[Federal Register Volume 79, Number 178 (Monday, September 15, 2014)]
[Rules and Regulations]
[Pages 55078-55314]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2014-20890]



[[Page 55077]]

Vol. 79

Monday,

No. 178

September 15, 2014

Part II





Securities and Exchange Commission





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17 CFR Parts 232, 240, 249, et al.





 Nationally Recognized Statistical Rating Organizations; Final Rule

Federal Register / Vol. 79 , No. 178 / Monday, September 15, 2014 / 
Rules and Regulations

[[Page 55078]]


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SECURITIES AND EXCHANGE COMMISSION

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

[Release No. 34-72936; File No. S7-18-11]
RIN 3235-AL15


Nationally Recognized Statistical Rating Organizations

AGENCY: Securities and Exchange Commission.

ACTION: Final rules.

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SUMMARY: In accordance with the Dodd-Frank Wall Street Reform and 
Consumer Protection Act (``Dodd-Frank Act'') and to enhance oversight, 
the Securities and Exchange Commission (``Commission'') is: adopting 
amendments to existing rules and new rules that apply to credit rating 
agencies registered with the Commission as nationally recognized 
statistical rating organizations (``NRSROs''); adopting a new rule and 
form that apply to providers of third-party due diligence services for 
asset-backed securities; and adopting amendments to existing rules and 
a new rule that implement a requirement added by the Dodd-Frank Act 
that issuers and underwriters of asset-backed securities make publicly 
available the findings and conclusions of any third-party due diligence 
report obtained by the issuer or underwriter. The Commission also is 
adopting certain technical amendments to existing rules.

DATES: This rule is effective November 14, 2014; except the amendments 
to Sec.  240.17g-3(a)(7) and (b)(2) and Form NRSRO, which are effective 
on January 1, 2015; and the amendments to Sec.  240.17g-2(a)(9), 
(b)(13) through (15), Sec.  240.17g-5(a)(3)(iii)(E), (c)(6) through 
(8), Sec.  240.17g-7(a) and (b), and Form ABS-15G, which are effective 
June 15, 2015. The addition of Sec. Sec.  240.15Ga-2, 240.17g-8, 
240.17g-9, 240.17g-10, and Form ABS Due Diligence-15E are effective 
June 15, 2015.

FOR FURTHER INFORMATION CONTACT: Randall W. Roy, Assistant Director, at 
(202) 551-5522; Raymond A. Lombardo, Branch Chief, at (202) 551-5755; 
Rose Russo Wells, Senior Counsel, at (202) 551-5527; Division of 
Trading and Markets; Harriet Orol, Branch Chief, at (212) 336-0554; 
Kevin Vasel, Attorney, at (212) 336-0981; Office of Credit Ratings; or, 
with respect to the rules for issuers and underwriters of asset-backed 
securities, Michelle M. Stasny, Special Counsel in the Office of 
Structured Finance, at (202) 551-3674; Division of Corporation Finance; 
Securities and Exchange Commission, 100 F Street NE., Washington, DC 
20549-7010.

SUPPLEMENTARY INFORMATION: The Commission, with respect to NRSROs, is 
adopting amendments to rules 17 CFR 232.101 (``Rule 101 of Regulation 
S-T''), 17 CFR 240.17g-1 (``Rule 17g-1''), 17 CFR 240.17g-2 (``Rule 
17g-2''), 17 CFR 240.17g-3 (``Rule 17g-3''), 17 CFR 240.17g-5 (``Rule 
17g-5''), 17 CFR 240.17g-6 (``Rule 17g-6''), 17 CFR 240.17g-7 (``Rule 
17g-7''), and 17 CFR 249b.300 (``Form NRSRO''); and is adopting new 
rules 17 CFR 240.17g-8 (``Rule 17g-8'') and 17 CFR 240.17g-9 (``Rule 
17g-9'').
    In addition, the Commission, with respect to providers of third-
party due diligence services for asset-backed securities, is adopting 
new rules 17 CFR 240.17g-10 (``Rule 17g-10'') and 17 CFR 249b.500 
(``Form ABS Due Diligence-15E'').
    Finally, the Commission, with respect to issuers and underwriters 
of asset-backed securities, is adopting amendments to 17 CFR 249.1400 
(``Form ABS-15G'') and is adopting new rule 17 CFR 240.15Ga-2 (``Rule 
15Ga-2'').

Table Of Contents

I. Introduction
    A. Background
    B. Economic Analysis
    1. Guiding Principles9
    2. Baseline
    a. NRSROs
    b. Asset-Backed Security Issuers, Underwriters, and Third-Party 
Due Diligence Providers
    c. Industry Practices
    3. Broad Economic Considerations
    a. Amendments and Rules Enhancing NRSRO Governance and Integrity 
of Credit Ratings
    b. Amendments and Rules Enhancing Disclosure and Transparency of 
Credit Ratings
II. Final Rules and Rule Amendments
    A. Internal Control Structure
    1. Prescribing Factors
    2. Amendment to Rule 17g-2
    3. Amendments to Rule 17g-3
    4. Economic Analysis
    B. Sales And Marketing Conflict of Interest
    1. New Prohibited Conflict
    2. Exemption for ``Small'' NRSROs
    3. Suspending or Revoking a Registration
    4. Economic Analysis
    C. ``Look-Back'' Review
    1. Paragraph (c) of New Rule 17g-8
    2. Amendment to Rule 17g-2
    3. Economic Analysis
    D. Fines and Other Penalties
    1. Final Rule
    2. Economic Analysis
    E. Disclosure of Information About the Performance of Credit 
Ratings
    1. Amendments to Instructions for Exhibit 1 to Form NRSRO
    a. Proposal
    b. Final Rule
    2. Amendments to Rule 17g-1
    3. Amendments to Rule 17g-2 and Rule 17g-7
    a. Proposal
    b. Final Rule
    4. Economic Analysis
    F. Credit Rating Methodologies
    1. Paragraph (a) of New Rule 17g-8
    2. Amendment to Rule 17g-2
    3. Economic Analysis
    G. Form And Certifications to Accompany Credit Ratings
    1. Paragraph (a) of Rule 17g-7--Prefatory Text
    2. Paragraph (a)(1)(i) of Rule 17g-7--Format of the Form
    3. Paragraph (a)(1)(ii) of Rule 17g-7--Content of the Form
    4. Paragraph (a)(1)(iii) of Rule 17g-7--Attestation
    5. Paragraph (a)(2) of Rule 17g-7--Third-Party Due Diligence 
Certification
    6. Economic Analysis
    H. Third-Party Due Diligence for Asset-Backed Securities
    1. New Rule 15Ga-2 and Amendments to Form ABS-15G
    2. New Rule 17g-10
    3. New Form ABS Due Diligence-15E
    4. Economic Analysis
    I. Standards of Training, Experience, and Competence
    1. New Rule 17g-9
    2. Amendment to Rule 17g-2
    3. Economic Analysis
    J. Universal Rating Symbols
    1. Paragraph (b) of New Rule 17g-8
    2. Amendment to Rule 17g-2
    3. Economic Analysis
    K. Annual Report of Designated Compliance Officer
    1. Amendment to Rule 17g-3
    2. Economic Analysis
    L. Electronic Submission of Form NRSRO and the Rule 17g-3 Annual 
Reports
    1. Amendments to Rule 17g-1, Form NRSRO, Rule 17g-3, and 
Regulation S-T
    2. Economic Analysis
    M. Other Amendments
    1. Changing ``Furnish'' to ``File''
    2. Amended Definition of NRSRO
    3. Definition of Asset-Backed Security
    4. Other Amendments to Form NRSRO
    a. Clarification with Respect to Items 6 and 7
    b. Clarification with Respect to Exhibit 8
    c. Clarification with Respect to Exhibits 10 through 13
    5. Economic Analysis
III. Effective Dates
    A. Amendments Effective Sixty Days After Publication in the 
Federal Register
    B. Amendments Effective On January 1, 2015
    C. Amendments and New Rules Effective Nine Months After 
Publication In the Federal Register
IV. Paperwork Reduction Act
    A. Summary of the Collection of Information Requirements
    1. Amendments to Rule 17g-1
    2. Amendments to Instructions for Exhibit 1 to Form NRSRO
    3. Amendments to Rule 17g-2
    4. Amendments to Rule 17g-3
    5. Amendments to Rule 17g-5
    6. Amendments to Rule 17g-7
    7. New Rule 17g-8

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    8. New Rule 17g-9
    9. New Rule 17g-10 and New Form ABS Due Diligence-15E
    10. New Rule 15Ga-2 and Amendments to Form ABS-15G
    11. Amendments to Regulation S-T
    12. Form ID
    B. Use of Information
    1. Amendments to Rule 17g-1
    2. Amendments to Instructions for Exhibit 1 to Form NRSRO
    3. Amendments to Rule 17g-2
    4. Amendments to Rule 17g-3
    5. Amendments to Rule 17g-5
    6. Amendments to Rule 17g-7
    7. New Rule 17g-8
    8. New Rule 17g-9
    9. New Rule 17g-10 and New Form ABS Due Diligence-15E
    10. New Rule 15Ga-2 and Amendments to Form ABS-15G
    11. Amendments to Regulation S-T
    12. Form ID
    C. Respondents
    D. Total Initial and Annual Recordkeeping and Reporting Burdens
    1. Amendments to Rule 17g-1
    2. Amendments to Form NRSRO Instructions
    3. Amendments to Rule 17g-2
    4. Amendments to Rule 17g-3
    5. Amendments to Rule 17g-5
    6. Amendments to Rule 17g-7
    7. New Rule 17g-8
    8. New Rule 17g-9
    9. New Rule 17g-10 and New Form ABS Due Diligence-15E
    10. New Rule 15Ga-2 and Amendments to Form ABS-15G
    11. Amendments to Regulation S-T
    12. Form ID
    13. Total Paperwork Burdens
    E. Collection of Information Is Mandatory
    F. Confidentiality
    G. Retention Period of Recordkeeping Requirements
V. Implementation and Annual Compliance Considerations
    A. Internal Control Structure
    B. Conflicts of Interest Relating to Sales and Marketing
    C. ``Look-Back'' Review
    D. Fines and Other Penalties
    E. Enhancements to Disclosures of Performance Statistics
    F. Enhancements to Rating Histories Disclosures
    G. Credit Rating Methodologies
    H. Form and Certification To Accompany Credit Ratings
    I. New Rule 15ga-2 and Amendments to Form Abs-15g
    J. New Rule 17g-10 and New Form ABS Due Diligence-15e
    K. Standards of Training, Experience, and Competence
    L. Universal Rating Symbols
    M. Electronic Submission of Form NRSRO and the Rule 17G-3 Annual 
Reports
VI. Final Regulatory Flexibility Analysis
    A. Need for and Objectives of the Amendments and New Rules
    B. Significant Issues Raised by Public Comments
    C. Small Entities Subject to the Rules
    1. NRSROs and Providers of Third-Party Due Diligence Services
    2. Issuers
    D. Reporting, Recordkeeping, and Other Compliance Requirements
    E. Agency Action To Minimize Effect on Small Entities
VII. Statutory Authority

I. Introduction

A. Background

    The Dodd-Frank Act,\1\ through Title IX, Subtitle C, ``Improvements 
to the Regulation of Credit Rating Agencies,'' among other things, 
establishes new self-executing requirements applicable to NRSROs and 
requires that the Commission adopt rules applicable to NRSROs in a 
number of areas.\2\ It also requires certain studies relating to 
NRSROs.\3\ The NRSRO provisions in the Dodd-Frank Act augment the 
Credit Rating Agency Reform Act of 2006 (the ``Rating Agency Act of 
2006''), which established a registration and oversight program for 
NRSROs through self-executing provisions added to the Exchange Act and 
implementing rules adopted by the Commission under the Exchange Act, as 
amended by the Rating Agency Act of 2006.\4\ Title IX, Subtitle C of 
the Dodd-Frank Act also provides that the Commission shall prescribe 
the format of a certification that providers of third-party due 
diligence services must provide to each NRSRO producing a credit rating 
for an asset-backed security to which the due diligence services 
relate.\5\ Finally, Title IX, Subtitle C of the Dodd-Frank Act 
establishes a new requirement for issuers and underwriters of asset-
backed securities

