[Federal Register Volume 76, Number 182 (Tuesday, September 20, 2011)]
[Notices]
[Pages 58319-58321]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2011-24028]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-65339]


 Order Granting Temporary Exemption of Kroll Bond Rating Agency, 
Inc. From the Conflict of Interest Prohibition in Rule 17g-5(c)(1) of 
the Securities Exchange Act of 1934

September 14, 2011.

I. Introduction

    Rule 17g-5(c)(1) of the Securities Exchange Act of 1934 (``Exchange 
Act'') prohibits a nationally recognized statistical rating 
organization (``NRSRO'') from issuing or maintaining a credit rating 
solicited by a person that, in the most recently ended fiscal year, 
provided the NRSRO with net revenue equaling or exceeding 10% of the 
total net revenue of the NRSRO for the fiscal year. In adopting this 
rule, the Commission stated that such a person would be in a position 
to exercise substantial influence on the NRSRO, which in turn would 
make it difficult for the NRSRO to remain impartial.\1\
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    \1\ Release No. 34-55857 (June 5, 2007), 72 FR 33564, 33598 
(June 18, 2007).
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II. Application and Exemption Request of Kroll Bond Rating Agency, Inc.

    Kroll Bond Rating Agency, Inc. (``Kroll''), f/k/a LACE Financial 
Corp. (``LACE''), is a credit rating agency registered with the 
Commission as an NRSRO under Section 15E of the Exchange Act for the 
classes of credit ratings described in clauses (i) through (v) of 
Section 3(a)(62)(B) of the Exchange Act. Kroll traditionally has 
operated mainly under the ``subscriber-paid'' business model, in which 
the NRSRO derives its revenue from restricting access to its ratings to 
paid

[[Page 58320]]

subscribers. Kroll has informed the Commission that it intends to 
expand its existing NRSRO business by establishing a new ``issuer-
paid'' rating service under which it will issue ratings paid for by the 
issuer, underwriter, or sponsor of the security being rated. In 
connection with this planned expansion, Kroll has requested a temporary 
and limited exemption from Rule 17g-5(c)(1) on the grounds that the 
restrictions imposed by Rule 17g-5(c)(1) would pose a substantial 
constraint on the firm's ability to compete effectively with large 
rating agencies offering comparable ratings services. Specifically, 
Kroll argues that given that the fees typically associated with issuer-
paid engagements tend to be relatively high when compared to the fees 
associated with its existing subscriber-based business, it is possible 
that in the early stages of its expansion the fees associated with a 
single issuer-paid engagement could exceed ten percent of its total net 
revenue for the fiscal year. Accordingly, Kroll has requested that the 
Commission grant it an exemption from Rule 17g-5(c)(1) for any revenues 
derived from non-subscription based business during the remainder of 
calendar years 2011 and 2012, which are also the end of Kroll's 2011 
and 2012 fiscal years, respectively.

