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July 8, 2011

Credit Rating Agencies SEC Proposes a Broad Range of Amendments to Implement Dodd-Frank Act Provisions

SUMMARY

The SEC has proposed a number of rules with respect to its oversight of registered credit rating agencies

(nationally recognized statistical rating organizations, or “NRSROs”) to implement certain provisions of

Title IX of the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”).

While most of the requirements contemplated by these proposals would apply directly to NRSROs,

certain requirements would apply to issuers and underwriters of rated asset-backed securities who use

third-party due diligence services, and other requirements would apply to the providers of those services.

The SEC’s proposals address, among other things:

disclosures made by NRSROs, including disclosures required for each credit rating action, disclosures regarding ratings performance and the use of rating symbols, and the electronic submission of certain forms and reports on EDGAR;

disclosures required of issuers and underwriters of rated asset-backed securities who use third-party due diligence services, and certifications required from the providers of such services;

the separation of NRSRO sales and marketing activities from rating activities;

NRSRO “look-back” review and disclosure requirements;

an expansion of the SEC’s enforcement powers with respect to NRSROs;

the consistent use and disclosure of appropriate rating methodologies by NRSROs;

standards of training, experience and competence for NRSRO rating analysts; and

NRSRO internal control structures.

Comments on the SEC’s proposals are due by August 8, 2011.

-2- Credit Rating Agencies July 8, 2011

I. NRSRO DISCLOSURE REQUIREMENTS

The proposed rules would require an NRSRO to publish a number of disclosures with each credit rating

action, revise certain disclosures regarding the performance of its credit ratings and rating histories,

disclose and consistently apply its credit rating symbols, and submit certain forms and reports to the SEC

electronically on the EDGAR system.

A. FORM AND CERTIFICATIONS TO ACCOMPANY CREDIT RATINGS

New Section 15E(s) of the Exchange Act, as added by the Dodd-Frank Act, requires the SEC to prescribe

rules requiring an NRSRO to make certain disclosures with the publication of each credit rating. To

implement this requirement, the SEC has proposed to amend paragraph (a) of Rule 17g-7 to require an

NRSRO to publish with each “rating action”: (i) a form containing specified information about the rating

action, and (ii) if the rating action relates to an asset-backed security, any certification relating to the

rating provided to the NRSRO by a third-party due diligence provider1. The term “rating action” is defined

broadly to include the publication of an expected or preliminary credit rating; an initial credit rating; an

upgrade, downgrade, affirmation or withdrawal of a rating; or the placement of an existing rating on credit

watch or review.2

The SEC has requested comment on all aspects of this general approach, including whether multiple

rating actions related to the same entity should trigger multiple publication requirements, how disclosures

should be disseminated, and how the “preliminary credit rating” trigger can be practically implemented. In

addition, with respect to rating actions for asset-backed securities issued in a registered shelf offering, the

SEC has requested comment on whether the deadline for disclosures should be no later than the

deadline for filing the preliminary prospectus proposed separately under Rule 424(h), which would be at

least five business days prior to the first sale in the offering.3

1 The statutory text of Section 15E(s)(4)(B)-(C) does not specify that this certification requirement is

limited to asset-backed securities; however, Section 15E(s)(4) is titled “Due diligence services for asset-backed securities,” and the SEC has interpreted the certification requirement to apply only to those securities. See Proposed Rule, Nationally Recognized Statistical Rating Organizations (“Release”), Exchange Act Release No. 64514 (May 18, 2011), 76 FR 33420, 33465 (June 8, 2011).

2 For these purposes, a “preliminary rating” would include any credit rating, range of ratings, or other indications of a credit rating published prior to the assignment of an initial credit rating for a new issuance. In particular, the proposing release notes that the definition of “credit rating” is designed to cover pre-sale reports typically issued by an NRSRO at the commencement of an offering of an asset-backed security. Such reports often include an expected or preliminary rating and a summary of transaction highlights.

3 Proposed Rule 424(h) would require an issuer of registered asset-backed securities using a shelf registration statement on proposed Form SF-3 to file a preliminary prospectus containing transaction-specific information at least five business days prior to the first sale of securities in the offering. See Asset-Backed Securities, Securities Act Release No. 9117 (April 7, 2010), 75 FR 23328 (May 3, 2010).


1. Format of the Form

Section 15E(s)(2) of the Exchange Act requires that the disclosure form be in a format that (i) is easy to

use and helpful for users of credit ratings, (ii) presents any quantitative content in a manner that facilitates

direct comparison across types of securities, and (iii) is readily available in a medium determined by the

SEC. Proposed Rule 17g-7(a) largely mirrors the statutory requirements of the first two clauses and

would require an NRSRO to make the form and certification available in the same medium as the

applicable credit rating and to the same persons who can receive or access the rating. The SEC has

requested comment on whether it should provide additional guidance on the form’s format (for example,

to make the form more easily comparable across NRSROs).

2. Content of the Form

Section 15E(s)(3) of the Exchange Act specifies extensive qualitative and quantitative content for the

disclosure form to accompany each rating action. Proposed Rule 17g-7(a)(1)(ii) largely mirrors these

statutory requirements and would require the form to include:

the symbol, number, or score that the NRSRO uses to denote the credit rating categories and notches within categories;

the identity of the obligor, security or money market instrument that is the subject of the rating action, in a manner that clearly notifies users of the form;

the version of the procedure or methodology used to determine the credit rating;

the main assumptions and principles used in constructing procedures and methodologies, including qualitative methodologies, quantitative inputs, and (for structured finance products) assumptions about the correlation of defaults across underlying assets;

potential limitations of the credit rating and risks excluded from the credit rating that the NRSRO does not comment on, including liquidity, market, and other risks;

information on the uncertainty of the credit rating, including information on the reliability, accuracy, and quality of data relied upon to determine the rating, and a statement disclosing the extent to which data essential to the credit rating determination was reliable or limited (for example, any limits on the scope of historical data or accessibility to certain deal documents);

whether and the extent to which the NRSRO used third-party due diligence services, as well as a description of the information reviewed by the third party and of its ultimate findings or conclusions;4

a description of how the NRSRO used servicer or remittance reports, if at all;

a description of the data about any obligor, issuer, security, or money market instrument that was relied upon for the rating;

4 The SEC preliminarily believes that this disclosure also would include (among other things) a

description of how the NRSRO used the findings or conclusions of any third-party diligence report made publicly available by an issuer or underwriter of an asset-backed security pursuant to the requirements of Section 15E(s)(4)(A) of the Exchange Act, discussed in Section II.A of this memorandum.