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to make publicly available the findings and conclusions of any third-
party due diligence report obtained by the issuer or underwriter.\6\
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    \1\ Public Law 111-203, 124 Stat. 1376, H.R. 4173 (July 21, 
2010).
    \2\ See Public Law 111-203, 931 through 939H. In addition, Title 
IX, Subtitle D, ``Improvements to the Asset-Backed Securitization 
Process,'' contains section 943, which provides that the Commission 
shall adopt rules, within 180 days, requiring an NRSRO to include in 
any report accompanying a credit rating of an asset-backed security 
a description of the representations, warranties, and enforcement 
mechanisms available to investors and how they differ from the 
representations, warranties, and enforcement mechanisms in issuances 
of similar securities. See Public Law 111-203, 943. On January 20, 
2011, the Commission adopted Rule 17g-7 to implement section 943. 
See Disclosure for Asset-Backed Securities Required by Section 943 
of the Dodd-Frank Wall Street Reform and Consumer Protection Act, 
Securities Act of 1933 (``Securities Act'') Release No. 9175 (Jan. 
20, 2011), 76 FR 4489 (Jan. 26, 2011). Prior to enactment of the 
Dodd-Frank Act and the adoption of Rule 17g-7, the Commission 
proposed a different rule to be codified at 17 CFR 240.17g-7. See 
Proposed Rules for Nationally Recognized Statistical Rating 
Organizations, Securities Exchange Act of 1934 (``Exchange Act'') 
Release No. 57967 (June 16, 2008), 73 FR 36212 (June 25, 2008). This 
proposed rule would have required an NRSRO to publish a report 
containing certain information with the publication of a credit 
rating for a structured finance product or, as an alternative, use 
ratings symbols for structured finance products that differentiate 
them from the credit ratings for other types of debt securities. See 
id. In November 2009, the Commission announced it was deferring 
consideration of action on that proposal and separately proposed a 
different rule to be codified at 17 CFR 240.17g-7 that would have 
required an NRSRO to annually disclose certain information. See 
Proposed Rules for Nationally Recognized Statistical Rating 
Organizations, Exchange Act Release No. 61051 (Nov. 23, 2009), 74 FR 
63866 (Dec. 4, 2009). As discussed above, a different rule from 
either of these proposals ultimately was adopted and codified at 17 
CFR 240.17g-7 in January 2011. See Disclosure for Asset-Backed 
Securities Required by Section 943 of the Dodd-Frank Wall Street 
Reform and Consumer Protection Act, 76 FR 4489.
    \3\ See Public Law 111-203, 939(h), 939C, 939D, 939E, 939F. 
Pursuant to section 939(h) of the Dodd-Frank Act, the Commission 
submitted a staff report to Congress on standardizing credit rating 
terminology. See Report to Congress Credit Rating Standardization 
Study As Required by Section 939(h) of the Dodd-Frank Wall Street 
Reform and Consumer Protection Act (Sept. 2012), available at http://www.sec.gov/news/studies/2012/939h_credit_rating_standardization.pdf 
(``2012 Staff Report on Credit Rating Standardization''). Pursuant 
to section 939F of the Dodd-Frank Act, the Commission submitted a 
staff report to Congress on the feasibility of establishing a system 
for assigning NRSROs to determine credit ratings for structured 
finance products. See Report to Congress on Assigned Credit Ratings 
As Required by Section 939F of the Dodd-Frank Wall Street Reform and 
Consumer Protection Act (Dec. 2012), available at http://www.sec.gov/news/studies/2012/assigned-credit-ratings-study.pdf 
(``2012 Staff Report on Assigned Credit Ratings''). Pursuant to 
section 939C of the Dodd-Frank Act, the Commission submitted a staff 
report to Congress on the independence of credit rating agencies. 
See Report to Congress on Credit Rating Agency Independence Study As 
Required by Section 939C of the Dodd-Frank Wall Street Reform and 
Consumer Protection Act (Nov. 2013), available at http://www.sec.gov/news/studies/2013/credit-rating-agency-independence-study-2013.pdf (``2013 Staff Report on Credit Rating Agency 
Independence'').
    \4\ See Public Law 109-291 (2006). The Rating Agency Act of 
2006, among other things, amended section 3 of the Exchange Act to 
add definitions, added section 15E to the Exchange Act to establish 
self-executing requirements for NRSROs and provide the Commission 
with the authority to implement a registration and oversight program 
for NRSROs, amended section 17 of the Exchange Act to provide the 
Commission with recordkeeping, reporting, and examination authority 
over NRSROs, and amended section 21B(a) of the Exchange Act to 
provide the Commission with the authority to assess penalties 
``against any person'' in administrative proceedings instituted 
under section 15E of the Exchange Act. See Public Law 109-291, 3 and 
4; 15 U.S.C. 78c; 15 U.S.C. 78o-7; 15 U.S.C. 78q; 15 U.S.C. 78u-2. 
The Commission adopted rules to implement a registration and 
oversight program for NRSROs in June 2007. See Oversight of Credit 
Rating Agencies Registered as Nationally Recognized Statistical 
Rating Organizations, Exchange Act Release No. 55857 (June 5, 2007), 
72 FR 33564 (June 18, 2007). The implementing rules were Form NRSRO, 
Rule 17g-1, Rule 17g-2, Rule 17g-3, Rule 17g-4, Rule 17g-5, and Rule 
17g-6. The Commission has twice adopted amendments to some of these 
rules. See Amendments to Rules for Nationally Recognized Statistical 
Rating Organizations, Exchange Act Release No. 59342 (Feb. 2, 2009), 
74 FR 6456 (Feb. 9, 2009); Amendments to Rules for Nationally 
Recognized Statistical Rating Organizations, Exchange Act Release 
No. 61050 (Nov. 23, 2009), 74 FR 63832 (Dec. 4, 2009).
    \5\ See Public Law 111-203, 932(a)(8) (adding new paragraph 
(s)(4)(C) to section 15E of the Exchange Act); 15 U.S.C. 78o-
7(s)(4)(C)).
    \6\ See Public Law 111-203, 932(a)(8) (adding new paragraph 
(s)(4)(A) to section 15E of the Exchange Act); 15 U.S.C. 78o-
7(s)(4)(A).
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    On May 18, 2011, the Commission proposed for comment amendments to 
existing rules and new rules in accordance with Title IX, Subtitle C of 
the Dodd-Frank Act and to enhance oversight of NRSROs.\7\ The 
Commission received a number of comment letters in response to the 
proposals.\8\ The comments on specific proposals are summarized below 
in the corresponding sections of this release discussing the proposals 
and the amendments and new rules being adopted today.
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    \7\ See Nationally Recognized Statistical Rating Organizations, 
Exchange Act Release No. 64514 (May 18, 2011), 76 FR 33420 (June 8, 
2011). The Commission also proposed technical amendments to its 
existing NRSRO rules. Id.
    \8\ See letter from Jeffrey W. Rubin, Chair, Business Law 
Section, American Bar Association, dated Aug. 19, 2011 (``ABA 
Letter''); letter from Bruce E. Stern, Chairman, Association of 
Financial Guaranty Insurers, dated Aug. 8, 2011 (``AFGI Letter''); 
letter from Gerald W. McEntee, President, American Federation of 
State, County and Municipal Employees, dated Aug. 5, 2011 (``AFSCME 
Letter''); letter from Marcus Stanley, Policy Director, Americans 
for Financial Reform, dated Apr. 1, 2014 (``AFR II Letter''); letter 
from Daryl Schubert, Chair, Auditing Standards Board, American 
Institute of Certified Public Accountants, dated Aug. 10, 2011 
(``AICPA Letter''); letter from Larry G. Mayewski, Executive Vice 
President, A.M. Best, dated Aug. 8, 2011 (``A.M. Best Letter''); 
letter from the Honorable Robert E. Andrews, U.S. Congress, House of 
Representatives, dated Mar. 3, 2012 (``Andrews Letter''); letter 
from Tom Deutsch, Executive Director, American Securitization Forum, 
dated Aug. 8, 2011 (``ASF Letter''); letter from Chris Barnard dated 
June 30, 2011 (``Barnard Letter''); letter from Joel Barton dated 
Aug. 8, 2011 (``Barton Letter''); letter from Marie Benson dated 
June 16, 2011 (``Benson Letter''); letter from Dennis M. Kelleher, 
President & CEO, and Stephen W. Hall, Securities Specialist, Better 
Markets, Inc., dated Aug. 8, 2011 (``Better Markets Letter''); 
letter from Zenia Brown dated May 21, 2011 (``Brown Letter''); 
letter from John J. Cadigan, General Partner, CECO LLC, dated June 
15, 2011 (``Cadigan Letter''); letter from Nancy Campbell dated 
Sept. 29, 2011 (``Campbell Letter''); letter from Barbara Roper, 
Director of Investor Protection, Consumer Federation of America, and 
Marcus Stanley, Policy Director, Americans for Financial Reform, 
dated Aug. 8, 2011 (``CFA/AFR Letter''); letter from Micah Hauptman, 
Financial Services Counsel, and Barbara Roper, Director of Investor 
Protection, Consumer Federation of America, dated Mar. 3, 2014 
(``CFA II Letter''); letter from Robert M. Chandler dated June 8, 
2011 (``Chandler Letter''); letter from Laurel Leitner, Senior 
Analyst, Council of Institutional Investors, dated Aug. 8, 2011 
(``CII Letter''); letter from Susan R. Clark dated June 17, 2011 
(``Clark Letter''); letter from Steven Cohen, Senior Vice President 
and General Counsel, Clayton Holdings LLC, dated Aug. 8, 2011 
(``Clayton Letter''); letter from Gregory W. Smith, Chief Operating 
Officer, General Counsel, Colorado Public Employees Retirement 
Association, dated Aug. 8, 2011 (``COPERA Letter''); letter from 
Dave Cowen dated May 23, 2011 (``Cowen Letter''); letter from 
Stephen M. Renna, Chief Executive Officer, CRE Finance Council, 
dated Aug. 8, 2011 (``CRE Letter''); letter from Gary D. Cristofani 
dated July 28, 2011 (``Cristofani Letter''); letter from William 
Michael Cunningham, Creative Investment Research, Inc., dated May 
23, 2005 (``Cunningham I Letter''); letter from William Michael 
Cunningham, Creative Investment Research, Inc., dated July 4, 2011 
(``Cunningham II Letter''); letter from Bonnie Davis dated June 16, 
2011 (``Davis Letter''); letter from Theresa Day dated June 16, 2011 
(``Day Letter''); letter from Daniel Curry, President, and Mary 
Keogh, Managing Director, Regulatory Affairs, DBRS, Inc., dated Aug. 
8, 2011 (``DBRS Letter''); letter from Daniel Curry, Chief Executive 
Officer, and Mary Keogh, Managing Director, Global Regulatory 
Affairs, DBRS, Inc., dated Dec. 5, 2013 (``DBRS II Letter''); letter 
from Deloitte & Touche LLP dated Aug. 8, 2011 (``Deloitte Letter''); 
letter from Sean Egan, Egan-Jones Ratings Company, dated Aug. 5, 
2011 (``EJR Letter''); letter from Roberta Y. Ely dated June 17, 
2011 (``Ely Letter''); letter from Ernst & Young LLP dated Aug. 8, 
2011 (``Ernst & Young Letter''); letter from Anne S. McCulloch, 
Senior Vice President and Deputy General Counsel, Federal National 
Mortgage Association, dated Aug. 8, 2011 (``Fannie Mae Letter''); 
letter from Charles D. Brown, General Counsel, Fitch, Inc., dated 
Aug. 5, 2011 (``Fitch Letter''); letter from Marianne Freebury dated 
June 16, 2011 (``Freebury Letter''); letter from Richard M. Whiting, 
Executive Director and General Counsel, The Financial Services 
Roundtable, dated Aug. 8, 2011 (``FSR Letter''); letter from Myrna 
D. Gardner dated June 14, 2011 (``Gardner Letter''); letter from 
Corrine M. Garza dated June 14, 2011 (``Garza Letter''); letter from 
David Gaus dated Nov. 1, 2012 (``Gaus Letter); letter from William 
J. Harrington, dated Aug. 8, 2011 (``Harrington Letter''); letter 
from William J. Harrington dated May 29, 2014 (``Harrington II 
Letter''); letter from Karrie McMillan, General Counsel, Investment 
Company Institute, dated Aug. 8, 2011 (``ICI Letter''); letter from 
KPMG LLP dated Aug. 8, 2011 (``KPMG Letter''); letter from Markus 
Krebsz dated Nov. 4, 2010 (``Krebsz Letter''); letter from Jules B. 
Kroll, Chairman and CEO, Kroll Bond Rating Agency, Inc., dated Aug. 
8, 2011 (``Kroll Letter''); letter from Jules B. Kroll, Chairman and 
CEO, Kroll Bond Rating Agency, Inc., dated August 19, 2014 (``Kroll 
II Letter''); letter from Francis Lambert dated Aug. 8. 2011 
(``Lambert Letter''); letter from Kashif Latif dated May 19, 2011 
(``Latif Letter''); letter from the Honorable Carl Levin, U.S. 
Senate, Permanent Subcommittee on Investigations, dated Aug. 8, 2011 
(``Levin Letter''); letter from Dee Longenbaugh dated June 15, 2011 
(``Longenbaugh Letter''); letter from Ray Lynch dated June 17, 2011 
(``Lynch Letter''); letter from Craig R. Mills, CraigRMills LLC, 
dated Aug. 19, 2011 (``Mills Letter''); letter from Michel Madelain, 
President and Chief Operating Officer, Moody's Investors Service, 
dated Aug. 8, 2011 (``Moody's Letter''); letter from Robert Dobilas, 
President, Morningstar Credit Ratings, LLC, dated Aug. 8, 2011 
(``Morningstar Letter''); letter from Kevin Overholt dated June 14, 
2011 (``Overholt Letter''); letter from Maneesh Pangasa dated July 
29, 2011 (``Pangasa Letter''); letter from PricewaterhouseCoopers, 
LLP, dated Aug. 8, 2011 (``PWC Letter''); letter from William E. 
Reno dated June 16, 2011 (``Reno Letter''); letter from LaVonne L. 
Rhyneer dated June 17, 2011 (``Rhyneer Letter''); letter from Andrew 
M. Siff, Esquire, Siff & Associates, PLLC, dated June 13, 2011 
(``Siff Letter''); letter from Deven Sharma, President, Standard and 
Poor's Ratings Services, dated Aug. 8, 2011 (``S&P Letter''); letter 
from Anne Rutledge, President, TradeMetrics Corporation, dated Aug. 
8, 2011 (``TradeMetrics Letter''). Copies of these letters are 
available on the Commission's Web site at: http://www.sec.gov/comments/s7-18-11/s71811.shtml. In addition, in connection with the 
Commission's solicitation of comments on the Commission's request 
pursuant to the Paperwork Reduction Act of 1995 (44 U.S.C. 3501 et 
seq.) for approval of the extension of the previously approved 
collection of information provided for in Rule 17a-7, several 
commenters submitted letters that are relevant to this rulemaking. 
See letter from Daniel Curry, President, and Mary Keogh, Managing 
Director, Regulatory Affairs, DBRS, Inc., dated Apr. 14, 2014 
(``DBRS PRA Letter''); letter from Angela Y. Liang, Assistant 
General Counsel, Kroll Bond Rating Agency, Inc., dated Apr. 17, 2014 
(``Kroll PRA Letter''); and letter from Michael Kanef, Chief 
Regulatory and Compliance Officer, Moody's Investors Service, dated 
Apr. 28, 2014 (``Moody's PRA Letter'').
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B. Economic Analysis

    The Commission has performed an economic analysis in connection 
with today's adoption of the amendments and new rules discussed in 
section II. of this release. The economic analysis is reflected in this 
section I.B. of the release as well as throughout the rest of the 
release.\9\
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    \9\ The discussion of the amendments and new rules in section II 
of this release is organized into sections that in large part are 
based on the distinct rulemaking mandates in Title IX, Subtitle C of 
the Dodd-Frank Act. See sections II.A. through II.M. of this 
release. Each section includes an economic analysis that focuses 
specifically on the amendments or rules being discussed in the 
section.
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1. Guiding Principles
    Title IX, Subtitle C of the Dodd-Frank Act mandates that the 
Commission prescribe rules to improve regulation of NRSROs.\10\ Section 
931 of the Dodd-Frank Act, ``Findings,'' introduces Title IX, Subtitle 
C of the Dodd-Frank Act and provides context to what motivated Congress 
to enact these provisions with respect to NRSROs.\11\ In particular, 
Congress found:
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    \10\ See Public Law 111-203, 931 through 939H, entitled 
``Improvements to the Regulation of Credit Rating Agencies.''
    \11\ See Public Law 111-203, 931.
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     Because of the systemic importance of credit ratings and 
the reliance placed on credit ratings by individual and institutional 
investors and financial regulators, the activities and performances of 
credit rating agencies, including NRSROs, are matters of national 
public interest, as credit rating agencies are central to capital 
formation, investor confidence, and the efficient performance of the 
U.S. economy.\12\
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    \12\ See Public Law 111-203, 931(1).
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     Credit rating agencies, including NRSROs, play a critical 
``gatekeeper'' role in the debt market that is functionally similar to 
that of securities analysts, who evaluate the quality of securities in 
the equity market, and auditors, who review the financial statements of 
firms. Such role justifies a similar level of public oversight and 
accountability.\13\
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    \13\ See Public Law 111-203, 931(2).
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     Because credit rating agencies perform evaluative and 
analytical services on behalf of clients, much as

[[Page 55081]]

other financial ``gatekeepers'' do, the activities of credit rating 
agencies are fundamentally commercial in character and should be 
subject to the same standards of liability and oversight as apply to 
auditors, securities analysts, and investment bankers.\14\
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    \14\ See Public Law 111-203, 931(3).
---------------------------------------------------------------------------

     In certain activities, particularly in advising arrangers 
of structured financial products on potential ratings of such products, 
credit rating agencies face conflicts of interest that need to be 
carefully monitored and that therefore should be addressed explicitly 
in legislation in order to give clearer authority to the 
Commission.\15\
---------------------------------------------------------------------------

    \15\ See Public Law 111-203, 931(4).
---------------------------------------------------------------------------

     In the recent financial crisis, the ratings on structured 
financial products have proven to be inaccurate. This inaccuracy 
contributed significantly to the mismanagement of risks by financial 
institutions and investors, which in turn adversely impacted the health 
of the economy in the United States and around the world. Such 
inaccuracy necessitates increased accountability on the part of credit 
rating agencies.\16\
---------------------------------------------------------------------------

    \16\ See Public Law 111-203, 931(5).
---------------------------------------------------------------------------

    The amendments and new rules being adopted today to implement 
sections 932, 936, and 938 of the Dodd-Frank Act are designed to 
address these findings of Congress. For example, they are intended to 
increase the integrity and transparency of credit ratings and promote 
public oversight and accountability of NRSROs as ``gatekeepers'' for 
the primary benefit of the users of credit ratings.\17\ The amendments 
and new rules also prescribe new disclosure requirements relating to 
structured finance products and, in particular, asset-backed 
securities.\18\ These requirements are designed to address concerns 
about the role of NRSROs in the financial crisis of 2007-2009 \19\ in 
terms of how they rated certain types of structured finance products 
and, in particular, the inherent conflicts of interest in rating these 
products.\20\
---------------------------------------------------------------------------

    \17\ See John C. Coffee, Jr., Adolf A. Berle Professor of Law, 
Columbia University Law School, Turmoil in the U.S. credit markets: 
the role of the credit rating agencies (Apr. 22, 2008) (testimony 
before the U.S. Senate Committee on Banking, Housing and Urban 
Affairs), p. 1, available at http://www.banking.senate.gov/public/_files/OpgStmtCoffeeSenateTestimonyTurmoilintheUSCreditMarkets.pdf 
(``Coffee Testimony I'').
    \18\ The term structured finance product as used throughout this 
release refers broadly to any security or money market instrument 
issued by an asset pool or as part of any asset-backed or mortgage-
backed securities transaction. This broad category of financial 
instrument includes an asset-backed security as defined in section 
3(a)(79) of the Exchange Act (15 U.S.C. 78c(a)(79)) and other types 
of structured debt instruments, including synthetic and hybrid 
collateralized debt obligations (``CDOs''). The term Exchange Act-
ABS as used throughout this release refers more narrowly to an 
asset-backed security as defined in section 3(a)(79) of the Exchange 
Act. 15 U.S.C. 78c(a)(79).
    \19\ Throughout this Release, unless indicated otherwise, when 
the Commission uses the term ``financial crisis'' it is referring to 
the financial crisis that took place between 2007 and 2009.
    \20\ See Public Law 111-203, 931 (setting forth, among other 
things, Congress' findings with respect to the role played by credit 
ratings agencies, the services provided by credit ratings agencies, 
certain conflicts of interests facing credit rating agencies, and 
inaccuracies in ratings on structured finance products).
---------------------------------------------------------------------------

    In the market for structured finance products, the pool of assets 
underlying or referenced by the product is often comprised of hundreds 
of thousands of loans, each requiring time and expense to evaluate. In 
these markets, the separation between the borrower and the ultimate 
provider of credit can introduce significant information asymmetries 
between the parties involved in the securitization process that creates 
a structured finance product \21\ and investors in the product, who may 
have less information on the credit quality and other relevant 
characteristics of the asset pool.\22\ Further, disclosures to 
investors regarding the asset pool may not be sufficiently detailed to 
allow investors to adequately evaluate the quality of the collateral 
backing the securities and, thereby, assess the credit risk of the 
securities. Consequently, the market for structured finance products 
has evolved as a ``rated'' market in which the credit risk of the 
products is assessed by credit rating agencies \23\ and the valuations 
of the products depend significantly on credit ratings.\24\ To curb 
their informational disadvantage, certain investors in structured 
finance products may use credit ratings to inform their investment 
decisions.\25\
---------------------------------------------------------------------------

    \21\ Asset-backed securitization--the process used to create 
asset-backed securities--is a financing technique in which financial 
assets are pooled and converted into instruments that may be offered 
and sold in the capital markets. In a basic securitization 
structure, an entity--often a financial institution--originates or 
otherwise acquires a pool of financial assets, such as mortgage 
loans, either directly or through an affiliate. It then sells the 
financial assets, again either directly or through an affiliate, for 
the purpose of depositing them into a specially created investment 
vehicle that issues securities ``backed'' by those financial assets. 
Payment on the asset-backed securities depends primarily on the cash 
flows generated by the assets in the underlying pool (and possibly 
other rights designed to assure timely payment, generally known as 
``credit enhancements''). See Asset-Backed Securities, Securities 
Act Release No. 8518 (Dec. 22, 2004), 70 FR 1506 (Jan. 7, 2005).
    \22\ See Adam B. Ashcraft and Til Schuermann, Understanding the 
Securitization of Subprime Mortgage Credit, Staff Report, Federal 
Reserve Bank of New York, Working Paper No. 318 (2008). The authors 
identify seven information frictions that can cause moral hazard and 
adverse selection problems in a subprime mortgage securitization 
transaction.
    \23\ See Joshua Coval, Jakub Jurek, and Erik Stafford, The 
Economics of Structured Finance, 23(1) J. Econ. Perspectives 3-26 
(2009).
    \24\ See Adam Ashcraft, Paul Goldsmith-Pinkham, Peter Hull, and 
James Vickery, Credit Ratings and Security Prices in the Subprime 
MBS Market, 101(3), Amer. Econ. Rev. 115-119 (2011).
    \25\ See Frank Partnoy, Overdependence on Credit Ratings Was a 
Primary Cause of the Crisis, in The Panic of 2008: Causes, 
Consequences, and Implications for Reform (Edward Elgar Press 2010, 
Lawrence Mitchell and Arthur Wilmarth, eds.). References to credit 
ratings in federal regulations also may have contributed to investor 
reliance on credit ratings. Section 939A of the Dodd-Frank Act 
requires each federal agency, including the Commission, to review 
any regulation issued by such agency that requires the use of an 
assessment of the creditworthiness of a security or money market 
instruments and any references to or requirements in such 
regulations regarding credit ratings. See Public Law 111-203, 939A. 
The section further provides that each such agency shall ``modify 
any such regulations identified by the review . . . to remove any 
reference to or requirement of reliance on credit ratings, and to 
substitute in such regulations such standard of creditworthiness as 
each respective agency shall determine as appropriate for such 
regulations.'' Id.
---------------------------------------------------------------------------

    Given that investors may not know the quality of the assets 
underlying structured finance products, certain originators of these 
assets may attempt to adversely transfer risks of poor origination 
decisions to investors by creating complex and opaque structured 
finance products.\26\ This risk is especially pronounced when the 
originator, sponsor, depositor, or underwriter receives compensation 
before investors learn about the quality of the assets.\27\ Because 
origination fees

[[Page 55082]]

are based on transaction volume and risks are transferred to investors, 
an originator may have the economic incentive to produce as many assets 
(for example, mortgage loans) as possible without adequately screening 
their credit quality.\28\
---------------------------------------------------------------------------

    \26\ See Chris Downing, Dwight Jaffee, and Nancy Wallace, Is the 
Market for Mortgage-Backed Securities a Market for Lemons?, 22(7) 
Rev. Fin. Stud. 2457-2494 (2009). The authors argue that the quality 
of the assets sold to investors through securitization is lower than 
the quality of similar assets that are not sold to investors. They 
find empirical support for this proposition using a comprehensive 
dataset of sales of mortgage-backed securities (Freddie Mac 
Participation Certificates) to special-purpose vehicles over the 
period 1991 through 2002.
    \27\ Several parties may be involved in the securitization 
process that creates an asset-backed security, including an 
originator, sponsor, depositor, issuing entity, underwriter, and 
arranger. See generally Asset-Backed Securities, 70 FR at 1508. The 
originator is the entity that creates a financial asset (for 
example, mortgage loan, auto loan, or credit card receivable) that 
collateralizes an asset-backed security through an extension of 
credit or otherwise and that sells the asset to be included in an 
asset-backed security. The sponsor is the entity that organizes and 
initiates the asset-backed securities transaction by transferring 
the financial assets underlying an asset-backed security directly or 
indirectly to the issuing entity. The depositor is an entity that 
receives or purchases the financial assets from the sponsor and 
transfers them to the issuing entity (in some cases the sponsor 
transfers the financial assets directly to the issuing entity, 
thereby by-passing the use of a separate depositor). The issuing 
entity is the trust or other vehicle created at the direction of the 
sponsor or depositor that owns or holds the financial assets and in 
whose name the asset-backed securities are issued. The underwriter 
is the entity that underwrites the offering of asset-backed 
securities and sells them to investors. The arranger is an entity 
that organizes and arranges a securitization transaction, but does 
not sell or transfer the assets to the issuing entity. It also 
structures the transaction and may act as an underwriter for the 
deal. In jurisdictions where an arranger is used, the arranger's 
role is similar to that of a sponsor in other jurisdictions. In some 
cases, a single entity may perform more than one function (for 
example, a financial institution may act as an originator and 
sponsor). The issuer of a structured finance product as used in this 
release can mean, depending on the context, the issuing entity or 
the person that organizes and initiates the offering of the 
structured finance product (for example, the sponsor or depositor). 
Generally, when this release discusses an issuer taking a specific 
action in the context of an offering of a structured finance product 
(for example, making a disclosure), the person that organizes and 
initiates the offering would be the person taking the action (as 
opposed to the issuing entity). Further, in the context of the 
discussion of Rules 17g-10 and 15Ga-2, the term issuer (which is 
defined in Rule 17g-10) includes a sponsor or depositor.
    \28\ See Amiyatosh Purnanandam, Originate-to-Distribute Model 
and the Subprime Mortgage Crisis, 24(6) Rev. Fin. Stud. 1881-1915 
(2011). The author argues that, during the financial crisis, banks 
with high involvement in the originate-to-distribute market 
originated excessively poor-quality mortgages, consistent with the 
view that the originating banks did not expend resources to 
adequately screen the credit quality of their borrowers.
---------------------------------------------------------------------------

