

(D) Extent of contacts with the management of issuers, including

access to senior level management of issuers; and

(E) Internal procedures to prevent misuse of non-public information

and compliance with these procedures.

(iii) A rating organization seeking NRSRO designation shall file an

application with the Director of the Commission's Division of Market

Regulation in Washington, DC. The application should provide detailed

information explaining how the rating organization satisfies the

attributes set forth in paragraph (c)(13)(i) of this section. The

rating organization shall also file any additional information

subsequently requested by the Commission relating to the attributes set

forth in paragraph (c)(13)(i) of this section.

(iv) An NRSRO shall notify the Director of the Commission's

Division of Market Regulation of any material changes that occur in the

facts and circumstances of this application for an NRSRO designation.

(v) In the event it is determined that an NRSRO no longer satisfies

all of the attributes set forth in (c)(13)(i) of this section, the

Commission may revoke or withdraw NRSRO designation.

* * * * *

Dated: December 17, 1997.

By the Commission.

Margaret H. McFarland,

Deputy Secretary.

[FR Doc. 97-33402 Filed 12-29-97; 8:45 am]

BILLING CODE 8010-01-P