an overall assessment of the quality of information available and considered in producing a rating for an obligor, issuer, security or money market instrument, in relation to the quality of information available when rating similar entities;

disclosures related to conflicts of interest, including: (i) whether the rating was unsolicited (e.g., subscriber-paid), solicited sell-side (e.g., issuer-paid) or solicited buy-side (e.g., investor-paid); (ii) for a solicited rating, whether the NRSRO provided non-rating services to the person that paid for the rating during the most recent fiscal year; and (iii) whether the rating action resulted from a look-back review;5

an explanation or measure of the potential volatility of the rating, including factors that might lead to a change in the rating, and the expected magnitude of changes under different market conditions;

information on the content of the rating, including the historical performance of the rating (if applicable) and the expected probability of default and loss given default;

information about the sensitivity of the rating to assumptions made by the NRSRO, including the five assumptions that would have the greatest impact on the rating if proven false or inaccurate, as well as an example-driven analysis of how each of these assumptions impacts the rating; and

for ratings of asset-backed securities, a description of the representations, warranties, and enforcement mechanisms available to investors and how they differ from those in similar securities.6

The SEC has requested comment on these proposed disclosure requirements, with emphasis on the

clarity and usefulness of the requirements. Among other things, the SEC also has requested input on

whether certain requirements (e.g., the requirement to disclose certain assumptions underlying the rating)

would require the disclosure of proprietary information, and whether the conflict-related disclosure

requirements are appropriate.

3. Attestation Requirement

Pursuant to Section 15E(q)(2)(F) of the Exchange Act, the SEC must require an NRSRO to provide an

attestation “with any credit rating it issues” affirming that no other business activities influenced the rating,

the rating is based solely on the merits of the instrument being rated, and the rating rests solely on an

independent evaluation of the risks and merits of the instrument. The SEC has proposed to require an

NRSRO to attach the attestation to the disclosure form accompanying each “rating action,” which includes

(among other things) the issuance of a preliminary rating, as described above. The attestation must be

signed by a person within the NRSRO with responsibility for the rating. The SEC has requested comment

on this attestation requirement, including who may qualify to make the attestation and whether the

attestation alternatively may be implemented in the proposed provisions requiring disclosure of the

performance of an NRSRO’s credit ratings (discussed in Section I.B of this memorandum).

5 Although the statute does not provide details on the types of conflict-related disclosures that the SEC

must require in the form, the SEC has proposed these three disclosure elements. For a more detailed discussion of the look-back review disclosure requirements, see Section III.B of this memorandum.

6 This requirement is carried over from the current disclosure requirement in Rule 17g-7.


4. Certification of Third-Party Due Diligence Providers for Asset-Backed Securities

As described in Section II.B of this memorandum, Section 15E(s)(4)(B) of the Exchange Act requires a

third party that provides due diligence services to an NRSRO, issuer or underwriter to provide a written

certification to any NRSRO that renders a credit rating to which those due diligence services relate. In

turn, Section 15E(s)(4)(D) compels the SEC to require an NRSRO that receives such a certification to

disclose it to the public. To implement this requirement, new paragraph (a)(2) of Rule 17g-7 would

require an NRSRO to disclose with each rating action any such certification it has received.

B. PUBLIC DISCLOSURES REGARDING THE PERFORMANCE OF CREDIT RATINGS AND RATING HISTORIES

New Section 15E(q) of the Exchange Act, as added by the Dodd-Frank Act, requires the SEC to prescribe

rules requiring an NRSRO to publicly disclose information on initial credit ratings and subsequent

changes to those ratings, so that users of credit ratings may evaluate their accuracy and compare

performance across NRSROs. To implement this statutory provision, the SEC has proposed to revise the

disclosures currently required of an NRSRO with respect to performance statistics and rating histories.

1. Disclosures of Performance Measurement Statistics

The instructions to Exhibit 1 to Form NRSRO currently require an NRSRO to provide performance

measurement statistics with respect to each class of credit ratings for which it is registered.7 At a

minimum, these statistics must show the performance of ratings in each class over 1-year, 3-year, and

10-year periods, including historical ratings transition and default rates within each rating category. The

SEC notes that since the current instructions do not prescribe the methodology for calculating and

presenting these statistics and do not limit the information that may be published, disclosures in response

to this requirement have varied widely among NRSROs.

To make these disclosures of performance statistics more consistent across NRSROs, facilitate

comparisons, and implement Section 15E(q) of the Exchange Act, the SEC has proposed a revised set of

requirements that are more prescriptive and limiting with respect to the information that may be disclosed

on Exhibit 1.8 Under proposed amendments to Rule 17g-1(f), these statistics must be updated yearly with

the NRSRO’s annual certification of Form NRSRO and must be made publicly and freely available (i) on

an easily accessible portion of the NRSRO’s website and (ii) in writing upon request.

7 These requirements also apply to persons seeking to apply for NRSRO registration. 8 An NRSRO would be free to include in Exhibit 1 a website address at which additional performance

measurement statistics may be obtained. The proposed rules would not limit the amount or types of such statistics that an NRSRO may disclose on its website.


Specifically, for each class and subclass9 of credit ratings, an NRSRO would be required to publish

matrices disclosing rating transition and default rates over the prior 1-year, 3-year and 10-year periods, as

shown in the example below from the proposing release:

The cohort used for each matrix would consist of all obligors, securities and money market instruments

that were assigned a credit rating that was outstanding as of the start date for the applicable time period

(i.e., the date 1, 3, or 10 years prior to the most recently ended calendar year). For each credit rating

category or notch used by the NRSRO, the matrix would show the ratings distribution as of the period end

date for the obligors, securities and money market instruments that were assigned a rating at that

particular category or notch as of the period start date. The matrix would also show the percentage of

ratings initially assigned a rating at each category or notch that were in “default,” “paid off,” or “withdrawn

[for other reasons]” as of the period end date.

“Default.” For these purposes, an obligor, security or money market instrument would be classified in

the “default” category if, at any time during the applicable time period (and regardless of whether the

NRSRO later withdrew the rating), (i) the obligor or issuer failed to timely pay principal or interest due

according to the terms of the obligation, security or instrument, or (ii) the NRSRO otherwise classified the

obligor, security or money market instrument as having gone into default using its own (broader)

definition.10

“Paid Off.” A security or money market instrument would be classified as “paid off” if (i) the issuer

extinguished its obligation during the applicable time period by paying in full all outstanding principal and

9 In contrast with the current instructions to Form NRSRO, the SEC has proposed to divide the class of

credit ratings representing structured finance products into separate subclasses for residential mortgage-backed securities, commercial mortgage-backed securities, collateralized loan obligations, collateralized debt obligations, issuances of asset-backed commercial paper conduits, other asset-backed securities, and other structured finance products. A separate matrix would be required for each subclass.

10 The SEC preliminarily believes that the first prong of the definition of “default” would apply to most cases commonly understood as a default, and that a classification of default under the second prong would be rare.


interest due (e.g., because the security or money market instrument matured, was called, or was

prepaid), and (ii) the NRSRO withdrew the credit rating because the obligation was extinguished.

An obligor would be classified as “paid off” if the same two criteria were met and the relevant rating was

assigned with respect to a single specifically-identified obligation of the obligor (e.g., the rating must not

relate to the obligor’s overall ability to meet any obligations as they come due).