    The rating process for structured finance products differs from the 
rating process for corporate bonds, whose ratings are largely based on 
publicly available data such as audited financial statements. The data 
used in rating structured finance products is primarily provided by the 
sponsor, depositor, or underwriter.\29\ Unlike credit ratings for 
corporate bonds, credit ratings of structured finance products are 
``highly sensitive to the assumptions of (1) default probability and 
recovery value, (2) correlation of defaults, and (3) the relation 
between payoffs and the economic states that investors care about 
most.'' \30\ The rating process for these products may happen in the 
reverse of how a more traditional product is rated because the sponsor, 
depositor, arranger, or underwriter often decides before the structure 
is finalized what credit rating it would like for each tranche of 
securities to be issued, within the limits of what is possible, and 
structures the product accordingly (for example, with regard to 
selecting the underlying assets and establishing the credit 
enhancements applicable to the different tranches of securities). 
Concerns have been raised that the inherently iterative nature of the 
process between the credit rating agency and the sponsor, depositor, 
arranger, or underwriter may give rise to potential conflicts of 
interest \31\ and that credit rating agencies marketing advisory and 
consulting services to their clients during this process may accentuate 
the conflict.\32\
---------------------------------------------------------------------------

    \29\ See Summary Report of Issues Identified in the Commission 
Staff's Examinations of Select Credit Rating Agencies (July 2008), 
available at http://www.sec.gov/news/studies/2008/craexamination070808.pdf (``2008 Staff Inspection Report''), pp. 7-
10. The report describes the rating process for a residential 
mortgage-backed security (``RMBS'') and CDO at the three examined 
credit rating agencies (Standard & Poor's Ratings Services, Moody's 
Investor's Services, Inc., and Fitch, Inc.). For example, with 
respect to a involving subprime loans, the arranger of the RMBS 
typically initiates the rating process by sending the credit rating 
agency data on each of the subprime loans to be held by the trust 
(for example, principal amount, geographic location of the property, 
credit history and FICO score of the borrower, ratio of the loan 
amount to the value of the property, and type of loan), the proposed 
capital structure of the trust and the proposed levels of credit 
enhancement for each tranche issued by the trust. Id. at 7. Upon 
receipt of the information, the credit rating agency assigns a lead 
analyst who is responsible for analyzing the loan pool, the proposed 
capital structure, and the proposed credit enhancement levels and, 
ultimately, for formulating a rating recommendation to a rating 
committee composed of analysts and/or senior-level analytic 
personnel. Id. at 7. The rating committee votes on the credit 
ratings for each tranche and usually communicates its decision to 
the issuer. Id. at 9. In most cases, the issuer can appeal a rating 
decision, although the appeal is not always granted (and, if 
granted, may not necessarily result in any change in the rating 
decision). Typically, the credit rating agency is paid for 
determining the credit rating only if the credit rating is issued.
    \30\ See Coval, Jurek, and Stafford, The Economics of Structured 
Finance, p. 23. The authors argue that, ``unlike corporate bonds, 
whose fortunes are primarily driven by firm-specific considerations, 
the performance of securities created by tranching large asset pools 
is strongly affected by the performance of the economy as a whole.'' 
Id. at 23.
    \31\ See International Organization of Securities Commissions 
(``IOSCO''), The Role of Credit Rating Agencies in Structured 
Finance Markets (May 2008), p. 5 (``Some critics have argued that 
the inherently iterative nature of this process may give rise to 
potential conflicts of interest.'').
    \32\ See Coffee Testimony I, p. 3, (``Today, the rating agency 
receives one fee to consult with a client, explain its model, and 
indicate the likely outcome of the rating process; then, it receives 
a second fee to actually deliver the rating (if the client wishes to 
go forward once it has learned the likely outcome)''). Rule 17g-6 
prohibits, among other things, an NRSRO from conditioning or 
threatening to condition the issuance of a credit rating on the 
purchase by an obligor or issuer, or an affiliate of the obligor or 
issuer, of any other services or products, including pre-credit 
rating assessment products, of the NRSRO or any person associated 
with the NRSRO. See 17 CFR 240.17g-6(a)(1).
---------------------------------------------------------------------------

    Just prior to the financial crisis, the size of the structured 
finance market was considerable. New issuances of RMBS, for example, 
peaked in 2006 for a total of $801.7 billion.\33\ Low interest rates 
drove investor demand for products that had high yields but also were 
highly rated by the credit rating agencies.\34\ Mortgage originators 
largely exhausted the supply of traditional quality mortgages and, to 
keep up with investor demand for RMBS, subprime lending became 
increasingly popular. As the number of delinquencies on subprime 
mortgages suddenly soared in late 2007, RMBS lost a considerable amount 
of value,\35\ and investors began to question the accuracy of credit 
ratings assigned to RMBS and CDOs linked to RMBS.\36\ Certain academic 
studies argue that, as the structured finance market boomed between 
2004 and 2007, NRSROs might have had an incentive to generate revenue 
by relaxing rating standards,\37\ inflating credit ratings,\38\ 
facilitating the sale of asset-backed securities by a small number of 
large issuers,\39\ and reducing due diligence in

[[Page 55083]]

the presence of investors that solely rely on credit ratings.\40\ The 
concerns about the accuracy of credit ratings fueled an emergent 
reluctance to invest in these products.\41\ The new issuances of RMBS 
totaled $715.3 billion in 2007 and plunged to $34.5 billion in 2008.
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    \33\ The total amount of new issuances is calculated by staff in 
the Commission's Division of Economics and Risk Analysis (``DERA'') 
using Asset-Backed Alert and Commercial Mortgage Alert databases. 
The amounts include only non-agency RMBS sold in the United States 
through Commission-registered offerings, Rule 144A offerings, or 
traditional private offerings.
    \34\ See Testimony of John B. Taylor, the Mary and Robert 
Raymond Professor of Economics at Stanford University and George P. 
Shultz Senior Fellow in Economics at Stanford's Hoover Institution, 
before the Subcommittee on Monetary Policy and Trade Committee on 
Financial Services, U.S. House of Representatives (Mar. 5, 2013), 
available at http://financialservices.house.gov/uploadedfiles/hhrg-113-ba19-wstate-jtaylor-20130305.pdf.
    \35\ See Board of Governors of the Federal Reserve System 
(``Federal Reserve''), Report to the Congress on Risk Retention 
(Oct. 2010), pp. 50-51 (discussing the drop in the triple-A and 
triple-B ABX.HE 2006-2 index (-70% by the end of 2008 for triple-A 
rated and -95% for triple-B rated subprime RMBS issued in 2006)).
    \36\ See IOSCO, The Role of Credit Rating Agencies in Structured 
Finance Markets, p. 2.
    \37\ See John M. Griffin and Dragon Yongjun Tang, Did 
Subjectivity Play a Role in CDO Credit Ratings?, 67(4) J. Fin. 1293-
1328 (2012). The authors analyze a sample of 916 CDOs and find that 
a large credit rating agency frequently made positive adjustments 
outside its main model that resulted in increasingly larger AAA 
tranche sizes. These adjustments are difficult to explain by likely 
determinants, such as manager experience or credit enhancements, but 
exhibit a clear pattern: CDOs with smaller model-implied AAA sizes 
receive larger adjustments and CDOs with larger adjustments 
experience more severe subsequent downgrading.
    \38\ See Vasiliki Skreta and Laura Veldkamp, Ratings Shopping 
and Asset Complexity: A Theory of Ratings Inflation, 56 J. Monetary 
Econ. 678-695 (2009); Efraim Benmelech and Jennifer Dlugosz, The 
Credit Rating Crisis, NBER Working Paper No. 15045 (2009); Bo Becker 
and Todd Milbourn, How Did Increased Competition Affect Credit 
Ratings?, 101 J. Fin. Econ. 493-514 (2011); Andrew Cohen and Mark D. 
Manuszak, Ratings Competition in the CMBS Market, 45(1) J. Money, 
Credit and Banking 93-119 (2013).
    \39\ See Jie He, Jun Qian, and Philip E. Strahan, Credit Ratings 
and the Evolution of the Mortgage-Backed Securities Market, 101(3) 
Amer. Econ. Rev., 131-135 (2011). The authors find that in 2006 the 
mortgage-backed securities (``MBS'') market was highly concentrated 
among large issuers, with the top five accounting for 39% of all 
newly issued securities; between 2004 and 2006, a larger fraction of 
MBS sold by large issuers received triple-A ratings than MBS sold by 
small issuers; and tranches sold by large issuers then experienced 
larger price drops than those sold by smaller issuers when the 
``housing bubble'' began to unravel.
    \40\ See Patrick Bolton, Xavier Freixas, and Joel Shapiro, The 
Credit Ratings Game, 67(1) J. of Finance 85-111 (2012), available at 
http://onlinelibrary.wiley.com/doi/10.1111/j.1540-6261.2011.01708.x/full. The authors develop a model of competition among credit rating 
agencies that includes two types of investors with different 
incentives to perform due diligence: sophisticated and ``trusting'' 
investors. Trusting investors take credit ratings at face value 
because their compensation depends only marginally on the ex-post 
returns of the assets they manage. In the authors' view, regulation 
that forces money managers to only purchase investments with good 
credit ratings could also provide incentives to be trusting. The 
authors find that competition can reduce efficiency, as it 
facilitates rating shopping. Moreover, credit ratings are more 
likely to be inflated during booms and when investors are more 
trusting.
    \41\ See Coval, Jurek, and Stafford, The Economics of Structured 
Finance.
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    In August 2007, the Commission staff initiated examinations of the 
three largest credit rating agencies to review their role in the 
turmoil in the subprime mortgage-related securities markets.\42\ Among 
other things, these examinations revealed that the credit rating 
agencies struggled to adjust the number of staff and resources employed 
in the rating process to the increasing volume and complexity of RMBS 
and CDOs.\43\ Certain significant aspects of the rating process and 
methodologies used to rate RMBS and CDOs were not documented or 
disclosed.\44\ The credit rating agencies examined did not have 
specific written procedures for rating RMBS and CDOs.\45\ Also, the 
credit rating agencies did not appear to have specific written policies 
and procedures to identify or address errors in their models or 
methodologies.\46\ In certain instances, Commission staff believed that 
adjustments to models were made without appropriately documenting a 
rationale for deviations from the model.\47\ Processes for performing 
surveillance and monitoring of outstanding credit ratings on an ongoing 
basis appeared to be less robust than the processes for determining 
initial credit ratings.\48\ Moreover, in the Commission staff's view, 
sufficient steps were not taken to prevent considerations of fees, 
market share, or other business interests from influencing credit 
ratings or rating criteria.\49\ Finally, the examined credit rating 
agencies appeared to solely rely on the information provided by RMBS 
sponsors.\50\ In particular, they did not appear to verify the 
integrity and accuracy of such information as, in their view, due 
diligence duties belonged to other parties and they did not appear to 
seek representations from sponsors that due diligence was 
performed.\51\
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    \42\ See 2008 Staff Inspection Report.
    \43\ See 2008 Staff Inspection Report, p. 10-13.
    \44\ See 2008 Staff Inspection Report, p. 13.
    \45\ See 2008 Staff Inspection Report, p. 16 (``One rating 
agency maintained comprehensive written procedures for rating 
structured finance securities, but these procedures were not 
specifically tailored to rating RMBS and CDOs. The written 
procedures for the two other rating agencies were not comprehensive 
and did not address all significant aspects of the RMBS and/or CDO 
ratings process. For example, written materials set forth guidelines 
for the structured finance ratings committee process (including its 
composition, the roles of the lead analyst and chair, the contents 
of the committee memo and the voting process) but did not describe 
the ratings process and the analyst's responsibilities prior to the 
time a proposed rating is presented to a ratings committee.'').
    \46\ See 2008 Staff Inspection Report, p. 17.
    \47\ Id. at 19.
    \48\ Id. at 21.
    \49\ Id. at 24.
    \50\ Id. at 18.
    \51\ Id. at 18.
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    Following the financial crisis, the Dodd-Frank Act mandated 
regulatory actions intended to enhance regulation, accountability, and 
transparency of NRSROs.\52\ Generally, the majority of the rulemaking 
mandated by the Dodd-Frank Act addresses all classes of credit ratings, 
rather than credit ratings for only structured finance products.\53\ In 
implementing the mandate, the amendments and new rules being adopted 
today are designed to further enhance the governance of NRSROs in their 
role as ``gatekeepers'' \54\ and increase the transparency of the 
credit rating process as a whole. Further, as discussed in section II. 
of this release, the amendments and new rules being adopted today 
include new requirements designed to enhance transparency with respect 
to structured finance products, including requirements for NRSROs to 
disclose information about the performance and history of credit 
ratings for subclasses of structured finance products and requirements 
for NRSROs, issuers, underwriters, and providers of third-party due 
diligence services to disclose information about due diligence services 
performed with respect to asset-backed securities.\55\
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    \52\ See Public Law 111-203, 932, entitled ``Enhanced 
Regulation, Accountability, and Transparency of Nationally 
Recognized Statistical Rating Organizations.''
    \53\ One commenter suggested that the proposed rules are overly 
broad in their application and ``fail to sufficiently account for 
the differences between corporate ratings (such as financial 
strength ratings of insurance companies) and ratings of the 
structured and asset-backed financial products that contributed to 
the recent economic crisis.'' See A.M. Best Letter. The Commission 
notes that the amendments and new rules being adopted today reflect 
the statutory mandate that generally, with one exception, was not 
limited to certain classes of credit ratings. In particular, 
sections 932, 936 and 938 of the Dodd-Frank Act generally do not 
focus exclusively on activities relating to rating structured 
finance products, with the exception of section 932(s)(4) (which 
focuses on third-party due diligence services with respect to asset-
backed securities).
    \54\ See John C. Coffee, Jr., Gatekeepers: The Professions and 
Corporate Governance, Oxford University Press (2006).
    \55\ See sections II.E.1. and II.E.2. of this release 
(discussing requirements for NRSROs to disclose performance 
statistics and rating history information for subclasses of 
structured finance products); sections II.G. and II.H. of this 
release (discussing requirements to disclose information about 
third-party due diligence services provided for asset-backed 
securities).
---------------------------------------------------------------------------

2. Baseline
    The amendments and new rules being adopted today primarily affect 
NRSROs, issuers, and underwriters of asset-backed securities, and 
providers of third-party due diligence services for asset-backed 
securities. To the extent that the new requirements change the business 
practices of the primarily affected parties, such changes may also 
affect clients of NRSROs (that is, obligors who pay NRSROs to obtain 
entity credit ratings, issuers who pay NRSROs to obtain credit ratings 
for their issued securities, subscribers who pay NRSROs to access 
credit ratings and research, and persons who pay NRSROs for other 
services), credit raters or credit rating agencies other than NRSROs, 
parties involved in asset-backed securities markets (other than 
issuers, underwriters, third-party due diligence providers, and 
NRSROs), and users of credit ratings in general.
    The baseline against which economic costs and benefits, as well the 
impact of the amendments and new rules being adopted today on 
efficiency, competition, and capital formation, are measured is the 
situation in existence today, prior to the adoption of the amendments 
and rules. The baseline includes an estimate of the number of entities 
that will likely be directly affected by the amendments and rules and a 
description of the relevant features of the regulatory and economic 
environment in which the affected entities operate. The discussion 
below identifies the main features of the regulatory and economic 
baseline, which will be further developed in section II of this release 
discussing the amendments and rules, including in the

[[Page 55084]]

focused economic analyses that follow the discussions of the amendments 
and rules.
a. NRSROs
    As discussed above, the Rating Agency Act of 2006, among other 
things, amended section 3 of the Exchange Act to add definitions, added 
section 15E to the Exchange Act to establish self-executing 
requirements for NRSROs and provide the Commission with the authority 
to implement a registration and oversight program for NRSROs, amended 
section 17 of the Exchange Act to provide the Commission with 
recordkeeping, reporting, and examination authority over NRSROs, and 
amended section 21B(a) of the Exchange Act to provide the Commission 
with the authority to assess penalties ``against any person'' in 
administrative proceedings instituted under section 15E of the Exchange 
Act.\56\
---------------------------------------------------------------------------

    \56\ See Public Law 109-291, 3, 4; 15 U.S.C. 78c; 15 U.S.C. 78o-
7; 15 U.S.C. 78q; 15 U.S.C. 78u-2.
---------------------------------------------------------------------------

    To implement the Rating Agency Act of 2006, the Commission adopted 
Rules 17g-1 through 17g-6 and Form NRSRO.\57\ Section 943 of the Dodd-
Frank Act mandates that the Commission adopt rules requiring an NRSRO 
to include in any report accompanying a credit rating of an asset-
backed security a description of the representations, warranties, and 
enforcement mechanisms available to investors and how they differ from 
the representations, warranties, and enforcement mechanisms in 
issuances of similar securities.\58\ In January 2011, the Commission 
adopted Rule 17g-7 to implement section 943.\59\ The Exchange Act, 
Rules 17g-1 through 17g-7, and Form NRSRO represent the baseline for 
the amendments and new rules being adopted today in terms of 
requirements applicable to NRSROs.
---------------------------------------------------------------------------

    \57\ See Oversight of Credit Rating Agencies Registered as 
Nationally Recognized Statistical Rating Organizations, 72 FR 33564.
    \58\ See Public Law 111-203, 943.
    \59\ See Disclosure for Asset-Backed Securities Required by 
Section 943 of the Dodd-Frank Wall Street Reform and Consumer 
Protection Act, 76 FR 4489.
---------------------------------------------------------------------------

    Pursuant to section 6 of the Rating Agency Act of 2006, the 
Commission is required to submit an annual report to the Committee on 
Banking, Housing, and Urban Affairs of the Senate and the Committee on 
Financial Services of the House of Representatives that includes the 
views of the Commission on the state of competition, transparency, and 
conflicts of interest among NRSROs.\60\ In addition, section 15E(b) of 
the Exchange Act provides that not later than ninety days after the end 
of each calendar year, each NRSRO shall file with the Commission an 
amendment to its registration application, in such form as the 
Commission, by rule, may prescribe: (1) Certifying that the information 
and documents in the application for registration continue to be 
accurate; (2) listing any material change that occurred to such 
information or documents during the previous calendar year; and (3) 
amending its credit ratings performance statistics.\61\ Rule 17g-1 
requires these filings (``annual certifications'') to be made on Form 
NRSRO.\62\ Further, each NRSRO is required to furnish the Commission 
with annual reports containing audited financial statements and 
information about revenues and other matters.\63\ The Commission's 
annual reports submitted to Congress and the NRSROs' annual 
certifications and annual reports are an integral part of establishing 
the baseline for the amendments and new rules being adopted today, as 
discussed below.
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    \60\ See Public Law 109-291, 6. The Commission staff annual 
reports are available at http://www.sec.gov/ocr.
    \61\ See 15 U.S.C. 78o-7(b).
    \62\ See paragraph (f) of Rule 17g-1. See also Oversight of 
Credit Rating Agencies Registered as Nationally Recognized 
Statistical Rating Organizations, 72 FR at 33567, 33569-33582.
    \63\ See 17 CFR 240.17g-3.
---------------------------------------------------------------------------

    As of today, there are ten credit rating agencies registered with 
the Commission as NRSROs.\64\ Based on the annual reports the NRSROs 
furnish with the Commission, in their 2013 fiscal years, the ten NRSROs 
had $5.4 billion of total revenue--an approximate 6% increase over 
their 2012 fiscal years. In addition, based on their annual 
certifications, the NRSROs employed a total of 4,218 credit analysts at 
the end of the 2013 calendar year. Table 1 shows the number of credit 
analysts employed by each NRSRO at the end of the 2013 calendar year 
and, of the total number of credit analysts employed by the NRSROs, the 
percent of credit analysts at S&P, Moody's, and Fitch (90%) and the 
remaining seven NRSROs (10%).
---------------------------------------------------------------------------

    \64\ The ten NRSROs are: A.M. Best Company, Inc. (``A.M. 
Best''); DBRS, Inc. (``DBRS''); Egan-Jones Ratings Company 
(``EJR''); Fitch, Inc. (``Fitch''); HR Ratings de Mexico, S.A. de 
C.V. (``HR Ratings''); Japan Credit Rating Agency, Ltd. (``JCR''); 
Kroll Bond Rating Agency, Inc. (``Kroll''); Moody's Investor's 
Services, Inc. (``Moody's''); Morningstar Credit Ratings, LLC 
(``Morningstar''); and Standard & Poor's Ratings Services (``S&P''). 
See Commission staff, Annual Report on Nationally Recognized 
Statistical Rating Organizations (Dec. 2013), p. 6, available at 
http://www.sec.gov/divisions/marketreg/ratingagency/nrsroannrep1213.pdf. (``2013 Annual Staff Report on NRSROs'').