III. Discussion

    The Commission, when adopting Rule 17g-5(c)(1), noted that it 
intended to monitor how the prohibition operates in practice, 
particularly with respect to asset-backed securities, and whether 
exemptions may be appropriate.\2\ The Commission has previously granted 
two temporary exemptions from Rule 17g-5(c)(1), including one on 
February 11, 2008 to LACE, as Kroll was formerly known, in connection 
with its initial registration as an NRSRO (``LACE Exemptive 
Order'').\3\ The Commission noted several factors in granting that 
exemption, including the fact that the revenue in question was earned 
prior to the adoption of the rule, the likelihood of smaller firms such 
as LACE being more likely to be affected by the rule, LACE's 
expectation that the percentage of total revenue provided by the 
relevant client would decrease, and the increased competition in the 
asset-backed securities class that could result from LACE's 
registration. In granting the LACE Exemptive Order, the Commission also 
noted that an exemption would further the primary purpose of the Credit 
Rating Agency Reform Act of 2006 (``Rating Agency Act'') as set forth 
in the Report of the Senate Committee on Banking, Housing, and Urban 
Affairs accompanying the Rating Agency Act: To ``improve ratings 
quality for the protection of investors and in the public interest by 
fostering accountability, transparency, and competition in the credit 
rating industry.'' \4\ On June 23, 2008, the Commission, citing the 
same factors set forth in the LACE Exemptive Order, issued a similar 
order granting Realpoint LLC a temporary exemption from the 
requirements of Rule 17g-5(c)(1) in connection with Realpoint LLC's 
registration as an NRSRO.\5\
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    \2\ Release No. 34-55857 (June 5, 2007), 72 FR 33564, 33598 
(June 18, 2007).
    \3\ Release No. 34-57301 (February 11, 2008), 73 FR 8720 
(February 14, 2008).
    \4\ See Report of the Senate Committee on Banking, Housing, and 
Urban Affairs to Accompany S. 3850, Credit Rating Agency Reform Act 
of 2006, S. Report No. 109-326, 109th Cong., 2d Sess. (Sept. 6, 
2006).
    \5\ Release No. 34-58001 (June 23, 2008), 73 FR 36362 (June 26, 
2008).
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    On September 2, 2010, the Commission issued an Order Instituting 
Administrative and Cease-and-Desist Proceedings (``LACE/Putnam Order'') 
against LACE and Barron Putnam, LACE's founder as well as its majority 
owner during the relevant time period. The LACE/Putnam Order found, 
among other things, that the firm made misrepresentations in its 
application to become registered as an NRSRO and its accompanying 
request for an exemption from Rule 17g-5(c)(1). Specifically, the 
Commission found that the firm materially misstated the amount of 
revenue it received from its largest customer during 2007.\6\ On 
November 9, 2010, the Commission issued an Order Making Findings and 
Imposing A Cease-and-Desist Order (the ``Mouzon Order'') against LACE's 
former president, Damyon Mouzon. The Mouzon Order found, among other 
things, that as LACE's president, Mouzon was responsible for ensuring 
the accuracy of the information provided to the Commission in 
connection with the firm's NRSRO application and its request for an 
exemption, and that he knew or should have known that the financial 
information that LACE provided to the Commission in connection with its 
NRSRO application and its request for an exemption from Rule 17g-
5(c)(1) was inaccurate.\7\ LACE, Putnam and Mouzon each consented to 
the entry of those orders on a neither admit nor deny basis.
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    \6\ In the Matter of LACE Financial Corp. and Barron Putnam, 
Respondents: Order Instituting Administrative and Cease-and-Desist 
Proceedings, Pursuant to Sections 15E(d) and 21C of the Securities 
Exchange Act of 1934, Making Findings, and Imposing Remedial 
Sanctions and Cease-and-Desist Orders, Release No. 62834 (September 
2, 2010).
    \7\ In the Matter of Damyon Mouzon, Respondent: Order Making 
Findings and Imposing a Cease-and-Desist Order Pursuant to Section 
21C of the Securities Exchange Act of 1934, Release No. 63280 
(November 9, 2010).
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    In the request that is subject to this Order, Kroll acknowledged 
the recent orders against LACE and its former owner and president and 
stated that it has taken significant steps to enhance the compliance 
and other functions associated with the traditional subscriber-based 
business, including replacing senior management, retaining new 
compliance and financial personnel, and adding new independent 
directors comprising a majority of the board. Kroll has informed 
Commission staff that LACE's former ownership and management personnel 
no longer have any ownership or other relationship, financial or 
otherwise, with Kroll. Kroll has further informed Commission staff that 
LACE ceased performing any work or analysis in connection with the 
issuer-paid ratings that were the subject of the LACE Exemptive Order 
in December 2008.
    The Commission believes that a temporary, limited and conditional 
exemption allowing Kroll to enter the market for rating structured 
finance products is consistent with the Commission's goal of improving 
ratings quality for the protection of investors and in the public 
interest by fostering accountability, transparency, and competition in 
the credit rating industry. In order to maintain this exemption, Kroll 
will be required to publicly disclose in Exhibit 6 to Form NRSRO, as 
applicable, that the firm received more than 10% of its net revenue in 
fiscal years 2011 and 2012 from a client or clients that paid it to 
rate asset-backed securities. This disclosure is designed to alert 
users of credit ratings to the existence of this specific conflict and 
is consistent with exemptive relief the Commission has previously 
granted to LACE and Realpoint LLC. Furthermore, in addition to Kroll's 
existing obligations as an NRSRO to maintain policies, procedures, and 
internal controls, by the terms of this order, Kroll will also be 
required to maintain policies, procedures, and internal controls 
specifically designed to address the conflict created by exceeding the 
10% threshold. Finally, the Commission notes that Kroll is subject to 
the September 2, 2010 Order Instituting Administrative and Cease-and-
Desist Proceedings against LACE Financial Corp.
    Section 15E(p) of the Exchange Act, as added by Section 932(a)(8) 
of the Dodd-

[[Page 58321]]

Frank Wall Street Reform and Consumer Protection Act, requires 
Commission staff to conduct an examination of each NRSRO at least 
annually. As part of this annual examination regimen for NRSROs, 
Commission staff will closely review Kroll's activities with respect to 
managing this conflict and meeting the conditions set forth below and 
will consider whether to recommend that the Commission take additional 
action, including administrative or other action.
    The Commission therefore finds that a temporary, limited and 
conditional exemption allowing Kroll to enter the market for rating 
structured finance products is consistent with the Commission's goal, 
as established by the Rating Agency Act, of improving ratings quality 
by fostering accountability, transparency, and competition in the 
credit rating industry, subject to Kroll's making public disclosure of 
the conflict created by exceeding the 10% threshold and maintaining 
policies, procedures and internal controls to address that conflict, is 
necessary and appropriate in the public interest and is consistent with 
the protection of investors.

IV. Conclusion

    Accordingly, pursuant to Section 36 of the Exchange Act,
    It is hereby ordered that Kroll Bond Rating Agency, Inc., formerly 
known as LACE Financial Corp., is exempt from the conflict of interest 
prohibition in Exchange Act Rule 17g-5(c)(1) until January 1, 2013, 
with respect to any revenue derived from issuer-paid ratings, provided 
that: (1) Kroll Bond Rating Agency, Inc. publicly discloses in Exhibit 
6 to Form NRSRO, as applicable, that the firm received more than 10% of 
its total net revenue in fiscal year 2011 or 2012 from a client or 
clients; and (2) in addition to fulfilling its existing obligations as 
an NRSRO to maintain policies, procedures, and internal controls, Kroll 
Bond Rating Agency, Inc. also maintains policies, procedures, and 
internal controls specifically designed to address the conflict created 
by exceeding the 10% threshold.

    By the Commission.
Elizabeth M. Murphy,
Secretary.
[FR Doc. 2011-24028 Filed 9-19-11; 8:45 am]
BILLING CODE 8011-01-P