“Withdrawn (other).” A rating would be classified in the “withdrawn (other)” category if it was withdrawn

by the NRSRO during the applicable time period for reasons other than those specified in the definitions

of “default” or “paid off.” For example, this might occur if the issuer stopped paying for the surveillance of

a rating or because the NRSRO decided to reallocate resources devoted to monitoring an unsolicited

rating.

The SEC has requested comment on all aspects of these proposed disclosure requirements, including

whether the single cohort approach is appropriate, whether the proposals would have an impact on

competition (for example, by causing certain NRSROs to stop determining a particular type of rating),

whether the proposed subclasses of structured finance products are appropriate, and whether the

definitions of “default,” “paid off” and “withdrawn (other)” should be modified (including, for example,

whether the definition of “default” should include cross-defaults or distinguish between degrees of

severity).

2. Disclosures of Rating Histories

Currently, Rule 17g-2 requires an NRSRO to disclose complete rating histories (dating back to the initial

credit rating and including all subsequent rating actions) for 10% of outstanding issuer-paid credit ratings,

selected on a random basis, in each class for which the NRSRO has 500 or more such issuer-paid

ratings (the “10% Rule”). A rating action subject to this requirement must be publicly disclosed no later

than 6 months after the date the action was taken.

Separately, Rule 17g-2 requires an NRSRO to disclose complete rating histories for all credit ratings

initially determined by the NRSRO after June 26, 2007 (the “100% Rule”). If such a rating is issuer-paid,

the disclosure may be made up to 12 months after the date the action was taken; for all non-issuer paid

ratings, this grace period is 24 months.

In order to enhance the usefulness of rating history disclosures, the SEC has proposed to expand the

scope of ratings that would be subject to the 100% Rule. In light of its disclosure-related proposals, the

SEC also has proposed to repeal the 10% Rule.

Specifically, the 100% Rule would be modified (through new paragraph (b) of Rule 17g-7) to require an

NRSRO to disclose complete rating histories for all credit ratings that were outstanding (rather than

initially determined) as of June 26, 2007, provided that these rating histories would not need to include


information about rating actions taken before that date. For each such credit rating, the NRSRO would be

required to disclose the credit rating assigned to the obligor, security or money market instrument as of

June 26, 2007, as well as any subsequent rating action taken. In each case, the disclosure of the June

26, 2007 rating and each subsequent rating action must include, in XBRL format:

the identity of the NRSRO disclosing the rating action;

the date of the rating action;

the CIK number and legal name of the obligor or issuer;

the CUSIP (with respect to a security or money market instrument);

a classification of the type of rating action as: (i) a rating outstanding as of June 26, 2007, (ii) an initial credit rating, (iii) an upgrade, (iv) a downgrade (including to default status), (v) placement of the rating on credit watch or review; (vi) an affirmation of an existing rating; or (vii) a withdrawal of an existing rating;11

the relevant class or subclass of the credit rating (e.g., corporate issuers or insurance companies, or various subclasses of structured finance products); and

the credit rating symbol, number or score resulting from the rating action.

The 12-month and 24-month grace periods for issuer-paid and non-issuer paid ratings, respectively,

would continue to apply under the revised 100% Rule. In addition, the revised rule would provide that an

NRSRO may cease disclosing a rating history no earlier than 20 years after the date the rating is

withdrawn, provided that no subsequent ratings are assigned to the obligor, security or money market

instrument after the withdrawal classification.

The SEC has requested comment on all aspects of these proposals, including whether the 10% Rule

should be retained, whether the 12-month and 24-month grace periods are appropriate, and whether the

proposals raise practical issues (including, for example, with respect to classifying ratings into separate

classes and subclasses).

C. UNIVERSAL RATING SYMBOLS

Largely mirroring the statutory requirements of Section 938(a) of the Dodd-Frank Act, paragraph (b) of

new Rule 17g-8 would require an NRSRO to implement policies and procedures reasonably designed to:

assess the probability that an issuer will default or otherwise fail to make payment in accordance with the terms of the security or money market instrument;

clearly define each symbol, number or score used to denote a credit rating category and notches within a category, and include such definitions in Exhibit 1 of Form NRSRO so that investors have clear access to them; and

apply any credit rating symbol, number or score consistently for all types of obligors, securities and money market instruments for which it is used.

11 With respect to a withdrawal, the disclosure also must include whether the rating was withdrawn

because (1) a default occurred, (2) the rated obligation was extinguished by payment in full according to its terms, or (3) another reason.


Proposed new paragraph (b)(14) to Rule 17g-2 would subject these policies and procedures to that rule’s

recordkeeping requirements. In accordance with those requirements, the NRSRO must retain

documentation for three years, make documentation easily accessible to its principal office, follow specific

requirements when using a third-party records custodian, and furnish the SEC promptly with legible,

complete, and current copies of records (in English if requested).12

D. WEBSITE DISCLOSURE OF FORM NRSRO

Rule 17g-1(i) currently requires an NRSRO to make its current Form NRSRO and certain exhibits publicly

available on its website or through another comparable, readily accessible means. Proposed

amendments to this rule and form would instead require an NRSRO to make these documents “publicly

freely available on an easily accessible portion” of its website in all cases, removing the option to make

them available through alternative means. The SEC preliminarily believes that Form NRSRO would be

on an “easily accessible” portion of a website if it could be accessed through a clearly and prominently

labeled hyperlink to the form on the NRSRO’s home page.13

E. ELECTRONIC SUBMISSION OF FORM NRSRO AND RULE 17G-3 ANNUAL REPORTS

The SEC has proposed to amend Rule 17g-1, Rule 17g-3, Regulation S-T, and the instructions to Form

NRSRO to require an NRSRO to file or furnish electronically on the EDGAR system: (i) Form NRSRO

and Exhibits 1-9 thereto, if the submission is an update of registration, annual certification, or withdrawal

from registration, and (ii) the annual reports required by Rule 17g-3.14 An NRSRO would continue to

submit in paper format a Form NRSRO required as part of an initial application for registration, an

application to register for an additional class of credit ratings, or a withdrawal of an initial application. The

stated purpose of these amendments is to facilitate the rapid dissemination of financial and business

information contained in SEC filings to investors and other users of ratings, and to increase efficiency in

the filing process. The SEC has emphasized that, as in the past, annual reports filed pursuant to Rule

17g-3 would not be made public.

12 The SEC’s proposed amendments to Rule 17g-2 also would extend these recordkeeping

requirements to certain substantive policies, procedures and documentation required by other parts of this rulemaking and discussed in this memorandum. These include policies and procedures related to rating methodologies; credit analyst standards for training, experience and competence; “look-back” reviews for potential conflicts of interest; and the NRSRO’s internal control structure.