        Table 1--Credit Analysts Employed by NRSROs (as of [--])
------------------------------------------------------------------------
                  NRSROs                       Total credit analysts
------------------------------------------------------------------------
S&P, Moody's, & Fitch....................  90%
Other NRSROs.............................  10%
A.M. Best................................  123
DBRS.....................................  98
EJR......................................  7
Fitch....................................  1,102
HR Ratings...............................  34
JCR......................................  57
Kroll....................................  58
Moody's..................................  1,244
Morningstar..............................  30
S&P......................................  1,465
                                          ------------------------------
    Total................................  4,218
------------------------------------------------------------------------
Note: The total number of credit analysts, including credit analyst
  supervisors, is provided by each NRSRO in Exhibit 8 to Form NRSRO,
  which is available on each NRSRO's Web site.

    Among other things, the operations of the ten NRSROs differ in 
terms of business model, classes of credit ratings for which they are 
registered, history of issuing credit ratings, size, and market share. 
Of the ten NRSROs, seven operate primarily under the issuer-pay 
model,\65\ in which an obligor pays the NRSRO to rate it as an entity 
or an issuer pays the NRSRO to rate the securities it issues.\66\ One 
NRSRO operates exclusively under the subscriber-pay model,\67\ in which

[[Page 55085]]

subscribers pay a fee to access the credit ratings issued by the 
NRSRO.\68\ Two NRSROs previously operated primarily under the 
subscriber-pay model but for several years have been issuing an 
increasing number of credit ratings paid for by the obligor being rated 
or the issuer of the securities that are rated.\69\
---------------------------------------------------------------------------

    \65\ The seven NRSROs are A.M. Best, DBRS, Fitch, HR Ratings, 
JCR, Moody's, and S&P. See 2013 Annual Staff Report on NRSROs, p. 6.
    \66\ The issuer-pay model often raises concerns of potential 
conflicts of interest because the collection of fees from rated 
entities and issuers of rated securities, as a principal source of 
revenue, may provide an NRSRO with an economic incentive to issue 
inflated ratings as a way to promote business with its clients. 
Several academic studies try to answer theoretically and empirically 
the question of whether reputational concerns of a credit rating 
agency effectively neutralize potential conflicts of interest in the 
issuer-pay model. The conclusions of these studies are neither 
unanimous nor definite. For example, recently, Kashyap and 
Kovrijnykh (2013) found that, under the issuer-pay model, a credit 
rating is less accurate than under the subscriber-pay model. 
However, the authors found that subscribers tend to ask for a credit 
rating inefficiently (that is, when the expected quality of the 
rated entity or security is sufficiently high) and that the 
subscriber-pay model suffers from a potential free-riding problem. 
Cole and Cooley (2014) argue that much of the regulatory concerns 
with the conflict created by issuers paying for ratings are a 
distraction. The authors argue that in equilibrium, reputation 
ensures that credit ratings have value and reflect sound assessments 
of creditworthiness. Regulatory reliance on credit ratings and the 
importance of risk-weighted capital in prudential regulation more 
likely contributed to distorted credit ratings than the matter of 
who pays for them. See Anil Kashyap and Natalia Kovrijnykh, Who 
Should Pay for Credit Ratings and How?, NBER working paper No. 18923 
(Mar. 2013); Harold Cole and Thomas F. Cooley, Rating Agencies, NBER 
working paper No. 19972 (Mar. 2014).
    \67\ The one NRSRO is EJR. See 2013 Annual Staff Report on 
NRSROs, p. 6.
    \68\ See 2013 Annual Staff Report on NRSROs, p. 23. The 
subscriber-pay model also is subject to potential conflicts of 
interest. See id. at p. 23. For example, the NRSRO may be aware that 
an influential subscriber holds a securities position (long or 
short) that could be advantaged if a credit rating upgrade or 
downgrade causes the market value of the security to increase or 
decrease; or that the subscriber invests in newly issued bonds and 
would obtain higher yields if the bonds were to have lower credit 
ratings. Another example of a conflict in the subscriber-pay model 
is that the NRSRO may be aware that a subscriber wishes to acquire a 
particular security but is prevented from doing so because the 
credit rating of the security is lower than internal investment 
guidelines or an applicable contract permit.
    \69\ The two NRSROs are Kroll and Morningstar. See 2013 Annual 
Staff Report on NRSROs, p. 7.
---------------------------------------------------------------------------

    The ten NRSROs also differ by the scope of their business and, in 
particular, by whether their operations include products and services 
other than credit ratings,\70\ which can be provided through business 
lines, segments, groups, or divisions within the NRSROs or through 
affiliated companies or other businesses not within the NRSRO.\71\ For 
credit ratings, there are five classes of credit ratings for which a 
credit rating agency can be registered as an NRSRO: (1) Financial 
institutions, brokers, or dealers; (2) insurance companies; (3) 
corporate issuers; (4) issuers of asset-backed securities (as that term 
is defined in section 1101(c) of part 229 of Title 17, Code of Federal 
Regulations, ``as in effect on the date of enactment of this 
paragraph''); and (5) issuers of government securities, municipal 
securities, or securities issued by a foreign government.\72\ Eight of 
the NRSROs are registered in multiple classes, while two NRSROs are 
registered in one class.\73\ Table 2 shows the approximate number of 
outstanding credit ratings as reported by each NRSRO in its annual 
certification for the 2013 calendar year end, in each of the five 
categories for which the NRSRO is registered.
---------------------------------------------------------------------------

    \70\ Ancillary services often raise concerns of potential 
conflicts of interest because, for example, an NRSRO might issue a 
more favorable credit rating to an issuer in exchange for purchasing 
ancillary services, or an issuer that purchases a large amount of 
ancillary services might pressure the NRSRO to issue a more 
favorable credit rating for the issuer. See 2013 Staff Report on 
Credit Rating Agency Independence, pp. 21-24. Another concern with 
respect to ancillary services is that they might have involved an 
NRSRO making recommendations on the structure of a security to be 
rated. Id. at 22-23. Paragraph (c)(5) of Rule 17g-5 prohibits an 
NRSRO from issuing or maintaining a credit rating with respect to an 
obligor or security where the NRSRO or a person associated with the 
NRSRO made recommendations to the obligor or the issuer, 
underwriter, or sponsor of the security about the corporate or legal 
structure, assets, liabilities, or activities of the obligor or 
issuer of the security. See 17 CFR 240.17g-5(c)(5). In addition, 
Rule 17g-6 prohibits, among other things, an NRSRO from: (1) 
Conditioning or threatening to condition the issuance of a credit 
rating on the purchase by an obligor or issuer, or an affiliate of 
the obligor or issuer, of any other services or products, including 
pre-credit rating assessment products, of the NRSRO or any person 
associated with the NRSRO; (2) issuing, or offering or threatening 
to issue, a credit rating that is not determined in accordance with 
the NRSRO's established procedures and methodologies for determining 
credit ratings, based on whether the rated person, or an affiliate 
of the rated person, purchases or will purchase the credit rating or 
any other service or product of the NRSRO or any person associated 
with the NRSRO; and (3) modifying, or offering or threatening to 
modify, a credit rating in a manner that is contrary to the NRSRO's 
established procedures and methodologies for modifying credit 
ratings based on whether the rated person, or an affiliate of the 
rated person, purchases or will purchase the credit rating or any 
other service or product of the NRSRO or any person associated with 
the NRSRO. See 17 CFR 240.17g-6.
    \71\ See 2013 Staff Report on Credit Rating Agency Independence, 
p. 19.
    \72\ See 15 U.S.C. 78c(a)(62) (defining the term nationally 
recognized statistical rating organization).
    \73\ See 2013 Annual Staff Report on NRSROs, p. 8.

                  Table 2--Approximate Number of NRSRO Credit Ratings Outstanding by Class of Credit Rating (as of [December 31, 2013])
--------------------------------------------------------------------------------------------------------------------------------------------------------
                                      Financial            Insurance                             Asset-backed         Government
             NRSROs                  institutions          companies       Corporate issuers      securities          securities         Total ratings
--------------------------------------------------------------------------------------------------------------------------------------------------------
S&P, Moody's, & Fitch..........  84%                  74%                 92%                 90%                 99%                 97%
Other NRSROs...................  16%                  26%                 8%                  10%                 1%                  3%
A.M. Best......................  N/R                  4,492               1,653               56                  N/R                 6,201
DBRS...........................  13,624               150                 3,790               10,706              16,038              44,308
EJR............................  104                  46                  877                 N/R                 N/R                 1,027
Fitch..........................  49,821               3,222               15,299              53,612              204,303             326,257
HR Ratings.....................  N/R                  N/R                 N/R                 N/R                 189                 189
JCR............................  150                  27                  463                 N/R                 56                  696
Kroll..........................  15,982               44                  2,749               1,401               25                  20,201
Moody's........................  53,383               3,418               40,008              76,464              728,627             901,900
Morningstar....................  N/R                  N/R                 N/R                 11,567              N/R                 11,567
S&P............................  59,000               7,200               49,700              90,000              918,800             1,124,700
                                ------------------------------------------------------------------------------------------------------------------------
    Total......................  192,064              18,599              114,539             243,806             1,868,038           2,437,046
--------------------------------------------------------------------------------------------------------------------------------------------------------
Note: The approximate number of NRSRO credit ratings outstanding as of December 31, 2013 is provided by each NRSRO in its annual certification, which is
  available on each NRSRO's Web site. ``N/R'' indicates that an NRSRO is not registered for that class of credit rating.

    As shown in Table 2, S&P has the greatest number of outstanding 
credit ratings in each of the five classes. S&P, Moody's, and Fitch are 
the top three producers of credit ratings in every class of credit 
ratings except for insurance companies (in this class, A.M. Best has 
the second highest number of outstanding credit ratings after S&P). 
Overall, S&P accounts for about 46% of the total NRSRO credit ratings 
outstanding, followed by Moody's (37%) and Fitch (13%), implying that 
two NRSROs (S&P and Moody's) account for 83% of all credit ratings 
outstanding and three NRSROs (S&P, Moody's, and Fitch) account for 
approximately 97%. Also, as discussed above, Table 1 shows that these 
three NRSROs employ 90% of the total number of NRSRO credit analysts. 
Comparing the number of credit ratings outstanding for established 
NRSROs and newly registered NRSROs may not provide a complete picture 
of competition in the industry. The incumbent NRSROs (particularly S&P, 
Moody's, and Fitch) have a longer history of issuing credit ratings, 
and their credit ratings include those for

[[Page 55086]]

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

    \74\ See 2013 Annual Staff Report on NRSROs, p. 12.
---------------------------------------------------------------------------

    Recent trends in the industry structure are shown in Table 3, which 
reports the inverse of the Herfindahl-Hirschman Index (HHI) as a 
measure of industry concentration by rating class.\75\ The HHI inverse 
is calculated from 2007 to 2013 for credit ratings outstanding as 
reported by the NRSROs in each rating class. Table 3 shows that the 
NRSRO industry concentration for all rating classes has moderately 
increased as suggested by the decrease in the HHI inverse since 2010. 
Despite a monotonic increase in competition in the rating class of 
asset-backed securities, the NRSRO industry remains concentrated, with 
the three largest NRSROs accounting for approximately 95% of the 
NRSROs' 2013 fiscal year total revenue, based on the annual reports the 
NRSROs furnish to the Commission.
---------------------------------------------------------------------------

    \75\ The inverse of HHI can be interpreted as the number of 
equally-sized firms necessary to replicate the degree of 
concentration in a particular industry.

                                        Table 3--Inverse of Herfindahl-Hirschman Index by Class of Credit Rating
--------------------------------------------------------------------------------------------------------------------------------------------------------
                                                             Financial       Insurance       Corporate     Asset-backed     Government
                          Year                             institutions      companies        issuers       securities      securities     Total ratings
--------------------------------------------------------------------------------------------------------------------------------------------------------
2007....................................................            3.37            4.02            3.27            2.71            2.35            2.65
2008....................................................            3.72            4.05            3.79            2.82            2.83            2.99
2009....................................................            3.85            3.84            3.18            3.18            2.65            2.86
2010....................................................            3.99            3.37            3.17            3.20            2.69            2.88
2011....................................................            4.16            3.76            3.02            3.38            2.47            2.74
2012....................................................            4.04            3.72            3.00            3.44            2.50            2.75
2013....................................................            3.99            3.68            3.03            3.48            2.46            2.72
--------------------------------------------------------------------------------------------------------------------------------------------------------
Note: The inverse of HHI is determined using the approximate numbers of NRSRO credit ratings outstanding reported in the Commission staff annual reports
  on NRSROs published in June 2008, September 2009, January 2011, March 2012, December 2012, and December 2013. For the 2013 calendar year end, the
  inverse of HHI is calculated using the number of outstanding credit ratings reported by NRSROs in their annual certifications.

    In particular, for the asset-backed security class--which includes, 
among other things, RMBS, commercial mortgage backed securities 
(``CMBS''), and consumer finance and other asset-backed securities--
Table 4 below shows the number of credit ratings outstanding from 2007 
to 2013. The total number of outstanding credit ratings has 
significantly decreased (by 38%) since 2007, mostly due to pay-downs of 
existing asset-backed securities that have not been replaced by newly 
issued asset-backed securities that are rated by NRSROs.\76\ While the 
three largest NRSROs accounted for 97% of the outstanding credit 
ratings for asset-backed securities in 2007, this number decreased to 
90% in 2013.
---------------------------------------------------------------------------

    \76\ See 2013 Annual Staff Report on NRSROs, p. 12.

                                                  Table 4--Approximate Number of Credit Ratings Outstanding in the Asset-Backed Security Class
------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
              NRSROs                        2007                   2008                   2009                   2010                   2011                  2012                  2013
------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
S&P, Moody's, & Fitch............  97%                    96%                    94%                    94%                    91%                    91%                   90%
Other NRSROs.....................  3%                     4%                     6%                     6%                     9%                     9%                    10%
A.M. Best........................  54                     54                     54                     54                     56                     55                    56
DBRS.............................  840                    7,470                  8,430                  10,091                 9,889                  10,054                10,706
EJR..............................  --                     14                     14                     13                     13                     N/R                   N/R
Fitch............................  72,278                 77,480                 69,515                 64,535                 58,315                 56,311                53,612
HR Ratings.......................  --                     --                     --                     --                     --                     N/R                   N/R
JCR..............................  68                     71                     64                     N/R                    N/R                    N/R                   N/R
Kroll............................  246                    0                      0                      0                      40                     352                   1,401
Moody's..........................  110,000                109,261                106,337                101,546                93,913                 82,357                76,464
Morningstar......................  10,235                 9,200                  8,856                  8,322                  16,070                 13,935                11,567
R&I..............................  214                    210                    186                    N/R                    --                     --                    --
S&P..............................  197,700                198,200                124,600                117,900                108,400                97,500                90,000
                                  --------------------------------------------------------------------------------------------------------------------------------------------------------------
    Total........................  391,635                401,960                318,056                302,461                286,696                260,564               243,806
------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
Note: ``N/R'' indicates that an NRSRO is not registered for the asset-backed security class of credit ratings and ``--'' indicates that the credit rating agency was not registered as an NRSRO
  for the applicable year. Kroll acquired LACE Financial Corp. in August 2010. Morningstar, formerly known as Realpoint LLC, changed its name in 2011. Rating and Investment Information, Inc.
  (``R&I'') withdrew its registration as an NRSRO with the Commission in October 2011. HR Ratings became registered as an NRSRO in 2012. Statistics come from the Commission staff annual
  reports on NRSROs published in June 2008, September 2009, January 2011, March 2012, December 2012, and December 2013. For calendar year 2013, the statistics come from the annual
  certifications of the NRSROs.

    In 2013, some of the relatively newer or smaller NRSROs increased 
their market shares in terms of rating asset-backed securities. Table 5 
reports full-year credit rating agency information for 2013, compared 
to 2007, the year immediately prior to the financial crisis. As the 
total issuances of asset-backed securities decreased considerably from 
2007 to 2013, DBRS has maintained its market share in rating new 
issuances and has become the most active participant in rating RMBS, 
while S&P, Moody's and Fitch have lost market shares. DBRS, Kroll, and 
Morningstar have gained market shares in rating CMBS after the 
financial crisis and have rated a significant number of newly issued 
CMBS in 2013. Finally, in the market for rating consumer finance and 
other asset-backed securities, which has

[[Page 55087]]

the largest number of issuances, DBRS and Kroll have increased their 
market shares, although S&P, Moody's and Fitch continue to play a 
significant role.