13 The SEC notes that all NRSROs currently make their Form NRSROs available on their websites. 14 The reports that must be filed with the SEC pursuant to Rule 17g-3 require information on revenues

from rating services and other sources; the compensation of credit analysts; certain large users of the NRSRO’s rating services; credit rating actions taken during the year; and the NRSRO’s internal control structure. These required reports also include certain financial statements and the annual report of the NRSRO’s designated compliance officer.


II. THIRD-PARTY DUE DILIGENCE SERVICES FOR ASSET-BACKED SECURITIES15

New Section 15E(s)(4) of the Exchange Act, as added by the Dodd-Frank Act, establishes certain public

disclosure requirements for issuers and underwriters of asset-backed securities who obtain third-party

due diligence reports. In addition, Section 15E(s)(4) requires certain third-party due diligence providers to

provide an SEC-prescribed certification to any NRSRO that produces a rating to which those services

relate, and it provides for the public disclosure of those certifications by NRSROs.

The SEC has proposed to implement these requirements through various amendments to Rule 314 of

Regulation S-T, Form ABS-15G and Rule 17g-7, and by proposing new Rules 15Ga-2 and 17g-10 and

new Form ABS-Due Diligence 15E.

As described below, the SEC has requested comments on all aspects of its proposals, but it has posed

two primary questions for general comment. First, how will a provider of third-party due diligence services

know the identities of the NRSROs that produce credit ratings to which the third party’s services relate?

The SEC suggests resolving this through a lenient reasonableness standard or through a centralized

database to which an NRSRO or a third party could provide notice of its credit rating or certification,

respectively. Second, when must a certification be provided to an NRSRO by a third party, and should

the requirement sunset?

A. PUBLIC DISCLOSURES REQUIRED OF CERTAIN ISSUERS AND UNDERWRITERS OF RATED ASSET-BACKED SECURITIES

Subject to a potentially significant exemption, proposed Rule 15Ga-2 would require the issuer or

underwriter of a registered or unregistered16 offering of an asset-backed security that is to be rated by an

NRSRO to disclose on Form ABS-15G the findings and conclusions of any third-party due diligence

report it has obtained.17 The form must be furnished18 through EDGAR19 at least five business days prior

15 For purposes of the statutory provisions and proposed rules discussed in this section, the definition

used for the term “asset-backed security” is the definition provided at Section 3(a)(77) of the Exchange Act.

16 The SEC is taking the view that issuers and underwriters of unregistered offerings of asset-backed securities may disclose the information required by Rule 15Ga-2 without jeopardizing reliance on the private offering exemptions and safe harbors under the Securities Act, provided that the information disclosed is limited to that required by the proposed rule, and the issuer does not otherwise use Form ABS-15G to offer or sell securities in a manner that conditions the market. See Release, 76 FR at 33469.

17 Section 15E(s)(4)(A) of the Exchange Act, which this proposed rule implements, requires an issuer or underwriter of an asset-backed security to make publicly available the findings and conclusions of any third-party due diligence report it obtains. The SEC believes that this requirement should be interpreted narrowly in the context of the other provisions of Section 15E(s)(4), such that it should apply only to an asset-backed security that is to be rated by an NRSRO.

18 Information that is “furnished” to the SEC is not subject to the liability provisions of Section 18 of the Exchange Act. See Section III.D of this memorandum.


to the first sale in the offering, and it must be signed by the senior officer in charge of securitization of the

depositor (if furnished by the issuer) or a duly authorized officer (if furnished by the underwriter).20

In the proposing release, the SEC notes that an NRSRO separately would be required to disclose in the

form accompanying a rating action (discussed in Section I.A of this memorandum) whether and to what

extent it used third-party due diligence services, a description of the information reviewed by the third-

party provider, and a description of the findings or conclusions of the third-party provider. To eliminate

redundant disclosures, the SEC has proposed to exempt the issuer or underwriter from furnishing Form

ABS-15G if it obtains a representation from an NRSRO21 that can be reasonably relied upon that the

disclosures required by Rule 15Ga-2 will be publicly disclosed22 by the NRSRO five business days prior to

the first sale in the offering.23 Notwithstanding an issuer’s or underwriter’s reasonable reliance on such

an assurance, if an NRSRO fails to make public the required information five business days prior to the

first sale in the offering, the issuer or underwriter would be required to furnish Form ABS-15G at least two

business days prior to the first sale. Thus, under the proposal, issuers and underwriters might still need

to monitor the compliance of the NRSRO with Rule 15Ga-2.

The SEC notes that an issuer of a registered asset-backed security separately may engage third parties

to assist in conducting the review of pool assets required by Securities Act Rule 193. The utilization of

third-party reports in such circumstances would not necessarily trigger the disclosure requirements of

Rule 15Ga-2. Similarly, and contrary to an earlier proposal by the SEC, an issuer of a registered asset-

backed security would not necessarily be required to disclose the information required by Rule 15Ga-2 in

19 A municipal entity that sponsors or issues an asset-backed security, or an underwriter of such an

offering, could instead furnish the information required by Form ABS-15G through the Electronic Municipal Market Access (“EMMA”) system, pursuant to a proposed amendment to Rule 314 of Regulation S-T.

20 This proposal represents a modification to an earlier proposal by the SEC to implement Section 15E(s)(4)(A) as part of a larger rulemaking initiative to implement Section 945 of the Dodd-Frank Act. See Issuer Review of Assets in Offerings of Asset-Backed Securities, Securities Act Release No. 9150 (Oct. 13, 2010), 75 FR 64182 (Oct. 19, 2010).

21 The text of proposed Rule 15Ga-2 only requires this representation to be received from “a [NRSRO];” however, the SEC’s proposing release describes this provision as requiring a representation from “each NRSRO engaged to produce a credit rating for the [asset-backed security]” (emphasis added). See Release, 76 FR at 33467.

22 The SEC preliminarily interprets the term “publicly disclose” to require the NRSRO to make the findings and conclusions readily available to any users of credit ratings, not merely to the NRSRO’s subscribers or prospective investors in the security. See Release, 76 FR at 33468, n. 534.

23 According to the proposing release, whether reliance on the NRSRO’s representation is reasonable would depend on the facts and circumstances, including whether there are ongoing or prior failures by the NRSRO to adhere to its representations, or whether there is a pattern of conduct by the NRSRO where it fails to promptly correct breaches of its representations. In addition, the issuer or underwriter would be required to provide to the SEC, upon request, information regarding the manner in which it obtained the representation.


its prospectus, unless the third party’s findings are part of the Rule 193 review and disclosure separately

is required by that rule and Item 1111 of Regulation AB.

The SEC has requested comment on all aspects of the proposed rule and form. Among other specific

issues for comment, the SEC seeks input on:

whether Rule 15Ga-2 should apply to both registered and unregistered offerings;

whether the rule should apply only if an asset-backed security is to be rated by an NRSRO;

whether the exemption relating to an issuer’s or underwriter’s reasonable reliance on an NRSRO’s representation is appropriate;

whether more effective alternatives exist for making third-party due diligence reports publicly available;

whether issuers of registered offerings should be required to furnish the information required by Rule 15Ga-2 on Form ABS-15G and not in a prospectus; and

whether certain issuers or underwriters (e.g., issuers or underwriters of “exempted securities” as defined in Section 3(a)(12) of the Exchange Act, including government securities and municipal securities) or other parties should be exempt altogether.