         Table 5--Market Shares of Credit Rating Agencies for RMBS, CMBS, and Consumer Finance and Other Asset-Backed Securities, 2013 and 2007
--------------------------------------------------------------------------------------------------------------------------------------------------------
                                                          2013 Issuance   Number of      Market     2007 Issuance   Number of      Market     2007-2013
               Rank                       NRSROs            ($ mil.)      offerings    share  (%)     ($ mil.)      offerings    share  (%)  Change  (%)
--------------------------------------------------------------------------------------------------------------------------------------------------------
                                                         Residential mortgage-backed securities
--------------------------------------------------------------------------------------------------------------------------------------------------------
1................................  DBRS................      $12,501.90           50         61.4      $12,817.60           20          2.9         -2.5
2................................  Fitch...............        9,969.60           23         48.9      253,721.10          318         58.2        -96.1
3................................  S&P.................        9,597.50           23         47.1      409,532.40          534         94.0        -97.7
4................................  Kroll...............        7,908.70           17         38.8             N/A          N/A          N/A          N/A
5................................  Moody's.............        3,796.00            9         18.6      324,923.50          421         74.6        -98.8
                                                        ------------------------------------------------------------------------------------------------
    Total........................  ....................       20,372.00           68        100.0      435,815.60          575        100.0        -95.3
--------------------------------------------------------------------------------------------------------------------------------------------------------
                                                          Commercial mortgage-backed securities
--------------------------------------------------------------------------------------------------------------------------------------------------------
1................................  Moody's.............      $62,802.60           67         72.9     $171,787.00           61         74.6        -63.4
2................................  Fitch...............       50,447.70           56         58.6      159,687.30           60         69.4        -68.4
3................................  Kroll...............       45,140.10           55         52.4             N/A          N/A          N/A          N/A
4................................  S&P.................       34,255.20           49         39.8      202,381.00           71         87.9        -83.1
5................................  DBRS................       18,574.90           26         21.6       13,295.30            6          5.8         39.7
6................................  Morningstar.........       17,089.00           27         19.8             N/A          N/A          N/A          N/A
                                                        ------------------------------------------------------------------------------------------------
    Total........................  ....................       86,135.80          122        100.0      230,195.80           86        100.0        -62.6
--------------------------------------------------------------------------------------------------------------------------------------------------------
                                                   Consumer finance and other asset-backed securities
--------------------------------------------------------------------------------------------------------------------------------------------------------
1................................  S&P.................     $134,860.60          244         69.3     $576,417.90          884         96.7        -76.6
2................................  Moody's.............      114,569.90          155         58.9      563,982.90          735         94.6        -79.7
3................................  Fitch...............      113,213.80          156         58.2      342,140.10          418         57.4        -66.9
4................................  DBRS................       16,530.60           51          8.5       43,102.70           73          7.2        -61.6
5................................  Kroll...............        3,983.10           16          2.0             N/A          N/A          N/A          N/A
                                                        ------------------------------------------------------------------------------------------------
    Total........................  ....................      194,600.70          341        100.0      596,016.20          981        100.0        -67.3
--------------------------------------------------------------------------------------------------------------------------------------------------------
Note: A single offering of asset-backed securities may consist of multiple tranches of securities. An NRSRO may rate one or multiple tranches of the
  securities issued in the offering. Market shares of individual NRSROs do not add up to 100% since more than one NRSRO may rate a particular offering.
  ``N/A'' indicates that statistics are not available for 2007. CMBS data relates to U.S. CMBS, including U.S. conduit/fusion and U.S. single borrower.
  Data comes from Asset-Backed Alert and Commercial Mortgage Alert Web sites, publicly available at http://www.abalert.com/ranks.php and http://www.cmalert.com/ranks.php.

b. Asset-Backed Security Issuers, Underwriters, and Third-Party Due 
Diligence Providers
    The asset-backed security market that existed in the United States 
as of the end of 2013 differed significantly from the market prior to 
the crisis. In 2004, issuing entities of non-agency asset-backed 
securities held $2.6 trillion in assets, which grew to $4.5 trillion in 
2007 and declined to $1.6 trillion in 2013.\77\ Table 6 presents 
issuance amounts, number of offerings, and number of unique issuers for 
non-agency asset-backed securities, categorized by type of 
offering.\78\ While new issuances of registered asset-backed securities 
represented the majority of offerings and totaled $1.0 trillion in 
2004, they drastically dropped to $140.7 billion in 2008. In 2013, the 
asset-backed security market totaled $393.6 billion, of which $174.1 
billion is the new issuance amount of registered asset-backed 
securities.
---------------------------------------------------------------------------

    \77\ This information is derived from data compiled by the 
Federal Reserve and published in quarterly Z.1 releases, which are 
available at http://www.federalreserve.gov/releases/Z1/default.htm. 
Statistics include private mortgage pools, consumer credit, business 
loans, student loans, consumer leases, and trade credit 
securitization.
    \78\ In this section of the release, the issuer of the asset-
back security means the person that primarily organizes and 
initiates the offering of the asset-backed security, often referred 
to as the sponsor.

                                       Table 6--Issuance Amount, Number of Offerings, and Number of Unique Issuers for Non-Agency Asset-Backed Securities
------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
                                                                        Issuance amount ($ bln)                       Number of offerings                      Number of unique issuers
                            Year                             -----------------------------------------------------------------------------------------------------------------------------------
                                                               Regist'd     144A     Private     Total     Regist'd     144A     Private     Total     Regist'd     144A     Private     Total
------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
2002........................................................     617.13     122.07       2.00     741.20      1,074        491         31      1,596        143        226         17        327
2003........................................................     790.47     149.20       0.17     939.85      1,271        589          3      1,863        139        223          3        309
2004........................................................   1,024.16     186.53       0.85   1,211.53      1,370        670          2      2,042        131        218          2        298
2005........................................................   1,450.33     322.64       3.70   1,776.68      1,594        907          3      2,504        134        300          2        376
2006........................................................   1,446.07     623.38       0.50   2,069.95      1,508      1,551          1      3,060        116        406          1        460
2007........................................................   1,048.81     518.59       0.55   1,567.95      1,088      1,102          1      2,191        111        342          1        396
2008........................................................     140.70     130.80       0.00     271.49        163        240          0        403         51         96          0        128

[[Page 55088]]

 
2009........................................................      85.45     120.14       0.00     205.58         80        266          0        346         30         81          0         97
2010........................................................      51.01     163.30      14.01     228.32         65        401          4        470         29        145          1        160
2011........................................................      74.94     139.06      13.58     227.59         86        291         15        392         39        163          6        179
2012........................................................     157.15     186.53       0.00     343.68        157        465          0        622         51        242          0        270
2013........................................................     174.06     219.47       0.08     393.61        182        532          1        715         61        294          1        336
------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
Note: Statistics are calculated by DERA using the Asset-Backed Alert and Commercial Mortgage Alert databases. A single offering of asset-backed securities may consist of multiple tranches of
  securities. An NRSRO may rate one or multiple tranches of the securities issued in the offering. The offerings are categorized by offering year and offering type (Commission registered, Rule
  144A, or traditional private offerings). Non-agency asset-backed securities include RMBS, CMBS, and other asset-backed securities. Non-agency RMBS include residential, Alt-A, subprime RMBS,
  high loan-to-value (``no-equity'') loans, and non-U.S. residential loans. Auto loan asset-backed securities include asset-backed securities backed by auto loans and auto leases, both prime
  and subprime, motorcycle loans, recreational vehicle loans, and truck loans. The first set of columns show the total issuance amounts in billions of dollars. The second set of columns show
  the total number of asset-backed security offerings. The third set of columns show the number of unique issuers of asset-backed securities in each category. The number in the column
  ``Total'' may not be the sum of numbers in the columns ``Regist'd'', ``144A'' and ``Private'' because some issuers may initiate offerings in several categories. Only non-agency asset-backed
  security offerings sold in the United States and issuers of such offerings are counted.

    Issuers of asset-backed securities often include banks, mortgage 
companies, finance companies, investment banks, and other entities that 
originate or acquire and package financial assets for resale as asset-
backed securities.\79\ As reported in Table 6, in 2004 there were 298 
unique issuers, while in 2013 there were 336 unique issuers, mostly 
involved in Rule 144A offerings.\80\ The ten most active issuers were 
responsible for about 30% of the total issuance amounts at the end of 
2013.\81\
---------------------------------------------------------------------------

    \79\ See Asset-Backed Securities, Securities Act No. 8518 (Dec. 
22, 2004), 70 FR 1506 (Jan. 7, 2005).
    \80\ The number of issuers varies across segments of the asset-
backed security market. For example, as of December of 2013 there 
were twenty-two and eighty-three issuers involved in RMBS and CMBS 
offerings, respectively.
    \81\ The market share attributed to the issuer of an asset-
backed security is calculated by DERA staff using the Asset-Backed 
Alert and Commercial Mortgage Alert databases.
---------------------------------------------------------------------------

    As noted in Figure 1 below, an analysis of the segments of the 
asset-backed security market shows that all segments experienced 
significant downturns during the crisis but only a few of them have 
experienced a recovery in the aftermath. Figure 1 focuses on non-agency 
asset-backed security offerings and reports the issuance volume by main 
asset classes (RMBS, CMBS, auto loans/leases, credit card loans, 
student loans, and other asset-backed securities).
[GRAPHIC] [TIFF OMITTED] TR15SE14.000

    As shown in Figure 1, new issuances of non-agency RMBS in 2004 
totaled $542 billion, with registered offerings representing the 
majority of non-agency RMBS issued before the crisis. Non-agency RMBS 
issuance--which totaled $715 billion in 2007--dropped drastically to 
$35 billion in 2008. As of the end of 2013, the non-agency RMBS

[[Page 55089]]

market remains weak and consists almost exclusively of unregistered 
RMBS offerings. In particular, new issuances of non-agency RMBS totaled 
$25 billion in 2013, which represents about 5% of the issuance level in 
2004. CMBS experienced a similar drop in issuance levels, though it has 
rebounded to a level that is closer to the 2004 issuance level than 
RMBS. In particular, CMBS issuance rose from $96 billion in 2004 to 
$231 billion in 2007. It then dropped to $12 billion in 2008. It was 
$86 billion in 2013, which is about 90% of the issuance level in 2004. 
The consumer finance asset-backed security market also declined 
drastically in terms of number of offerings and issuance volume after 
the financial crisis. For example, $70 billion of securities backed by 
auto loans and leases were issued in 2004, but issuance decreased to 
$38 billion in 2008. The issuances of consumer finance asset-backed 
securities, especially those securities backed by auto loans and 
leases, and other asset-backed securities have steadily increased since 
2008 to reach pre-crisis levels of about $75 billion in 2013.
    Among the asset-backed security segments, the non-agency RMBS 
segment has experienced a significant decline in the number of issuers 
with twenty-two issuers arranging non-agency RMBS (and only one issuer 
arranging non-agency registered RMBS) as of the end of 2013, compared 
to fifty-eight issuers in 2004. In the RMBS market, issuers arranging 
non-agency RMBS encounter competitive pressure from government-
sponsored enterprises that arrange RMBS that are guaranteed \82\ and 
exempt from registration and reporting requirements.\83\ As non-agency 
RMBS issuance has declined, issuance of agency RMBS has increased. 
Issuances of RMBS arranged by the Federal National Mortgage 
Association, the Federal Home Loan Mortgage Corporation, and the 
Government National Mortgage Association were $1.4 trillion in 2004 and 
grew to $1.9 trillion in 2013.\84\
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    \82\ See N. Eric Weiss, GSEs and the Government's Role in 
Housing Finance: Issues for the 113th Congress, Congressional 
Research Service Report for Congress (2013).
    \83\ Mortgage-backed securities issued by government-sponsored 
enterprises and the Government National Mortgage Association have 
been and continue to be exempt from registration under the 
Securities Act and most provisions of the federal securities laws. 
For example, the mortgage-backed securities issued by the Government 
National Mortgage Association are exempt securities under section 
3(a)(2) of the Securities Act (15 U.S.C. 77c(a)(2)) and section 
3(a)(12) of the Exchange Act (15 U.S.C. 78c(a)(12)). The chartering 
legislation for the Federal National Mortgage Association and the 
Federal Home Loan Mortgage Corporation contain exemptions with 
respect to the mortgage-backed securities issued by these entities. 
See 12 U.S.C. 1723c; 12 U.S.C. 1455g.
    \84\ See Securities Industry Financial Market Association 
(``SIFMA''), U.S. Mortgage-Related Issuance and Outstanding Data 
from 1996 to May 2014 (issuance), 2002 to 2014 Q1 (outstanding) 
(June 3, 2014 update).
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    Table 7 shows the number of unique underwriters of non-agency 
asset-backed securities. As of the end of 2013, it is a highly 
concentrated industry with ninety underwriters (if international 
securitizations are included in the data) and fifty underwriters (if 
international securitizations are excluded), with the top ten 
underwriters by volume underwriting about 70% of the 
securitizations.\85\
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    \85\ The market share attributed to an asset-backed security 
underwriter is calculated by DERA staff using Asset-Backed Alert and 
Commercial Mortgage Alert databases.

                          Table 7--Number of Unique Asset-Backed Security Underwriters
----------------------------------------------------------------------------------------------------------------
                                                                              Total                     Total
                 Year                     Regist'd      144A     Private    excluding    Internat'l   including
                                                                            internat'l                internat'l
----------------------------------------------------------------------------------------------------------------
2002..................................           22         40         15           47           86          107
2003..................................           29         41          3           47           87          109
2004..................................           29         46          2           56           99          123
2005..................................           29         45          3           50          101          118
2006..................................           28         57          1           59          114          137
2007..................................           27         59          1           61          109          132
2008..................................           19         42          0           44           95          113
2009..................................           14         26          0           28           58           72
2010..................................           15         45          1           46           76           90
2011..................................           18         44          5           45           62           79
2012..................................           20         46          0           48           63           81
2013..................................           22         47          0           50           72           90
----------------------------------------------------------------------------------------------------------------
Note: Statistics are calculated by DERA staff using the Asset-Backed Alert and Commercial Mortgage Alert
  databases. A single offering of asset-backed securities may consist of multiple tranches of securities. An
  NRSRO may rate one or multiple tranches of the securities issued in the offering. The number of unique
  underwriters of asset-backed securities is divided into categories by type of offering (registered, 144A,
  private, or international). The total number in the last column may not be the sum of numbers in the columns
  labeled ``Public'', ``144A'', ``Private,'' and ``Internat'l'' because some underwriters may market offerings
  in several categories. Only non-agency asset-backed security offerings and underwriters of such deals are
  counted.

    Finally, providers of third-party due diligence services with 
respect to asset-backed securities are significantly affected by the 
amendments and new rules being adopted today. The Commission has little 
information about these firms and the characteristics of the industry. 
The Commission estimates that there are approximately fifteen providers 
of third-party due diligence services.\86\ Because there are very few 
publicly traded firms specializing in due diligence, little is known 
about these service providers in terms of loan review volume, market 
share, and revenue.\87\
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    \86\ This number comes from combining the names of third-party 
due diligence firms cited by Vicki Beal, Senior Vice President of 
Clayton Holdings, in her testimony before the Financial Crisis 
Inquiry Commission, and the names of third-party due diligence firms 
that S&P reviews as a part of its U.S. RMBS rating process. See 
Testimony of Vicki Beal, Senior Vice President of Clayton Holdings 
before the Financial Crisis Inquiry Commission, (Sept. 23, 2010), 
available at http://fcic-static.law.stanford.edu/cdn_media/fcic-testimony/2010-0923-Beal.pdf (``Clayton Testimony''). S&P's 
updated list of third-party due diligence firms reviewed for U.S. 
RMBS is available at https://www.globalcreditportal.com/ratingsdirect/renderArticle.do?articleId=1246530&SctArtId=208825&from=CM&nsl_code=LIME. The Commission does not know whether the estimate of 
fifteen providers of third-party due diligence services captures all 
of the primary participants in this business but believes that, 
based on available information, this is a reasonable estimate for 
purposes of this economic analysis.
    \87\ See Clayton Testimony, p. 1 (describing the market for due 
diligence services as ``highly fragmented, highly competitive and 
rapidly changing'').
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    Asset-backed security issuers and underwriters may use third-party 
due diligence services to identify issues with loans, to negotiate 
better prices on pools of loans they are considering for

[[Page 55090]]

purchase, and to negotiate expanded representations and warranties in 
purchase and sale agreements from sellers.\88\ The reviews of third-
party due diligence providers are performed on an adverse or random 
sample of loans consistent with the guidelines of clients. Compensation 
is likely not contingent on due diligence findings or the ultimate 
performance of the loans reviewed. Instead, third-party due diligence 
providers may be paid a standard service fee for each loan 
reviewed.\89\
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    \88\ See id. at 2.
    \89\ See id. at 3.
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c. Industry Practices
    The Commission staff conducts annual examinations of each NRSRO and 
publishes a report summarizing the essential findings of the 
examinations, as required by section 15E(p)(3) of the Exchange Act.\90\ 
The staff's 2013 report noted improvements, relative to prior 
examinations, among the NRSROs in five general areas that are related 
to the amendments and new rules being adopted today: Enhanced 
documentation, disclosure, and board of director oversight of criteria 
and methodologies; investment in software or computer systems for 
electronic recordkeeping and monitoring employee securities trading; 
increased prominence of the role of the designated compliance officer 
within NRSROs; implementation or enhancement of internal controls over 
the rating process (for example, use of audits and other testing to 
verify compliance with federal securities laws, and employee training 
on compliance matters); and adherence to internal policies and 
procedures.\91\ The report also discussed certain weaknesses or 
concerns in a number of review areas: Adherence to policies, 
procedures, and methodologies; \92\ management of conflicts of 
interest; \93\ implementation of ethics policies; \94\ internal 
supervisory controls; \95\ governance; \96\ the activities of the 
designated compliance officer; \97\ the processing of complaints; \98\ 
and the policies governing post-employment activities of former staff 
of the NRSRO.\99\ These essential findings were related to several 
areas of NRSRO operations and were not limited to activities relating 
to rating asset-backed securities.
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    \90\ Section 923(a)(8) of the Dodd-Frank Act struck the existing 
text in paragraph (p) of section 15E of the Exchange Act, which 
related to the date of applicability of the Rating Agency Act of 
2006, and added new text. See Public Law 111-203, 932(a)(8). Section 
15E(p)(3) of the Exchange Act requires, among other things, the 
Commission staff to conduct an examination of each NRSRO at least 
annually. See 15 U.S.C. 78o-7(p)(3). Annual inspection reports for 
2011, 2012, and 2013 are available at http://www.sec.gov/divisions/marketreg/ratingagency.htm.
    \91\ See Commission staff, 2013 Summary Report of Commission 
Staff's Examinations of Each Nationally Recognized Statistical 
Rating Organization (Dec. 2013) (``2013 Annual Staff Inspection 
Report''), pp. 7-9.
    \92\ See 2013 Annual Staff Inspection Report, pp. 9-11.
    \93\ Id. at 11-13.
    \94\ Id. at 13-14.
    \95\ Id. at 14-19.
    \96\ Id. at 19-20.
    \97\ Id. at 20-21.
    \98\ Id. at 21-22.
    \99\ Id. at 22-23.
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3. Broad Economic Considerations
    In this section, the Commission describes the primary economic 
impacts that may derive from the amendments and new rules being adopted 
today, relative to the baseline discussed above. A detailed analysis of 
the particular economic effects--including the costs and benefits and 
the impact on efficiency, competition, and capital formation--that may 
result from the amendments and rules is presented in the focused 
economic analyses in section II of this release.\100\
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    \100\ See sections II.A.4., II.B.4., II.C.3., II.D.2., II.E.4., 
II.F.3., II.G.6., II.H.4., II.I.3., II.J.3., II.K.2., II.L.2., and 
II.M.5. of this release.
---------------------------------------------------------------------------

    Section 3(f) of the Exchange Act requires the Commission, when 
engaging in rulemaking that requires the Commission to consider or 
determine whether an action is necessary or appropriate in the public 
interest, to also consider whether the action will promote efficiency, 
competition, and capital formation.\101\ Further, section 23(a)(2) of 
the Exchange Act requires the Commission, when adopting rules under the 
Exchange Act, to consider the impact that any new rule would have on 
competition and to not adopt any rule that would impose a burden on 
competition that is not necessary or appropriate in furtherance of the 
purposes of the Exchange Act.\102\ The Commission's analysis of the 
economic effects, including the likely costs and benefits and the 
likely impact on efficiency, competition, and capital formation of the 
amendments and new rules, include those attributable to the rulemaking 
that the Commission is mandated to undertake in accordance with the 
Dodd-Frank Act and those attributable to the exercise of the 
Commission's discretionary authority.
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    \101\ See 15 U.S.C. 78c(f).
    \102\ See 15 U.S.C. 78w(a)(2); see also Current Guidance on 
Economic Analysis in SEC Rulemakings (available at: http://insider.sec.gov/divisions_offices/hqo/dera/rsfi-guidance-econ_analysis-rulemaking.pdf)
---------------------------------------------------------------------------

    In the proposing release, the Commission solicited comments on all 
aspects of the costs and benefits associated with the proposed rules. 
In addition to comments on the economic effects of specific provisions, 
which will be discussed in section II of this release, the Commission 
received comments on the overall economic effects of the proposed 
amendments and new rules. Generally, commenters expressed concerns that 
the potential cumulative burden and costs associated with the proposed 
amendments and new rules could be so onerous that they would have 
negative effects on competition by imposing an excessive burden on 
smaller NRSROs and raising barriers to entry for credit rating agencies 
that seek to register as NRSROs.\103\ In particular, one commenter 
suggested that ``fostering competition among rating agencies was a 
primary goal of both the Rating Agency Act of 2006 and the Dodd-Frank 
Act'' but that ``the proposed rules will be so costly to implement that 
additional credit rating agencies are unlikely to register as NRSROs 
and the existing pool of registrants may contract.'' \104\
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    \103\ See A.M. Best Letter; DBRS Letter; EJR Letter; Kroll 
Letter; Morningstar Letter; S&P Letter; TradeMetrics Letter.
    \104\ See DBRS Letter. This commenter also stated that a 
``contradiction lies in the fact that, while directing the 
Commission to impose costly and onerous new obligations on rating 
agencies who choose to register as NRSROs, the Dodd-Frank Act also 
directs the Commission to remove all references to credit ratings 
from the federal securities regulations.'' See DBRS Letter. See also 
Public Law 111-203, 939A.
---------------------------------------------------------------------------

    As discussed in section II of this release, the Commission has 
considered these comments and has modified the amendments and new rules 
being adopted today from the proposals in a number of ways that are 
designed to reduce the cumulative burden and costs associated with 
complying with the new requirements. Nonetheless, the Commission 
recognizes--as reflected in the economic analysis--that the amendments 
and rules establish a substantial package of new requirements 
applicable to NRSROs and that complying with these requirements will 
entail significant costs to NRSROs.\105\ The amendments and rules also 
impose burdens on issuers and underwriters of asset-backed securities 
and providers of third-party due diligence services with respect to 
asset-backed securities. As discussed throughout the economic analysis, 
the Commission believes that

[[Page 55091]]

the new requirements should result in substantial benefits and should 
not impose a burden on competition that is not necessary or appropriate 
in furtherance of the purposes of the Exchange Act.
---------------------------------------------------------------------------

    \105\ Some NRSROs may be subject to rules in foreign 
jurisdictions under which certain of their policies and procedures 
or other practices are affected by requirements of these foreign 
jurisdictions that may be similar to some of the requirements 
imposed by the amendments and new rules. While the requirements of 
foreign jurisdictions are not analyzed here in detail, they may 
impact the incremental costs and benefits of the amendments and new 
rules.
---------------------------------------------------------------------------

    In particular, the amendments and new rules being adopted today are 
designed to implement Title IX, Subtitle C of the Dodd-Frank Act, 
which, in turn, was designed to address the causes of certain market 
failures (that is, the principal-agent problem,\106\ including 
conflicts of interest, and asymmetric information) that may impair the 
integrity and transparency of NRSRO credit ratings and the procedures 
and methodologies NRSROs use to determine credit ratings. Some of the 
amendments and new rules are primarily designed to enhance the 
integrity of how NRSROs determine credit ratings by improving internal 
governance of NRSROs, managing potential principal-agent problems and 
conflicts of interest in the credit rating process, and promoting 
adherence to the procedures and methodologies for determining credit 
ratings and compliance with laws and regulations.\107\ For example, 
provisions in the amendments and new rules require an NRSRO, among 
other things, to: (1) Assess and report on the effectiveness of 
internal controls; (2) address conflicts of interest relating to sales 
and marketing activities and employment of former analysts; (3) have 
policies and procedures relating to their procedures and methodologies 
for determining credit ratings; (4) have standards of training, 
experience and competence for their credit analysts; and (5) have 
policies and procedures to promote the consistent use of credit rating 
symbols.\108\
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    \106\ A principal-agent problem occurs when one person (the 
``agent'') is able to act in the person's own best interest rather 
than in the interest of another person (the ``principal''). The 
problem arises when the parties have different interests and the 
agent has more information than the principal so that the principal 
cannot ensure that the agent is always acting in the principal's 
best interests, especially where activities that are useful to the 
principal are costly to the agent and where monitoring of the 
agent's activities is costly to the principal. For example, a 
principal-agent problem may arise if an NRSRO produces credit 
ratings that, as a result of conflicts of interest, are not 
informative to the users of credit ratings.
    \107\ These requirements are discussed below in sections II.A., 
II.B., II.C., II.D., II.F., II.I., II.J., and II.K. of this release.
    \108\ These requirements are discussed below in sections II.A., 
II.B., II.C., II.F., II.I., and II.J. of this release.
---------------------------------------------------------------------------

    Other provisions in the amendments and new rules being adopted 
today are designed mainly to enhance the transparency of NRSRO credit 
ratings by increasing disclosure and reducing information asymmetries 
that may adversely affect users of credit ratings. This should 
facilitate external scrutiny of NRSRO activities. More specifically, 
provisions in the amendments and new rules require an NRSRO, among 
other things, to disclose: (1) Standardized performance statistics; (2) 
increased information about credit rating histories; (3) information 
about material changes and significant errors in the procedures and 
methodologies used to determine credit ratings; and (4) information 
about a specific rating action.\109\ The main objective of these 
requirements is to improve the information provided to users of credit 
ratings, including investors. The enhanced disclosure may reduce 
information asymmetries between the NRSRO and the users of its credit 
ratings, enabling the users to make more informed investment and credit 
related decisions and allowing them to compare the performance of 
credit ratings by different NRSROs. Additionally, there are 
requirements in the amendments and new rules that are designed to 
reduce information asymmetries among issuers and underwriters of asset-
backed securities, NRSROs rating asset-backed securities, and the users 
of credit ratings for asset-backed securities.\110\ These requirements 
may benefit NRSROs and users of credit ratings, including investors in 
these securities.
---------------------------------------------------------------------------

    \109\ These requirements are discussed below in sections II.E., 
II.F., II.G., and II.L. of this release.
    \110\ These requirements are discussed below in sections II.E., 
II.G., and II.H of this release.
---------------------------------------------------------------------------

a. Amendments and Rules Enhancing NRSRO Governance and Integrity of 
Credit Ratings
    The requirements in the amendments and new rules being adopted 
today that are primarily designed to enhance an NRSRO's internal 
governance should have economic benefits, relative to the existing 
baseline, in terms of promoting the integrity of how NRSROs determine 
and monitor credit ratings. In particular, there are new requirements 
applicable to NRSROs that assign responsibilities to an NRSRO's 
management and board of directors, which should promote accountability 
and facilitate internal oversight over the processes governing the 
determination of credit ratings and the implementation of the 
procedures and methodologies an NRSRO uses to determine credit ratings. 
For example, an NRSRO is required to file an annual report containing 
an assessment by management of the effectiveness during the fiscal year 
of the internal control structure governing the implementation of and 
adherence to policies, procedures, and methodologies for determining 
credit ratings.\111\ Similarly, an NRSRO is required to establish, 
maintain, enforce, and document policies and procedures reasonably 
designed to ensure that the procedures and methodologies, including 
qualitative and quantitative data and models, the NRSRO uses to 
determine credit ratings are approved by its board of directors or a 
body performing a function similar to that of a board of 
directors.\112\ The board's oversight may prevent situations in which 
an NRSRO seeks to implement a procedure or methodology to determine 
credit ratings that is designed to inappropriately issue favorable 
credit ratings for existing and prospective clients in order to retain 
or gain market share.\113\
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    \111\ This requirement is discussed below in section II.A.3. of 
this release.
    \112\ This requirement is discussed below in section II.F.1. of 
this release.
    \113\ See Griffin and Tang, Did Subjectivity Play a Role in CDO 
Credit Ratings?
---------------------------------------------------------------------------

    There are new requirements applicable to NRSROs pursuant to which 
they must avoid certain conflicts of interest and have policies and 
procedures to take certain actions to address credit ratings that are 
influenced by a conflict of interest.\114\ These requirements may 
facilitate the alignment of incentives at both the NRSRO and individual 
NRSRO employee level to ultimately promote the production of unbiased 
credit ratings. At the NRSRO level, for example, sales and marketing 
considerations may influence the NRSRO's production of credit ratings. 
Consequently, there is a new requirement that prohibits an NRSRO from 
issuing or maintaining a credit rating where a person within the NRSRO 
who participates in determining or monitoring the credit rating, or 
developing or approving procedures or methodologies used for 
determining the credit rating, including qualitative and quantitative 
models, also: (1) Participates in sales or marketing of a product or 
service of the NRSRO or a product or service of an affiliate of the 
NRSRO; or (2) is influenced by sales or marketing considerations.\115\ 
This absolute prohibition should result in internal policies, 
procedures, and organizational solutions that isolate the analytical 
function from sales and marketing considerations within the NRSRO. To 
the extent that the absolute prohibition prevents credit analysts that 
participate in the determination of

[[Page 55092]]

credit ratings from being influenced by sales and marketing 
considerations, this should curb potential conflicts of interest 
related to ``rating catering'' practices that have been suggested by 
anecdotal evidence \116\ and academic literature.\117\ Isolating the 
production of credit ratings and the development of procedures and 
methodologies for determining credit ratings from sales and marketing 
considerations should promote the integrity and quality of credit 
ratings to the benefit of their users.
---------------------------------------------------------------------------

    \114\ These requirements are discussed below in sections II.B. 
and II.C. of this release.
    \115\ This requirement is discussed below in section II.B.1. of 
this release.
    \116\ See Coffee Testimony I, pp. 2-3.
    \117\ See John M. Griffin, Jordan Nickerson, Dragon Yongjun 
Tang, Rating Shopping or Catering? An Examination of the Response to 
Competitive Pressure for CDO Credit Ratings, Rev. Fin. St. 2270-2310 
(2013). The authors draw a distinction between rating shopping and 
rating catering. ``Rating shopping'' refers to a situation in which 
issuers solicit ratings from multiple credit rating agencies and 
then hire the credit rating agencies that will issue the most 
favorable credit ratings (Skreta and Veldkamp, 2009). Even though 
rating agencies adhere to their rating procedures and methodologies 
and issue unbiased ratings, credit rating inflation is a natural 
consequence of the rating shopping process and is not driven by the 
rating agencies. ``Rating catering'' refers to a situation in which 
issuers solicit credit ratings from multiple credit rating agencies 
and the credit rating agencies may not strictly adhere to their 
procedures and methodologies for determining credit ratings in order 
to issue more favorable credit ratings. The authors argue that under 
pressure from investment banks, the credit rating agency with a more 
stringent procedure or methodology for determining credit ratings 
stretches the procedure or methodology to match more lenient 
competitors (Bolton, Freixas, and Shapiro, 2012).
---------------------------------------------------------------------------

    At the individual level, an analyst's incentives may be distorted 
by the prospect of future employment at an issuer or underwriter, which 
could influence the analyst in determining a credit rating for that 
issuer or underwriter. Consequently, there is a new requirement that an 
NRSRO must have policies and procedures that address instances in which 
this conflict of interest influenced a credit rating that are 
reasonably designed to ensure that the NRSRO promptly determines 
whether the current credit rating must be revised so that it no longer 
is influenced by a conflict of interest and is solely a product of the 
documented procedures and methodologies the NRSRO uses to determine 
credit ratings and to promptly publish a revised credit rating, an 
affirmation of the credit rating, or potentially place the credit 
rating on watch or review and in each case include certain disclosures 
about the existence of the conflict.\118\ This provision is designed to 
require the NRSRO to promptly address a conflicted credit rating, and 
it will likely limit the potential risk that users of credit ratings 
may make investment decisions using biased or inaccurate information. 
The disclosures also should provide information to investors and other 
users of credit ratings that they can use to scrutinize an NRSRO, 
thereby promoting accountability to the market for failing to 
appropriately manage this conflict of interest.
---------------------------------------------------------------------------

    \118\ This requirement is discussed below in section II.C.1. of 
this release.
---------------------------------------------------------------------------

    In terms of accountability, the Commission is finalizing a rule 
amendment pursuant to which an NRSRO could have its registration 
suspended or revoked for violating a rule governing conflicts of 
interest.\119\ In addition, the Commission is amending Form NRSRO to 
provide notice to an NRSRO or a credit rating agency applying for 
registration as an NRSRO that an NRSRO is subject to applicable fines, 
penalties, and other sanctions under the Exchange Act.\120\ This may 
serve as a reminder to the NRSRO or applicant of the potential 
consequences of failing to comply with federal laws and regulations. 
Taken together, these accountability measures may have incremental 
effects on the integrity of an NRSRO's activities and credit ratings by 
promoting compliance with the Commission's rules.
---------------------------------------------------------------------------

    \119\ This requirement is discussed below in section II.B.3. of 
this release.
    \120\ This requirement is discussed below in section II.D.1. of 
this release.
---------------------------------------------------------------------------

    There are new requirements applicable to NRSROs pursuant to which 
they must establish, maintain, enforce, and document policies and 
procedures that are reasonably designed to ensure that: (1) The 
procedures and methodologies, including qualitative and quantitative 
data and models, the NRSRO uses to determine credit ratings are 
developed and modified in accordance with the policies and procedures 
of the NRSRO; and (2) material changes to the procedures and 
methodologies, including changes to qualitative and quantitative data 
and models, that the NRSRO uses to determine credit ratings are applied 
consistently to all current and future credit ratings to which the 
changed procedures or methodologies apply and, to the extent that the 
changes are to surveillance or monitoring procedures and methodologies, 
applied to current credit ratings to which the changed procedures or 
methodologies apply within a reasonable period of time, taking into 
consideration the number of credit ratings impacted, the complexity of 
the procedures and methodologies used to determine the credit ratings, 
and the type of obligor, security, or money market instrument being 
rated.\121\ To the extent that these policies and procedures are 
effectively implemented and enforced, their application may enhance the 
integrity of how NRSROs determine credit ratings.
---------------------------------------------------------------------------

    \121\ This requirement is discussed below in section II.F.1. of 
this release.
---------------------------------------------------------------------------

    There are new requirements applicable to NRSROs pursuant to which 
they must establish, maintain, enforce, and document standards of 
training, experience, and competence for the individuals they employ to 
participate in the determination of credit ratings that are reasonably 
designed to achieve the objective that the NRSRO produces accurate 
credit ratings in the classes of credit ratings for which the NRSRO is 
registered. At a minimum, these standards must include: (1) A 
requirement for periodic testing of the individuals employed by the 
NRSRO to participate in the determination of credit ratings on their 
knowledge of the procedures and methodologies used by the NRSRO to 
determine credit ratings in the classes and subclasses of credit 
ratings for which the individual participates in determining credit 
ratings; and (2) a requirement that at least one individual with an 
appropriate level of experience in performing credit analysis, but not 
less than three years, participates in the determination of a credit 
rating.\122\ These requirements may increase the level of competence 
and experience of the credit analysts employed by the NRSRO to 
participate in the production of credit ratings with possible positive 
effects on the integrity and quality of credit ratings.\123\
---------------------------------------------------------------------------

    \122\ See section II.I.1. of this release (providing a more 
detailed discussion of the requirements of this paragraph).
    \123\ See Cesare Fracassi, Stefan Petry, and Geoffrey Tate, Are 
Credit Ratings Subjective? The Role of Credit Analysts in 
Determining Ratings (2014), available at http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2230915. The authors find that 
the identity of the credit analysts covering a firm significantly 
affects the firm's credit rating, comparing credit ratings for the 
same firm at the same time across credit rating agencies. Analyst 
effects account for 30% of the variation within credit ratings. In 
addition, the quality of credit ratings varies with observable 
analyst characteristics.
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    There are new requirements applicable to NRSROs pursuant to which 
they must have reasonably designed policies and procedures relating to: 
(1) Assessing the probability that an issuer of a security or money 
market instrument will default, fail to make timely payments, or 
otherwise not make payments in accordance with the terms of the 
security or money market instrument; (2) clearly defining each symbol, 
number, or score in the rating scale used by the NRSRO and including 
the definitions in Exhibit 1 to Form NRSRO; and (3) applying any 
symbol,

[[Page 55093]]

number, or score in the rating scale used by the NRSRO in a manner that 
is consistent for all types of obligors, securities, and money market 
instruments for which the symbol, number, or score is used.\124\ 
Compliance with these policies and procedures may increase the 
likelihood that NRSROs apply rating symbols, numbers, or scores 
consistently across classes of credit ratings to the benefit of the 
users of credit ratings and obligors and issuers that are subject to 
credit ratings.
---------------------------------------------------------------------------

    \124\ These requirements are discussed below in section II.J. of 
this release.
---------------------------------------------------------------------------

    Finally, there are new requirements applicable to NRSROs pursuant 
to which they must retain records of certain internal controls, 
policies, procedures and standards they are required to document.\125\ 
These record retention requirements should facilitate Commission 
oversight of NRSROs to the benefit of users of credit ratings. 
Similarly, the Exchange Act requires an annual report of the NRSRO's 
designated compliance officer to be filed on a confidential basis with 
the Commission.\126\ The new requirement should facilitate Commission 
oversight as well.
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    \125\ These requirements are discussed below in sections 
II.A.2., II.C.2., II.F.2., II.I.2., and II.J.2. of this release.
    \126\ This requirement is discussed below in section II.K. of 
this release.
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    There will be costs associated with the amendments and new rules 
being adopted today related to governance of NRSROs.\127\ These costs 
will be primarily incurred by NRSROs.\128\ Initial and ongoing direct 
costs, including compliance costs, may vary among the NRSROs depending 
on the size and complexity of their business activities (for example, 
number of credit ratings outstanding, number of analysts, or number of 
classes of credit ratings). Among other costs, NRSROs also may incur 
training costs in order to make their personnel aware of the changes in 
internal controls, policies, and procedures required by the amendments 
and new rules. These costs are difficult to quantify because they 
depend significantly on how the required changes differ from the 
internal policies and procedures currently in place within each NRSRO. 
In addition, they depend on factors such as the NRSRO's size and 
business complexity. For example, an NRSRO may need to train its credit 
analysts and sales and marketing staff in the updated policies and 
procedures related to the sales and marketing conflict requirements. 
Among other factors, this cost will likely vary significantly with the 
degree of the existing separation between the functions of analytical 
staff and sales and marketing personnel.\129\
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    \127\ A detailed analysis of the economic costs, including 
compliance costs that can potentially result from each amendment 
and/or rule is presented in the focused economic analyses in section 
II of this release. See sections II.A.4., II.B.4., II.C.3., II.D.2., 
II.E.4., II.F.3., II.G.6., II.H.4., II.I.3., II.J.3., II.K.2., 
II.L.2., and II.M.5. of this release.
    \128\ NRSROs may be able to pass some of the incremental costs 
to their clients.
    \129\ This requirement is discussed below in section II.B.4. of 
this release.
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    Keeping all other factors constant, the costs associated with 
establishing, maintaining, enforcing, and documenting internal policies 
and procedures may be higher for structured finance products because 
the inherent conflict of interest that credit rating agencies face in 
rating these products is more acute than it is with respect to rating 
other types of securities.\130\ In addition, keeping all other factors 
constant, NRSROs operating under a business model that combines the 
issuer-pay and subscriber-pay models may face greater direct costs, 
given that the two models may entail different internal policies and 
procedures to prevent different sources of potential conflicts of 
interest. A component of these costs may also be fixed, which may have 
a disproportionate impact on smaller NRSROs that may find it more 
difficult to bear the costs. If NRSROs are not able to readily pass the 
overall additional costs to clients, there may be adverse effects, 
particularly on smaller NRSROs.
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    \130\ See Amendments to Rules for Nationally Recognized 
Statistical Rating Organizations, 74 FR at 63844. (``In the case of 
structured finance products, the Commission believes this `issuer/
underwriter-pay' conflict is particularly acute because certain 
arrangers of structured finance products repeatedly bring ratings 
business to the NRSROs. As sources of frequent, repeated deal-based 
revenue, some arrangers have the potential to exert greater undue 
influence on an NRSRO than, for example, a corporate issuer that may 
bring far less ratings business to the NRSRO.'') (footnotes 
omitted).
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    As a result of the amendments and new rules being adopted today, 
the number of credit rating agencies registered with the Commission as 
NRSROs may decline if current registrants believe that the cost of 
being registered and being subject to these new requirements outweighs 
the benefit of registration. The barriers to entry for credit rating 
agencies to register as NRSROs may rise, discouraging credit rating 
agencies from registering as NRSROs. Further, historically, successful 
new entrants have established themselves by first specializing in a 
particular industry, creating a track record in a particular rating 
class, and building the necessary reputational capital to achieve 
marketplace acceptance of their credit ratings.\131\ Compliance costs 
may reduce the incentive for an NRSRO to expand its rating business 
into new classes of credit ratings, with adverse effects on competition 
in certain market segments. Also, if compliance costs significantly 
erode profit margins for NRSROs, the barriers to exit from being 
registered as an NRSRO in certain or all classes of credit ratings may 
lower. The risk for deregistration may likely be higher for smaller 
NRSROs. As mentioned earlier, these costs also should depend on the 
complexity of operations within the NRSRO. Further, given that the 
conflict of interest in rating structured finance products is more 
acute, the competitive effects could be greater within the markets for 
rating these products. These potential consequences could reduce 
competition among NRSROs.
---------------------------------------------------------------------------