B. CERTIFICATIONS FROM THIRD-PARTY PROVIDERS OF DUE DILIGENCE SERVICES

New Section 15E(s)(4)(B) of the Exchange Act, as added by the Dodd-Frank Act, requires a third-party

provider of “due diligence services” that is hired by an NRSRO, issuer24 or underwriter to provide a written

certification to any NRSRO that produces a rating to which those services relate. Proposed new Rule

17g-10 would provide a definition of “due diligence services” for purposes of triggering this requirement,

and proposed new Form ABS Due Diligence-15E would prescribe the contents of the required

certification.

1. Trigger for Certifications Required from Third-Party Providers of Due Diligence Services – Proposed New Rule 17g-10

Rule 17g-10 would define “due diligence services” to mean a review of the assets underlying an asset-

backed security for the purpose of making findings with respect to:

the quality or integrity of the information or data about the assets provided, directly or indirectly, by the securitizer or originator25 (for example, the proposing release notes that this may include comparing data in an electronic “loan tape” database with the data in the

24 In implementing the statute, the SEC has interpreted the term “issuer” to include a “sponsor” or

“depositor,” each as defined at 17 C.F.R. § 229.1101, that participates in the issuance of an asset-backed security. See proposed Rule 17g-10(c)(2).

25 The terms “securitizer” and “originator” would have the meanings ascribed to them in Section 15G(a) of the Exchange Act, which was added by the Dodd-Frank Act. Specifically, a “securitizer” would be defined as “(A) an issuer of an asset-backed security; or (B) a person who organizes and initiates an asset-backed securities transaction by selling or transferring assets, either directly or indirectly, including through an affiliate, to the issuer.” An “originator” would be defined as “a person who (A) through the extension of credit or otherwise, creates a financial asset that collateralizes an asset-backed security; and (B) sells an asset directly or indirectly to a securitizer.”


underlying hard-copy loan documentation for accuracy, or verifying that the loan tape contains all the information required by the NRSRO to determine a rating);

whether the origination of the assets conformed to stated underwriting or credit extension standards (for example, this may include reviewing whether a sampled loan meets the originator’s underwriting guidelines, or how the originator verified information such as income or employment status);

the value of collateral securing the assets (for example, this may include analyzing how the originator verified asset values and analyzing the quality of any appraisers and appraisals used);

whether the originator complied with federal, state or local laws or regulations (for example, this may include analyzing a sampled loan file to verify that the loan was made in conformance with truth-in-lending regulations); or

any other factor material to the likelihood that the issuer will pay interest and principal according to the stated terms and conditions.

Although the final catch-all component of the definition of “due diligence services” appears broad, the

SEC notes in the proposing release that the definition should not cover asset reviews designed to

generate findings that would not be relevant to determining a credit rating. The SEC believes that the

scope of the statutory certification requirement is intended only to address third-party diligence reports

obtained from specialized providers of due diligence services that are relevant to the determination of a

credit rating by an NRSRO for an asset-backed security; consequently, the proposed definition is not

intended to cover “every type of person that might perform some type of diligence in the offering process.”

The SEC has requested comment on proposed new Rule 17g-10, including with respect to the five-part

definition of “due diligence services;” whether the rule should apply to other structured finance products in

addition to asset-backed securities; and whether the definitions of “issuer,” “originator,” and “securitizer”

identify the types of entities that should trigger the rule’s requirements.

2. Form for Certifications Required from Third-Party Providers of Due Diligence Services – Proposed Form ABS Due Diligence-15E

As noted above, the certification required by a third-party provider of due diligence services would be

submitted to an NRSRO on proposed Form ABS Due Diligence-15E. This form, which would in turn be

disclosed by the NRSRO in the form accompanying the relevant rating action, contains the following five

items:

the identity and address of the provider of the due diligence services;

the identity and address of the issuer, underwriter or NRSRO that paid for the due diligence services;

if the services provided by the third party satisfied specific due diligence criteria published by an NRSRO, the identity of each such NRSRO and the title and date of the published criteria;

a description of the scope and manner of the review sufficiently detailed to convey an understanding of the individual steps taken in performing due diligence (including, for example, a description of the types and sample sizes of assets reviewed and the specific types of reviews conducted); and


a summary of the findings and conclusions sufficiently detailed to convey an understanding of what was provided to the hiring issuer, underwriter or NRSRO.

In addition, the individual executing the form would be required to represent that: (i) he or she has

executed the form on behalf of, and on the authority of, the third party, (ii) the third party conducted a

thorough review in performing the due diligence described on the form, and (iii) the form is accurate in all

significant respects.

The SEC has requested comment on all aspects of Form ABS Due Diligence-15E. In particular, the SEC

has asked whether the form should be more prescriptive with respect to the steps that a third party must

take in providing due diligence services (for example, whether the form should specify minimum sample

sizes), and whether the form would provide useful information for NRSROs, investors, and other users of

credit ratings.

III. AMENDMENTS TO NRSRO CONFLICT OF INTEREST AND ENFORCEMENT PROVISIONS

The SEC’s proposals would create a prohibited conflict of interest with respect to sales and marketing

considerations influencing the rating process, and they would require an NRSRO to conduct a “look-back”

in certain cases if a rating employee becomes employed by a rated entity or an issuer, underwriter, or

sponsor of a rated security. In addition, the proposals implement statutory provisions for suspending or

revoking an NRSRO’s registration and for deeming certain reports to be “filed” with the SEC, rather than

“furnished.” The SEC has deferred implementing additional penalty provisions at this time.

A. PROPOSED NEW PROHIBITED SALES AND MARKETING CONFLICT

New Section 15E(h)(3) of the Exchange Act, as added by the Dodd-Frank Act, requires the SEC to

prescribe rules to prevent sales and marketing considerations from influencing the credit ratings of an

NRSRO, with exceptions for small NRSROs as the SEC determines appropriate. To implement this

requirement, new paragraph (c)(8) of Rule 17g-5 would prohibit an NRSRO from issuing or maintaining a

rating if a person within the NRSRO who participates in the sales and marketing of a service or product of

the NRSRO (or of an affiliate) also participates in either the determination or monitoring of a credit rating

or the development or approval of procedures to determine the credit rating, including qualitative or

quantitative models.26 The stated purpose of this rule is to insulate employees responsible for the

analytic functions of an NRSRO from sales and marketing concerns.