    \131\ See Commission, Report on the Role and Function of Credit 
Rating Agencies in the Operation of the Securities Markets (Jan. 
2003), p. 24.
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    An amendment being adopted today provides a mechanism for a small 
NRSRO to seek an exemption from the sales and marketing 
prohibition.\132\ The exemption based on size may decrease the burden 
on small NRSROs. However, this amendment could create adverse effects 
on competition as exempted NRSROs may be able to draw business through 
rating catering. In particular, exempted NRSROs may be able to more 
readily produce conflicted and inflated ratings \133\ or generate a 
greater stream of revenue from selling rating and ancillary services 
than non-exempted NRSROs. Reputation, which is an important 
disciplinary mechanism in this industry, may mitigate this risk to a 
certain extent.\134\
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    \132\ This provision is discussed below in section II.B.3. of 
this release.
    \133\ See Griffin, Nickerson, and Tang, Rating Shopping or 
Catering? An Examination of the Response to Competitive Pressure for 
CDO Credit Ratings.
    \134\ See Jerome Mathis, James McAndrews, and Jean-Charles 
Rochet, Rating the Raters: Are Reputation Concerns Powerful Enough 
to Discipline Rating Agencies?, J. of Monetary Economics 657-674 
(July 2009).
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    A number of credit rating agencies located in the United States 
have not registered as NRSROs.\135\ As U.S. regulatory agencies 
continue to remove references to NRSRO credit ratings from the 
regulations they administer, market

[[Page 55094]]

participants subject to these regulations may choose to use 
unregistered credit rating agencies thereby diminishing the incentive 
to register as an NRSRO.\136\ On the other hand, users of credit 
ratings may choose to use NRSROs over unregistered credit rating 
agencies because of the NRSRO registration and oversight program, which 
is being enhanced by the amendments and new rules being adopted today.
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    \135\ See, e.g., James H. Gellert, Chairman and CEO, Rapid 
Ratings International, Inc., Testimony Concerning: Oversight of the 
Credit Rating Agencies Post Dodd-Frank (July 27, 2011) (testimony 
before the U.S. House of Representatives, Committee on Financial 
Services, Subcommittee on Oversight and Investigations), available 
at http://www.rapidratings.com/images/custom/gellert_testimony_to_house_cfs_oversight_and_investigations_july_27_2011_final_w_bio.pdf.
    \136\ See Public Law 111-203, 939A.
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    To the extent that these amendments and new rules improve the 
quality of credit-related information, they may have effects related to 
allocative efficiency and capital formation. As a result of these 
amendments and new rules, users of credit ratings could make more 
efficient investment decisions based on higher-quality information. 
Market efficiency also may improve if credit ratings become more 
informative and the additional information is reflected in asset 
prices. To the extent that the amendments and rules will be effective 
in enhancing the integrity and quality of NRSRO credit ratings, users 
of these credit ratings may benefit from an enhanced confidence in the 
quality of the creditworthiness assessments reflected in the credit 
ratings, which may have positive effects on the willingness of 
investors to participate in the securities markets and thereby enhance 
capital formation, as capital efficiently flows to more productive 
uses. The benefits in terms of efficiency and capital formation arising 
from the rules enhancing governance and the integrity of credit ratings 
are likely to be greater for asset-backed securities, where the 
inherent conflict of interest in the issuer-pay model is more acute, 
and, as a result of the amendments and new rules, investors may become 
less reluctant to invest in asset-backed securities.
b. Amendments and Rules Enhancing Disclosure and Transparency of Credit 
Ratings
    The requirements in the amendments and new rules being adopted 
today that are primarily designed to enhance disclosure should have 
economic benefits, relative to the baseline that existed before the 
amendments and rules were adopted, in terms of promoting the 
transparency of credit ratings and NRSRO activities and, therefore, 
NRSRO accountability. This should benefit users of credit ratings, 
including investors. The amendments and rules also should enhance 
disclosure requirements with respect to asset-backed securities for the 
benefit of users of credit ratings, including investors in these 
securities.
    The amendments significantly enhance the existing requirements for 
NRSROs to produce and disclose performance statistics to make the 
disclosures more comparable across NRSROs and easier for users of 
credit ratings and others to understand.\137\ Similarly, the existing 
requirements for NRSROs to disclose rating histories are being enhanced 
to make the histories more complete in terms of the scope of credit 
ratings that must be included in the histories and more robust in terms 
of the information that must be disclosed with each rating action.\138\ 
To the extent that the new disclosures facilitate the evaluation of the 
performance of an NRSRO's credit ratings and the comparison of rating 
performance across all NRSROs--including direct comparisons of the 
rating history of the same obligor or instrument across two or more 
NRSROs--the rules may benefit users of credit ratings, including 
investors. In particular, the enhanced disclosure may allow them to 
better assess the reliability of credit ratings from different NRSROs 
and, in the case of issuer-paid credit ratings or subscriber-paid 
credit ratings, make more informed decisions regarding whether to hire, 
or subscribe to the credit ratings of, a particular NRSRO.
---------------------------------------------------------------------------

    \137\ These amendments are discussed below in section II.E.1. of 
this release.
    \138\ These amendments are discussed below in section II.E.3. of 
this release.
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    There are new requirements applicable to NRSROs pursuant to which 
they must publish on their Internet Web sites: (1) Material changes to 
the procedures and methodologies, including to qualitative models or 
quantitative inputs, the NRSRO uses to determine credit ratings, the 
reason for the changes, and the likelihood the changes will result in 
changes to any current credit ratings; and (2) notice of the existence 
of a significant error identified in a procedure or methodology, 
including a qualitative or quantitative model, the NRSRO uses to 
determine credit ratings that may result in a change to current credit 
ratings.\139\ These requirements may benefit users of NRSRO credit 
ratings in terms of their ability to evaluate the procedures and 
methodologies used by an NRSRO to determine credit ratings. In this 
way, they also may promote the NRSROs' accountability to the market and 
the issuance of quality credit ratings.
---------------------------------------------------------------------------

    \139\ These amendments are discussed below in section II.F.1. of 
this release.
---------------------------------------------------------------------------

    There are new requirements applicable to NRSROs pursuant to which 
they must publish two items when taking a rating action: (1) A form 
containing certain quantitative and qualitative information about the 
credit rating that is the result or subject of the rating action; and 
(2) any certification of a third-party due diligence provider relating 
to the credit rating.\140\ The required disclosures may be used by 
investors and other users of credit ratings to better understand credit 
ratings issued by NRSROs. Specifically, the forms and certifications 
will provide incremental information about how a credit rating was 
produced (for example, disclosure about assumptions, limitations, 
information relied on, version of the procedure or methodology used, 
potential conflicts of interest) and the information content of the 
credit rating. The information disclosed in the form, including 
information about the limitations of the credit rating and information 
regarding due diligence, may discourage undue reliance on credit 
ratings by investors and other users of credit ratings in making 
investment and other credit-based decisions.
---------------------------------------------------------------------------

    \140\ These amendments are discussed below in section II.G. of 
this release.
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    There is a new requirement applicable to issuers and underwriters 
of asset-backed securities pursuant to which they must disclose the 
findings and conclusions of any third-party due diligence report they 
obtain.\141\ The rule applies to both registered and unregistered 
offerings of asset-backed securities. Additionally, there is a new 
requirement applicable to providers of third-party due diligence 
services with respect to asset-backed securities pursuant to which they 
must provide a written certification to any NRSRO that is producing a 
credit rating with respect to the asset-backed security.\142\ The 
certification must disclose information about the due diligence 
performed, including a summary of the findings and conclusions of the 
third party, and identification of any relevant NRSRO due diligence 
criteria that the third party intended to meet in performing the due 
diligence.
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    \141\ These amendments are discussed below in section II.H.1. of 
this release.
    \142\ These amendments are discussed below in sections II.H.2. 
and II.H.3. of this release.
---------------------------------------------------------------------------

    As discussed above, the amendments and new rules are intended to 
reduce asymmetric information in the asset-backed security market. 
NRSROs producing credit ratings for asset-backed securities may benefit 
from receiving the information in the certification. The certification 
also will be signed by an individual who is duly authorized by the 
third-party due diligence provider to

[[Page 55095]]

make such a certification, promoting confidence in the accuracy of the 
information disclosed. Importantly, issuers and underwriters can no 
longer select what part of this information to provide to NRSROs, 
reducing the possibility of less favorable information being withheld 
from NRSROs and reducing the risk that the credit ratings will be based 
on imperfect or incomplete information (to the extent the NRSROs use 
information about due diligence in producing their credit ratings). 
Further, making this information available to all NRSROs (rather than 
just the NRSROs hired to rate the asset-backed security) could promote 
the issuance of more credit ratings for a given asset-backed security, 
including credit ratings that provide a more diverse range of views on 
the creditworthiness of the security. Users of credit ratings, 
including investors and other participants in the asset-backed 
securities markets, may benefit both directly and indirectly from the 
disclosures made by issuers, underwriters, and providers of third-party 
due diligence services. To the extent that findings and conclusions of 
all third-party due diligence reports were not previously disclosed to 
these persons, the amendments and new rules should enhance information 
available to the public.
    Finally, there are new requirements pursuant to which NRSROs must 
use the Commission's Electronic Data Gathering, Analysis, and Retrieval 
(``EDGAR'') system to electronically submit Form NRSRO and required 
exhibits to the form to the Commission.\143\ Having all information 
available in an electronic format in EDGAR will provide a centralized 
location and should make the information and the history of that 
information more easily accessible, comparable, and searchable to users 
of credit ratings, including investors.
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    \143\ See section II.L. of this release (providing a more 
detailed discussion of the amendments).
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    There will be costs associated with the amendments and new rules 
being adopted today that are related to enhanced disclosure and 
transparency.\144\ These costs will be primarily incurred by 
NRSROs,\145\ issuers and underwriters of asset-backed securities, and 
third-party due diligence providers. Initial and ongoing direct costs, 
including compliance costs, may vary among the affected parties 
depending on their size and the complexity of their business activities 
(for example, number of credit ratings outstanding, number of analysts, 
number of classes of credit ratings, number of years issuing credit 
ratings, and number of historical credit ratings). Keeping all other 
factors constant, NRSROs operating according to a subscriber-pay model 
may face greater losses in revenue from the sale of access to 
historical ratings data, as more of this data becomes publicly 
available, since they are likely to be more dependent on this source of 
revenue than NRSROs operating according to the issuer-pay model. A 
component of these costs may also be fixed, affecting more 
significantly smaller NRSROs that may find it more difficult to bear 
the costs. If NRSROs are not able to readily pass the overall 
additional costs to clients, there may be adverse effects, especially 
on smaller NRSROs.
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    \144\ A detailed analysis of the economic costs, including 
compliance costs that can potentially result from each rule is 
presented in the focused economic analyses in section II of this 
release. See sections II.A.4., II.B.4., II.C.3., II.D.2., II.E.4., 
II.F.3., II.G.6., II.H.4., II.I.3., II.J.3., II.K.2., II.L.2., and 
II.M.5. of this release.
    \145\ NRSROs may be able to pass some of the incremental costs 
to their clients.
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    Similar to the amendments and new rules relating to governance, the 
amendments and new rules relating to disclosure and transparency could 
reduce the number of credit rating agencies registered with the 
Commission as NRSROs to the extent that current registrants believe the 
cost of being registered and subject to these new requirements 
outweighs the benefit of registration. In addition, the barriers to 
entry for credit rating agencies to register as NRSROs may rise, 
especially for smaller credit rating agencies. NRSROs may have a 
reduced incentive to register for a new class of credit ratings with 
adverse effects on competition in certain market segments. Barriers to 
exit from registration as an NRSRO may lower due to the possible 
erosion of profit margins, though an NRSRO's decision to deregister 
from certain or all classes of credit ratings may depend on whether 
users of credit ratings will favor NRSROs because of the NRSRO 
registration and oversight program, which is being enhanced by the 
amendments and new rules being adopted today. The risk for 
deregistration will likely be higher for smaller NRSROs, given the 
fixed component of some compliance costs and the greater difficulty to 
pass the increase in costs to their clients.
    Also, the amendments and new rules may impact competition among 
third-party due diligence providers. Although the Commission knows 
little about the characteristics of the market for the services they 
provide, the certification requirement may increase the liability risk 
for these providers, particularly for those who do not already bear 
expert liability under Rule 193.\146\ If third-party due diligence 
providers are not able to charge more for performing the asset review 
to account for the heightened risk of liability, some providers may 
exit the market or some entities that otherwise would have entered the 
market may decide against doing so.
---------------------------------------------------------------------------

    \146\ See 17 CFR 230.193; 17 CFR 229.1111. Under Rule 193 and 
Item 1111 of Regulation AB, an issuer of a registered asset-backed 
security is required to perform a review of the assets underlying 
the asset-backed security and disclose the nature of the review. In 
meeting this requirement, an issuer may engage a third party to 
perform the required review of the underlying assets. If the third 
party's findings and conclusions are to be attributed to it, the 
third-party must consent to being named in the issuer's registration 
statement as an ``expert,'' thus subjecting the third party to so-
called ``expert liability'' under the Securities Act. If third-party 
diligence providers are not subject to legal liability as experts, 
the issuer itself remains legally accountable for the accuracy of 
the disclosures it makes to investors.
---------------------------------------------------------------------------

    The amendments and new rules also may have positive effects on 
competition, efficiency and capital formation. The enhanced 
standardization of the information content may facilitate comparing 
performance statistics and rating histories across NRSROs. Clients of 
NRSROs (for example, issuers, subscribers, and others) may use the 
performance statistics to inform their hiring or subscribing decisions, 
increasingly promoting competition among NRSROs on the basis of the 
quality of their credit ratings and the procedures and methodologies 
used to determine credit ratings. To the extent that the adopted rules 
facilitate the external monitoring and comparative analysis of NRSROs, 
they may allow users of credit ratings to develop more refined views of 
NRSRO performance and thereby indirectly increase accountability and 
encourage integrity in the production of credit ratings. This, in turn, 
may facilitate the ability of NRSROs to establish and maintain 
reputations for issuing quality credit ratings to remain competitive. 
More comparable performance data may also help relatively smaller and 
newer NRSROs, including subscriber-paid NRSROs, to attract attention to 
their rating performance, enhancing their ability to develop a 
reputation for producing quality credit ratings. This may allow them to 
better compete with more established competitors. Also, the ability of 
non-hired NRSROs to obtain the information disclosed in the third-party 
due diligence certification may provide them with an advantage in 
producing informative unsolicited credit ratings, relative to 
unregistered

[[Page 55096]]

credit rating agencies that cannot obtain this information.
    The new disclosure requirements in the form and certifications that 
accompany a rating action may reduce information asymmetries about how 
a credit rating was determined by providing additional information 
about the rating process, such as assumptions, limitations, version of 
the procedures or methodologies used, and, in the case of an asset-
backed security, a description of the findings and conclusions of a 
third-party due diligence provider, if such services were employed. To 
the extent that the required disclosure does not diminish the content 
and timeliness of the information conveyed with the rating actions, the 
enhanced information may increase the ability of users of credit 
ratings to accurately interpret the information, potentially resulting 
in more efficient investment decisions and higher overall market 
efficiency to the benefit of those investors that use credit ratings. 
This, in turn, may increase investors' participation in the securities 
markets with positive effects on capital formation. Because of the 
higher degree of information asymmetry in the asset-backed security 
market, the benefits in efficiency and capital formation resulting from 
the enhanced disclosure and transparency of credit ratings are likely 
to be greater for these securities, with the result that investors may 
become more willing to participate in this market.