The SEC has requested comment on several issues, including whether it should provide guidance on (i)

the definition of “sales and marketing” activities, (ii) what it means to “participate” in sales and marketing

26 Rule 17g-5 contains two broad categories of conflicts. Certain conflicts are permissible as long as

they are appropriately disclosed and managed, such as being paid by an issuer to determine a credit rating. Other conflicts, including this proposed conflict related to sales and marketing, are prohibited entirely.


activities, and (iii) what it means to “participate in developing or approving procedures and methodologies

used for determining credit ratings.” In addition, the SEC has requested comment on how the proposal

would impact existing governance structures, reporting lines and internal organizations of NRSROs, and

whether there are certain sales and marketing activities that should be exempt from the prohibition.

Exemption for Small NRSROs. The new conflict prohibition would provide for an exemption or

conditional exemption for a small NRSRO if, upon application, the SEC finds that the small size of the

NRSRO would make it inappropriate to require the separation of sales and marketing activities from rating

activities, and that the exemption is in the public interest. The SEC preliminarily believes that the rule’s

prohibition would apply to all NRSROs, but it notes that certain NRSROs may not have the resources or

staff to fully effect the required separation. In granting any relief from the prohibition, the SEC may

impose conditions designed to preserve as much of the separation as possible.

The SEC has requested comment on how it should implement this exemption, including how it should

determine which NRSROs are “small” NRSROs, which factors it should consider in granting an exemption

(including whether the exemption should be automatic in certain cases), and whether the exemption

should be conditional in all or certain cases.

B. “LOOK-BACK” REVIEW REQUIREMENTS

New Section 15E(h)(4) of the Exchange Act, as added by the Dodd-Frank Act, requires an NRSRO to

implement policies and procedures for conducting a “look-back” review of conflicts of interest in respect of

any case in which an employee of a person subject to an NRSRO credit rating, or of any issuer,

underwriter or sponsor of a rated security or money market instrument, was employed by the NRSRO and

participated in determining the relevant credit rating during the one-year period prior to a rating action.

Section 15E(h)(4) further requires the SEC to prescribe rules requiring an NRSRO to revise a rating, if

appropriate, after such a look-back review.

To implement this requirement, paragraph (c) of new Rule 17g-8 would require an NRSRO to have

policies and procedures reasonably designed to ensure that the NRSRO does the following three things

in the event that a look-back review indicates that a conflict of interest influenced a credit rating:27

Placement of the Rating on Credit Watch. First, the NRSRO must place the rating on credit

watch “immediately” upon discovering that the rating was influenced by a conflict, even if the

NRSRO is in the process of determining whether other ratings were influenced as well. The

27 These policies and procedures would be subject to the general recordkeeping requirements of Rule

17g-2.


disclosure form accompanying the credit watch rating action must indicate that the rating had

been placed on credit watch because it was influenced by a conflict of interest.28

Reassessment of the Rating. Second, the NRSRO must promptly determine whether it should

revise the rating to ensure that the rating is no longer influenced by the conflict. The SEC

preliminarily believes that one way for an NRSRO to make this determination would be to apply

its rating procedures and methodologies de novo to the rated obligor, security or money market

instrument and revise the current rating if the de novo application produces a different result.

Revision or Affirmation of the Rating. Third, based on this determination, the NRSRO must

either revise or affirm the rating in a new rating action. In the case of a revised rating, the

accompanying disclosure form must explain that the rating is being revised because prior rating

actions were influenced by a conflict of interest; similarly, in the case of an affirmation, the

disclosure form must explain why no rating action is being taken notwithstanding the conflict. In

either case, the disclosure form must also provide the date and rating of each prior rating action

influenced by the conflict, and an estimate of the impact the conflict had on each such prior

action. The SEC preliminarily believes that one way for the NRSRO to estimate this impact would

be to reconstruct each such prior rating action through a “conflict-free” application of its rating

procedures and methodologies, and then disclose the difference between that reconstructed

rating action and the rating action actually taken.

The SEC has requested comment on all aspects of these proposals, including how they would impact an

obligor or issuer subject to a credit rating that has been determined to have been influenced by a conflict.

The SEC also has requested comment on whether it should be more prescriptive regarding what it means

for a conflict to “influence” a credit rating, whether the requirement to estimate the impact of a conflict

would substantially prolong the time it would take an NRSRO to revise a rating, and whether additional or

alternative information about a conflict should be disclosed.

C. SUSPENSION OR REVOCATION OF AN NRSRO’S REGISTRATION

New Section 15E(h)(3)(B)(ii) of the Exchange Act, as added by the Dodd-Frank Act, requires the SEC to

provide for the suspension or revocation of an NRSRO’s registration if the SEC finds, on the record after

notice and opportunity for a hearing, that the NRSRO has violated any rule issued under Section 15E(h)

and that the violation affected a credit rating. Although Section 15E(h)(3) generally appears to focus only

on conflicts of interest relating to sales and marketing, one particular provision (Section 15E(h)(3)(B)(ii))

requires the SEC to provide for the suspension or revocation of an NRSRO’s registration upon “a violation

of a rule issued under this subsection,” which the SEC has interpreted more broadly to mean any rule

issued under Section 15E(h). The rules issued under Section 15E(h) consist primarily of the SEC’s 28 The Dodd-Frank Act requires an NRSRO to publish a disclosure form with credit rating action; the

SEC’s proposals to implement this requirement are discussed at Section I.A of this memorandum.


conflict of interest regulations at Rule 17g-5. In the proposing release, the SEC notes that an NRSRO’s

rule violation need not be “willful” for the SEC to take action under the statute.

The SEC has proposed to implement this suspension and revocation authority in conjunction with

enforcement proceedings under Sections 15E(d) and 21C of the Exchange Act, as those statutory

provisions already provide the SEC with the authority to take action against an NRSRO for violations (or,

in the case of Section 15E(d), willful violations) of rules issued under Section 15E(h) of the Exchange

Act.29

Specifically, new paragraph (g) of Rule 17g-5 would provide that, in a proceeding pursuant to Section

15E(d) or Section 21C, the SEC will suspend or revoke an NRSRO’s registration if it finds that: (i) the

NRSRO has violated a rule issued under Section 15E(h), (ii) the violation affected a rating, and (iii) the

suspension or revocation is necessary for the protection of investors and in the public interest. Although

the public interest finding is not required by Section 15E(h), such a finding already is required for the

imposition of sanctions under Section 15E(d). The SEC preliminarily believes that such a finding also

should be applicable to suspensions and revocations issued under Section 21C, due to the lesser intent

required to establish a violation and the substantial consequences of suspending or revoking a

registration.

The SEC has requested comment on all aspects of this proposal, including whether this new suspension

and revocation authority should be implemented and enforced independently of proceedings under

Sections 15E(d) and 21C. Among other things, the SEC also has requested comment on how to

determine whether a violation “affected a rating,” and whether the requirement of a public interest finding

(or some other finding) is appropriate.

D. ADDITIONAL SEC “FILING” REQUIREMENTS

Section 932(a) of the Dodd-Frank Act amended Section 15E of the Exchange Act to designate certain

submissions by an NRSRO to the SEC as “filings” rather than “furnishings.” The primary significance of

this change is that under Section 18 of the Exchange Act, any person who makes or causes to be made a

statement that is “false or misleading with respect to any material fact” in a report or document filed with

the SEC may be liable for damages caused to a person who traded the security in reliance on the

information contained in the statement. Section 18 does not provide for similar liability for misstatements

contained in “furnishings.”

29 Under Section 15E(d) of the Exchange Act, the SEC can take enforcement actions against an

NRSRO – including revoking or suspending for up to 12 months the NRSRO’s registration – for certain enumerated violations, including a willful violation of any provision of the Exchange Act or the SEC’s rules issued thereunder. A sanction under Section 15E(d) requires notice and opportunity for a hearing, as well as a finding that the sanction is “necessary for the protection of investors and in the public interest.” Separately, Section 21C of the Exchange Act permits the SEC to take certain actions for violations of the securities laws, even if the violations are not willful.


Proposed amendments to Rule 17g-1, Rule 17g-3 and the instructions to Form NRSRO would reflect this

change. Specifically, submissions that now would be considered “filings” include initial applications on

and updates to Form NRSRO, annual certifications to Form NRSRO, and the annual financial reports

required pursuant to Rule 17g-3, with the exception of the report that lists all credit rating actions taken

during the prior year.30

E. FINES AND OTHER PENALTIES

New Section 15E(p)(4)(A) of the Exchange Act, as added by the Dodd-Frank Act, requires the SEC to

establish, by rule, fines and other penalties applicable to an NRSRO that violates the requirements of

Section 15E and the rules issued thereunder. Noting that the Exchange Act already provides the SEC

with broad authority to impose sanctions upon an NRSRO, and that the SEC has not identified a specific

need for a fine or penalty not otherwise provided for, the SEC has deferred establishing new fines or

penalties at this time. Instead, the SEC has proposed to add an instruction to Form NRSRO providing

notice that NRSROs are subject to fines, penalties and other sanctions under Sections 15E, 21, 21A,

21B, 21C and 32 of the Exchange Act for violating the securities laws. The SEC may establish new fines

and penalties in the future, if a specific need is identified.

The SEC has requested comment on whether existing sanctions are sufficient, or whether additional fines

or penalties should be established by rule.

IV. CREDIT RATING METHODOLOGIES

New Section 15E(r) of the Exchange Act, as added by the Dodd-Frank Act, requires an NRSRO to ensure

that it meets certain specified objectives with respect to its credit rating procedures and methodologies.

The SEC has proposed to implement these requirements in new Rule 17g-8(a), which largely mirrors the

statutory text. Specifically, the SEC’s proposal would require an NRSRO to implement policies and

procedures reasonably designed to ensure that:

credit ratings are determined using procedures and methodologies that are (i) approved by the NRSRO’s board of directors and (ii) in accordance with the NRSRO’s internal policies for the development and modification of rating procedures and methodologies;

the NRSRO applies material changes to credit rating methodologies consistently to all applicable credit ratings – to the extent that changes are made to surveillance procedures and methodologies, such changes must be applied to then-current ratings within a “reasonable” time;31

30 Even though Section 932 of the Dodd-Frank Act did not replace the word “furnish” with “file” in

Section 15E(a), which governs the submission of initial applications for registration as an NRSRO, the SEC has stated that it believes this omission was in error, and the SEC would therefore apply the change to initial applications as well.

31 The SEC has requested comment on whether it should prescribe specific time frames in this context. Although the SEC has not defined “reasonable” for these purposes, the proposed rule provides that


the NRSRO promptly publishes on an easily accessible portion of its website: (i) material changes to rating procedures and methodologies, the reason for the changes, and the likelihood the changes will result in changes to any current ratings, and (ii) “significant errors” identified in a rating procedure or methodology that may result in a change to current ratings;32 and

the NRSRO discloses the version of a rating procedure or methodology used with respect to a particular credit rating.

These policies and procedures would be subject to the general recordkeeping requirements of Rule

17g-2. The SEC has requested comment on whether its proposal appropriately meets the mandates of

Section 15E(r) of the Exchange Act.

V. STANDARDS OF TRAINING, EXPERIENCE, AND COMPETENCE FOR NRSRO CREDIT RATING ANALYSTS

Section 936 of the Dodd-Frank Act requires the SEC to prescribe rules reasonably designed to ensure

that an NRSRO employee who performs credit ratings (i) meets standards of training, experience, and

competence necessary to produce accurate ratings, and (ii) is tested for knowledge of the credit rating

process. To implement this requirement, the SEC has proposed new Rule 17g-9, which would require an

NRSRO to establish and maintain standards for training, experience, and competence that are

reasonably designed to ensure that its ratings employees produce accurate credit ratings. Although this

proposed rule grants NRSROs some discretion in designing these standards, it requires NRSROs to

consider several factors, including:

for employees engaging in qualitative analysis, the knowledge necessary to evaluate and process the data relevant to the creditworthiness of the obligor or issuer;

for employees engaged in quantitative analysis, the technical expertise necessary to understand relevant models and model inputs;

factors relevant to the particular classes and subclasses of ratings covered by the employee, including the geography, sector, industry, regulatory and legal framework, and underlying assets with respect to the applicable obligors or issuers; and

the complexity of the obligors, securities or money market instruments rated by the employee.

Specific Testing and Experience Requirements. In addition, proposed Rule 17g-9(c) would require an

NRSRO’s standards to incorporate specific testing and experience requirements, including (i) periodic

testing of employees who determine credit ratings on their knowledge of the NRSRO’s procedures and

an NRSRO may take into consideration the number of ratings impacted, the complexity of the applicable rating procedures and methodologies, and the type of rated obligor, security or money market instrument. The SEC has requested comment on whether it should prescribe specific time frames in this context.

32 The SEC has requested comment on whether it should define “significant error.”


methodologies, and (ii) a requirement that at least one individual with at least three years of credit

analysis experience participates in each credit rating determination.33

The standards established by an NRSRO pursuant to new Rule 17g-9 would be subject to the general

recordkeeping provisions of Rule 17g-2.

The SEC has requested comment on all aspects of this proposal, including:

whether requiring NRSROs to design their own standards appropriately serves the objectives of the Dodd-Frank Act, or whether the SEC should prescribe specific, industry-wide standards;

whether the SEC should clarify or omit any of the proposed factors, or whether additional factors should be considered;

whether the SEC should establish a standardized review process for assessing an NRSRO’s standards;

how the accuracy of credit ratings should be measured;

whether the requirement for “periodic” testing of analysts is sufficient, or whether the SEC should prescribe the frequency of such testing; and

whether the three-year experience requirement would be an effective benchmark for ensuring accurate credit ratings, or whether the experience requirement should be adjusted.

VI. NRSRO INTERNAL CONTROL STRUCTURE AND COMPLIANCE REPORTING REQUIREMENTS

As amended by the Dodd-Frank Act, Section 15E(c) of the Exchange Act requires an NRSRO to

implement an effective internal control structure to govern the implementation of and adherence to

policies, procedures and methodologies for determining credit ratings, taking into consideration factors

that the SEC may prescribe. In addition, Sections 15E(c) and 15E(j) require the SEC to prescribe rules

requiring an NRSRO to submit annually an internal controls report and a report of the NRSRO’s

designated compliance officer, respectively.

The SEC’s proposals to implement these requirements largely mirror the statutory requirements.

A. INTERNAL CONTROL STRUCTURE IMPLEMENTATION REQUIREMENTS

New Section 15(c)(3)(A) of the Exchange Act, as added by the Dodd-Frank Act, requires an NRSRO to

“establish, maintain, enforce, and document an effective internal control structure governing the

implementation of and adherence to policies, procedures, and methodologies for determining credit

ratings, taking into consideration such factors as the [SEC] may prescribe, by rule.” The SEC has

proposed to defer prescribing factors for an NRSRO to consider in implementing such an internal control

structure, noting that the statutory requirement is self-executing and that the rulemaking process may be

33 The proposing release notes that this requirement may be met, for example, by having the

experienced individual serve on the rating committee or review and approve a rating action proposed by a junior analyst. See Release, 76 FR at 33479.


better informed by permitting the SEC to first observe (through the examination and annual reporting

process) how NRSROs achieve compliance. However, the SEC has requested comment on this

approach generally, and whether the SEC should instead prescribe rules specifying factors as part of this

rulemaking initiative.

The SEC also has requested comment on which individual elements of the internal control structure

requirement – establishment, maintenance, enforcement, and documentation – would benefit from

prescriptive factors. In addition, although no factors are formally included as part of the proposed

rulemaking, the SEC has invited comment on several suggestions. For example, the SEC has requested

comment on whether an NRSRO’s establishment of an internal control structure should incorporate

controls reasonably designed to ensure that, among other things:

newly-developed methodologies or proposed updates to methodologies are appropriately reviewed and/or disclosed to the public prior to being employed by the NRSRO;

persons independent of the development and use of in-use methodologies periodically review the methodologies, and market participants have an opportunity to provide comment, in each case to determine whether methodologies should be updated;34

the NRSRO engages in analysis before commencing the rating of an “exotic” or “bespoke” type of obligor, security or money market instrument to review the feasibility of determining a credit rating; and/or

analysts document the steps taken in developing rating actions in sufficient detail to permit after-the-fact review or internal audit of the rating file for adherence to the NRSRO’s rating procedures and methodologies, and that such reviews or audits are conducted periodically.

The SEC has requested comment on whether an NRSRO’s maintenance of an internal control structure

should incorporate controls reasonably designed to ensure that:

the NRSRO conducts periodic reviews of whether it has devoted sufficient resources to implement and operate the internal control structure, and whether the internal control structure is effective; and/or

any identified deficiencies are timely assessed and addressed.

The SEC has requested comment on whether an NRSRO’s enforcement of an internal control structure

should incorporate controls reasonably designed to ensure that:

the NRSRO provides additional training or takes discipline with respect to employees who fail to adhere to the internal control structure’s requirements; and/or

a process is in place for employees to report failures to adhere to the internal control structure.

Finally, the SEC has requested comment on whether factors for an NRSRO’s documentation of the

internal control structure should describe the level of written detail that should be documented. Proposed

34 The SEC also requests comment on whether to require the NRSRO to make such comments from

market participants publicly available and to consider those comments before implementing a methodology.


new paragraph (b)(12) to Rule 17g-2 would subject the documentation of an NRSRO’s internal control

structure to the rule’s recordkeeping requirements. However, the SEC’s proposed amendment does not

specify the form or content that such documentation would take.

B. ANNUAL INTERNAL CONTROLS REPORT

Proposed new paragraphs (a)(7) and (b)(2) to Rule 17g-3 would require an NRSRO to file an annual

internal controls report with the SEC within 90 days of the end of the NRSRO’s fiscal year. The report

must describe management’s responsibility in establishing and maintaining an effective internal control

structure, assess the effectiveness of the structure, and provide an attestation of the chief executive

officer. Although the rule as proposed would closely mirror the statutory requirements, the SEC has

requested extensive comment on whether and how it should make these requirements more explicit

and/or provide additional guidance to NRSROs. Among other things, the SEC has requested comment

on the appropriate level of board involvement in the internal controls system, and whether the internal

controls report should be made public on EDGAR.

C. ANNUAL REPORT OF DESIGNATED COMPLIANCE OFFICER

New Section 15E(j)(5) of the Exchange Act, as added by the Dodd-Frank Act, requires an NRSRO’s

designated compliance officer to submit to the NRSRO—and the NRSRO to subsequently file with the

SEC—an annual report assessing the NRSRO’s compliance with its policies and procedures and with the

securities laws. The report must include a description of any material changes to the NRSRO’s code of

ethics and conflict of interest policies and a certification that the report is accurate and complete.

The SEC has proposed adding paragraph (a)(8) to Rule 17g-3 to clarify that the designated compliance

officer’s unaudited report is one of the reports that must be filed with the SEC within 90 days of the end of

the NRSRO’s fiscal year.

VII. OTHER AMENDMENTS

A. CLARIFICATION TO THE DESCRIPTION OF STRUCTURED FINANCE PRODUCTS

Section 941(a) of the Dodd-Frank Act amended Section 3 of the Exchange Act to establish a definition of

the term “asset-backed security” that includes (among other things) collateralized mortgage obligations.

A number of existing provisions in the SEC’s NRSRO regulations currently refer broadly to a structured

finance product as “any security or money market instrument issued by an asset pool or as part of an

asset-backed or mortgage-backed securities transaction” (emphasis added). To eliminate any

redundancy, the SEC has proposed striking the term “or mortgage-backed” from the applicable rules

(specifically Rules 17g-2, 17g-3, 17g-5 and 17g-6). The SEC has requested comment on whether this

change would narrow any rule to exclude any security or transaction that previously had been covered.


B. CLARIFYING AMENDMENTS TO THE INSTRUCTIONS TO FORM NRSRO

The SEC has proposed a number of clarifying amendments to the instructions to Form NRSRO to

eliminate confusion and address interpretive questions raised by NRSROs concerning the disclosures

required by the form. These amendments relate to:

calculating the number of credit ratings outstanding in a given class of ratings and classifying ratings appropriately;

calculating the number of credit analysts employed;

clarifying that Exhibits 10-13 of Form NRSRO are not required to be made publicly available and should not be updated with the annual certification; and

clarifying that a new NRSRO applicant no longer must have been in business as a credit rating agency for the three years immediately preceding the date of application.35

* * *

35 Section 932(b) of the Dodd-Frank Act eliminated this requirement from the definition of NRSRO. See

Section 3(a)(62) of the Exchange Act.

Copyright © Sullivan & Cromwell LLP 2011


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