II. Final Rules and Rule Amendments

    As discussed in detail below, the Commission is adopting new rules 
and amendments to existing rules to implement Title IX, Subtitle C of 
the Dodd-Frank Act and to enhance the NRSRO registration and oversight 
program administered by the Commission. In designing rules to implement 
Title IX, Subtitle C of the Dodd-Frank Act, the Commission has taken 
into account section 15E(c)(2) of the Exchange Act.\147\ This section 
provides, in pertinent part, that neither the Commission nor any State 
(or political subdivision thereof) may regulate the substance of credit 
ratings or the procedures and methodologies by which any NRSRO 
determines credit ratings.\148\ One way the Commission has sought to 
reconcile the rulemaking mandated by the Exchange Act, as amended by 
the Dodd-Frank Act, with the limitation in section 15E(c)(2) is to 
model rule text closely on statutory text.
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    \147\ 15 U.S.C. 78o-7(c)(2).
    \148\ See 15 U.S.C. 78o-7(c)(2).
---------------------------------------------------------------------------

A. Internal Control Structure

    Section 932(a)(2)(B) of the Dodd-Frank Act added paragraph (3) to 
section 15E(c) of the Exchange Act.\149\ Section 15E(c)(3)(A) requires 
an NRSRO to establish, maintain, enforce, and document an effective 
internal control structure governing the implementation of and 
adherence to policies, procedures, and methodologies for determining 
credit ratings (``internal control structure''), taking into 
consideration such factors as the Commission may prescribe, by 
rule.\150\ While section 15E(c)(3)(A) provides that the Commission 
``may'' prescribe factors an NRSRO would need to take into 
consideration when establishing, maintaining, enforcing, and 
documenting the internal control structure, the requirement that an 
NRSRO ``establish, maintain, enforce, and document an effective 
internal control structure'' is self-executing.\151\ Consequently, an 
NRSRO must adhere to this provision irrespective of whether the 
Commission prescribes factors pursuant to section 15E(c)(3)(A).
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    \149\ See Public Law 111-203, 932(a)(2)(B); 15 U.S.C. 78o-
7(c)(3)(A).
    \150\ See 15 U.S.C. 78o-7(c)(3)(A).
    \151\ See id.
---------------------------------------------------------------------------

    Section 15E(c)(3)(B) of the Exchange Act provides that the 
Commission ``shall prescribe'' rules requiring each NRSRO to submit an 
annual internal controls report to the Commission, which shall contain: 
(1) A description of the responsibility of the management of the NRSRO 
in establishing and maintaining an effective internal control 
structure; (2) an assessment of the effectiveness of the internal 
control structure; and (3) the attestation of the chief executive 
officer (``CEO''), or equivalent individual, of the NRSRO.\152\
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    \152\ See 15 U.S.C. 78o-7(c)(3)(B)(i) through (iii).
---------------------------------------------------------------------------

    In the proposing release, the Commission: (1) Deferred prescribing 
factors the NRSRO must take into consideration in establishing, 
maintaining, enforcing, and documenting an effective internal control 
structure; (2) proposed amending the NRSRO recordkeeping rule (Rule 
17g-2) to require that the documentation of the internal control 
structure be subject to the rule's record retention requirements; and 
(3) proposed amending the NRSRO annual reporting rule (Rule 17g-3) to 
require an NRSRO to file an unaudited annual internal controls report 
with the Commission.\153\
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    \153\ See Nationally Recognized Statistical Rating 
Organizations, 76 FR at 33421-33425.
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1. Prescribing Factors
    In the proposing release, the Commission stated that it was 
deferring prescribing factors an NRSRO must take into consideration 
when establishing, maintaining, enforcing, and documenting an effective 
internal control structure to provide the Commission with an 
opportunity--through the NRSRO examination process and the submission 
of annual reports by the NRSROs on the effectiveness of their internal 
control structures--to review how NRSROs have complied with the self-
executing requirement in section 15E(c)(3)(A) of the Exchange Act to 
establish, maintain, enforce, and document an effective internal 
control structure.\154\ However, the Commission sought comment on 
whether it would be appropriate as part of this rulemaking to prescribe 
factors and on potential factors the Commission could prescribe.\155\ 
In particular, the Commission identified factors relating to: (1) The 
establishment of an internal control structure; (2) the maintenance of 
an internal control structure; and (3) the enforcement of an internal 
control structure.\156\
---------------------------------------------------------------------------

    \154\ Id. at 33421-33423.
    \155\ Id.
    \156\ Id. at 33422-33423.
---------------------------------------------------------------------------

    In terms of establishing an internal control structure, the 
Commission requested comment on the following factors:
     Controls reasonably designed to ensure that a newly 
developed methodology or proposed update to an in-use methodology for 
determining credit ratings is subject to an appropriate review process 
(for example, by persons who are independent from the persons that 
developed the methodology or methodology update) and to management 
approval prior to the new or updated methodology being employed by the 
NRSRO to determine credit ratings; \157\
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    \157\ Section 15E(t)(3)(A) of the Exchange Act contains a self-
executing provision requiring that the board of directors of the 
NRSRO shall ``oversee'' the ``establishment, maintenance, and 
enforcement of policies and procedures for determining credit 
ratings.'' See 15 U.S.C. 78o-7(t)(3)(A). At the same time, section 
15E(r) of the Exchange Act requires the Commission to adopt rules 
``to ensure that credit ratings are determined using procedures and 
methodologies, including qualitative and quantitative data and 
models'' that are approved by the board of the NRSRO. See 15 U.S.C. 
78o-7(r)(1)(A).
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     Controls reasonably designed to ensure that a newly 
developed methodology or update to an in-use methodology for 
determining credit ratings is disclosed to the public for consultation 
prior to the new or updated

[[Page 55097]]

methodology being employed by the NRSRO to determine credit ratings, 
that the NRSRO makes comments received as part of the consultation 
publicly available, and that the NRSRO considers the comments before 
implementing the methodology;
     Controls reasonably designed to ensure that in-use 
methodologies for determining credit ratings are periodically reviewed 
(for example, by persons who are independent from the persons who 
developed and/or use the methodology) in order to analyze whether the 
methodology should be updated;
     Controls reasonably designed to ensure that market 
participants have an opportunity to provide comment on whether in-use 
methodologies for determining credit ratings should be updated, that 
the NRSRO makes any such comments received publicly available, and that 
the NRSRO considers the comments;
     Controls reasonably designed to ensure that newly 
developed or updated quantitative models proposed to be incorporated 
into a credit rating methodology are evaluated and validated prior to 
being put into use;
     Controls reasonably designed to ensure that quantitative 
models incorporated into in-use credit rating methodologies are 
periodically reviewed and back-tested;
     Controls reasonably designed to ensure that an NRSRO 
engages in analysis before commencing the rating of a class of 
obligors, securities, or money market instruments the NRSRO has not 
previously rated to determine whether the NRSRO has sufficient 
competency, access to necessary information, and resources to rate the 
type of obligor, security, or money market instrument;
     Controls reasonably designed to ensure that an NRSRO 
engages in analysis before commencing the rating of an ``exotic'' or 
``bespoke'' type of obligor, security, or money market instrument to 
review the feasibility of determining a credit rating;
     Controls reasonably designed to ensure that measures (for 
example, statistics) are used to evaluate the performance of credit 
ratings as part of the review of in-use methodologies for determining 
credit ratings to analyze whether the methodologies should be updated 
or the work of the analysts employing the methodologies should be 
reviewed;
     Controls reasonably designed to ensure that, with respect 
to determining credit ratings, the work and conclusions of the lead 
credit analyst developing an initial credit rating or conducting 
surveillance on an existing credit rating is reviewed by other 
analysts, supervisors, or senior managers before a rating action is 
formally taken (for example, having the work reviewed through a rating 
committee process);
     Controls reasonably designed to ensure that a credit 
analyst documents the steps taken in developing an initial credit 
rating or conducting surveillance on an existing credit rating with 
sufficient detail to permit an after-the-fact review or internal audit 
of the rating file to analyze whether the analyst adhered to the 
NRSRO's procedures and methodologies for determining credit ratings; 
and
     Controls reasonably designed to ensure that the NRSRO 
conducts periodic reviews or internal audits of rating files to analyze 
whether analysts adhere to the NRSRO's procedures and methodologies for 
determining credit ratings.\158\
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    \158\ See Nationally Recognized Statistical Rating 
Organizations, 76 FR at 33422.
---------------------------------------------------------------------------

    In terms of maintaining an internal control structure, the 
Commission requested comment on the following factors:
     Controls reasonably designed to ensure that the NRSRO 
conducts periodic reviews of whether it has devoted sufficient 
resources to implement and operate the documented internal control 
structure as designed;
     Controls reasonably designed to ensure that the NRSRO 
conducts periodic reviews or ongoing monitoring to evaluate the 
effectiveness of the internal control structure and whether it should 
be updated; and
     Controls designed to ensure that any identified 
deficiencies in the internal control structure are assessed and 
addressed on a timely basis.\159\
---------------------------------------------------------------------------

    \159\ Id.
---------------------------------------------------------------------------

    In terms of enforcing an internal control structure, the Commission 
requested comment on the following factors:
     Controls designed to ensure that additional training is 
provided or discipline taken with respect to employees who fail to 
adhere to requirements imposed by the internal control structure; and
     Controls designed to ensure that a process is in place for 
employees to report failures to adhere to the internal control 
structure.\160\
---------------------------------------------------------------------------

    \160\ Id. at 33422-33423.
---------------------------------------------------------------------------

    In terms of documenting the internal control structure, the 
Commission asked for comment on whether there should be a factor 
relating to the level of written detail about the internal control 
structure that should be documented.\161\
---------------------------------------------------------------------------

    \161\ Id.
---------------------------------------------------------------------------

    A number of commenters addressed whether the Commission should 
prescribe factors as part of this rulemaking and, if so, the type of 
factors the Commission should prescribe.\162\ NRSROs urged the 
Commission to defer rulemaking and stated that the Commission should 
not prescribe factors.\163\ For example, one NRSRO stated that the 
Commission should defer rulemaking until it has the opportunity to 
determine through the examination process and its review of the NRSROs' 
annual reports the ``best practices utilized'' by NRSROs to comply with 
the self-executing requirement in section 15E(c)(3)(A) and that the 
Commission's ``examination feedback regarding best practices related to 
internal controls will be an important element for the adequate design 
and monitoring of internal controls.'' \164\ Another NRSRO stated that 
it ``strongly agrees'' with the Commission's proposal to defer 
rulemaking but that, if the Commission proceeds with rulemaking, it 
should ``exercise caution'' because attempting to create a ``one-size 
fits all'' rule in ``such a short timeframe could result in the 
creation of an anti-competitive environment and the attendant 
unintended consequences.'' \165\ A third NRSRO stated that ``NRSROs 
should have the flexibility to implement whatever control structure 
suits their size and particular business operations.'' \166\
---------------------------------------------------------------------------

    \162\ See AFSCME Letter; A.M. Best Letter; Better Markets 
Letter; CFA/AFR Letter; CFA II Letter; COPERA Letter; DBRS Letter; 
Kroll Letter; Levin Letter; Morningstar Letter; S&P Letter; 
TradeMetrics Letter.
    \163\ See A.M. Best Letter; DBRS Letter; Kroll Letter; 
Morningstar Letter; S&P Letter.
    \164\ See Morningstar Letter.
    \165\ See A.M. Best Letter (``prescribing specific factors 
implies that all NRSROs are the same, which they are not. NRSROs 
vary in size, ownership, business plans, and management. `Specific 
factors' would undoubtedly be designed to apply to the largest 
NRSROs--this scenario would create a disproportionate impact on 
smaller NRSROs, whose internal control structure would be best 
served by designing and implementing policies and procedures that 
apply the law to the specific characteristics of the NRSRO.'').
    \166\ See DBRS Letter.
---------------------------------------------------------------------------

    In contrast, several other commenters stated that the Commission 
should not defer rulemaking.\167\ For example, one commenter stated 
that the Commission ``already has significant information about the 
weak internal controls at the NRSROs and has already identified a 
number of factors critical to an effective internal control system'' 
and that ``[p]ostponing the issuance of any standards will result in 
the NRSROs developing different internal control

[[Page 55098]]

structures, making oversight and the implementation of minimum 
standards more difficult, time consuming, and expensive down the 
line.'' \168\ Another commenter stated that the proposed approach 
``will be ineffective in reforming credit rating agency practices and 
will leave the Commission with little if any ability to hold ratings 
agencies accountable if they adopt weak and ineffective controls.'' 
\169\ These commenters and others recommended that the Commission 
prescribe factors,\170\ and one of the commenters recommended that the 
Commission re-propose the rule to prescribe factors.\171\
---------------------------------------------------------------------------

    \167\ See AFR II Letter; AFSCME Letter; Better Markets Letter; 
CFA/AFR Letter; COPERA Letter; Levin Letter.
    \168\ See Levin Letter.
    \169\ See CFA/AFR Letter. See also CFA II Letter.
    \170\ See AFGI Letter; AFSCME Letter; Better Markets Letter; 
CFA/AFR Letter; COPERA Letter; Harrington Letter; Levin Letter; 
TradeMetrics Letter.
    \171\ See CFA II Letter
---------------------------------------------------------------------------

    One commenter discussed factors that the commenter believed should 
be included in ``a set of mandatory minimum standards for an effective 
internal control system for credit ratings.'' \172\ Another commenter 
stated that ``the criteria on which the Commission seeks comment are 
precisely the sort of controls that ought to be in place if the system 
is operating effectively.'' \173\ A third commenter agreed that the 
rule should ``incorporate all of these factors [as described in the 
proposing release].'' \174\ Two commenters pointed to the internal 
control framework developed by the Committee of Sponsoring 
Organizations of the Treadway Commission in 1992 as a model.\175\ Two 
commenters stated that the rule should require that the documentation 
of the internal control structure include specific elements, such as 
how the board of directors conducted its oversight of the internal 
control structure.\176\
---------------------------------------------------------------------------

    \172\ See Levin Letter.
    \173\ See CFA/AFR Letter.
    \174\ See Better Markets Letter.
    \175\ See CFA/AFR Letter; AFSCME Letter.
    \176\ See AFSCME Letter (stating that the NRSRO should be 
required to document: the control environment; risk assessment; 
control activities; and information and communication within the 
NRSRO); CFA/AFR Letter (stating that the NRSRO should be required to 
document: The design of the system of internal controls; the 
evidence obtained and conclusions reached during testing of the 
effectiveness of the internal controls; material weaknesses 
identified and how they were remediated; how the board of directors 
conducted its oversight; significant matters that arose in the 
design, operation, or monitoring of internal controls and how they 
were resolved; and the basis for reports to the Commission on the 
effectiveness of the internal control structure).
---------------------------------------------------------------------------

    The Commission believes it is critically important to investors and 
other users of credit ratings that, as required by section 15E(c)(3)(A) 
of the Exchange Act, NRSROs establish, maintain, enforce, and document 
an effective internal control structure governing the implementation of 
and adherence to their policies, procedures, and methodologies for 
determining credit ratings.\177\ The Commission agrees that the 
requirements established by the NRSROs to address the internal control 
structure should ``provide the companies' management the ability to 
effectively administer their internal compliance measures, and instill 
confidence in their investors and the public that the companies in fact 
are achieving the objectives of their internal control rules and, in so 
doing, promoting ratings that are high-quality, objective, independent, 
reliable, and free from influence by any conflicts of interest.'' \178\ 
This is one of the reasons that the Commission previously has expressed 
concerns about--and has taken action to address--the integrity of 
policies, procedures, and methodologies for determining credit ratings 
used by certain NRSROs in light of the role these NRSROs played in 
determining credit ratings for securities collateralized by or linked 
to subprime residential mortgages.\179\
---------------------------------------------------------------------------

    \177\ See 15 U.S.C. 78o-7(c)(3)(A).
    \178\ See CFA II Letter.
    \179\ See, e.g., Proposed Rules for Nationally Recognized 
Statistical Rating Organizations, 73 FR 36212; Amendments to Rules 
for Nationally Recognized Statistical Rating Organizations, 74 FR 
63832; 2008 Staff Inspection Report.
---------------------------------------------------------------------------

    Moreover, the Commission staff conducts annual examinations of each 
NRSRO and publishes a report summarizing the essential findings of the 
examinations, as required by section 15E(p)(3) of the Exchange 
Act.\180\ The annual report attributes the essential findings, as 
applicable, to the ``smaller'' NRSROs or ``larger'' NRSROs, and 
describes for the public the nature and extent of the deficiencies 
cited. The Commission staff, as part of the annual examination of each 
NRSRO, reviews whether the internal control structure of the NRSRO is 
effective as required by section 15E(c)(3)(A) of the Exchange Act.\181\
---------------------------------------------------------------------------

    \180\ See 15 U.S.C. 78o-7(p)(3).
    \181\ See 15 U.S.C. 78o-7(c)(3)(A). See also 15 U.S.C. 78o-
7(p)(3)(B) (requiring the Commission to review, among other things, 
whether the NRSRO conducts business in accordance with the policies, 
procedures, and rating methodologies of the NRSRO, the internal 
supervisory controls of the NRSRO, and the governance of the NRSRO).
---------------------------------------------------------------------------

    For example, in the annual report published in December 2013, the 
Commission staff noted that all NRSROs had ``added or improved internal 
controls over the rating process'' since the examinations began in 2010 
and generally improved adherence to their rating policies and 
procedures, which ``appear[ed] to be attributable, in part, to 
improvements in the internal control structure at NRSROs.'' \182\ 
However, in several instances the staff found that an NRSRO did not 
follow its policies and procedures and the staff recommended that the 
NRSRO improve its internal controls to ensure compliance with the 
policies and procedures.\183\ In particular, the Commission staff cited 
section 15E(c)(3)(A) of the Exchange Act in its report and stated that 
many NRSROs relied on a testing or internal audit program as an 
internal supervisory control.\184\ The staff then described certain 
weaknesses it found in those controls, and recommended that those 
NRSROs improve and better document their testing and audit 
programs.\185\
---------------------------------------------------------------------------

    \182\ See 2013 Annual Staff Inspection Report, p. 8.
    \183\ See, e.g., 2013 Annual Staff Inspection Report, p. 10 
(discussing Commission staff finding that an NRSRO did not 
consistently follow its policies and procedures for rating criteria 
development).
    \184\ See 2013 Annual Staff Inspection Report, p. 18.
    \185\ See id.
---------------------------------------------------------------------------

    Deficiencies in the internal control structure found by the 
examination staff are brought to the attention of the NRSRO, and the 
staff monitors whether and how those deficiencies are addressed. If 
warranted, the examination staff also can refer an NRSRO to the 
enforcement staff for potential violations of section 15E(c)(3)(A).
    Given the importance of the NRSROs' internal control structures, 
the Commission believes that an NRSRO should be required to consider 
the factors identified in the proposing release when establishing, 
maintaining, enforcing, and documenting an effective internal control 
structure. The exercise of considering these factors will provide the 
NRSROs with an opportunity to critically evaluate the effectiveness of 
their existing internal control structures and new registrants a 
reference point for designing or modifying existing internal control 
structures to comply with the statutory requirement. This should 
improve the overall effectiveness of the internal control structures of 
the NRSROs.
    Consequently, the Commission is adding paragraph (d) to new Rule 
17g-8 to provide that an NRSRO must consider certain factors when 
establishing, maintaining, enforcing, or documenting an effective 
internal control structure governing the implementation of and 
adherence to policies, procedures, and methodologies for determining 
credit ratings pursuant to section 15E(c)(3)(A) of the Act.\186\ The 
factors identified in this paragraph are

[[Page 55099]]

the same factors the Commission identified in the proposing 
release.\187\ Paragraph (d)(1) identifies the factors relating to 
establishing an effective internal control structure, paragraph (d)(2) 
identifies the factors relating to maintaining an effective internal 
control structure, and paragraph (d)(3) identifies the factors relating 
to enforcing an effective internal control structure.\188\
---------------------------------------------------------------------------

    \186\ See paragraph (d) of Rule 17g-8.
    \187\ See id. See also Nationally Recognized Statistical Rating 
Organizations, 76 FR at 33422-33423.
    \188\ See paragraphs (d)(1) through (3) of Rule 17g-8.
---------------------------------------------------------------------------

    In considering a given factor, an NRSRO should determine whether it 
would be appropriate for the firm's internal control structure. 
Moreover, paragraphs (d)(1), (d)(2), and (d)(3) contain a ``catchall'' 
provision that provides that the NRSRO must consider any other controls 
necessary to establish, maintain, or enforce an effective internal 
control structure taking into consideration the nature of the business 
of the NRSRO, including its size, activities, organizational structure, 
and business model. The Commission is including the catchall provisions 
because the factors identified in paragraph (d) of Rule 17g-8 may not 
be comprehensive or sufficient for the circumstances of a particular 
NRSRO. An NRSRO should not treat them as a checklist or ``safe harbor'' 
that allows the firm to conclude that it has established, maintained, 
enforced, and documented an effective internal control structure.
    Paragraph (d)(4) of Rule 17g-8 addresses the documentation of the 
internal control structure.\189\ In the proposing release, the 
Commission did not identify a factor relating to this provision of the 
statute.\190\ Consequently, paragraph (d)(4) does not identify a 
specific factor.\191\ Instead, the paragraph provides--consistent with 
the catchall provisions in paragraphs (d)(1) through (d)(3)--that an 
NRSRO must take into consideration any controls necessary to document 
an effective internal control structure taking into consideration the 
nature of the business of the nationally recognized statistical rating 
organization, including its size, activities, organizational structure, 
and business model.\192\
---------------------------------------------------------------------------

    \189\ See paragraph (d)(4) of Rule 17g-8.
    \190\ See Nationally Recognized Statistical Rating 
Organizations, 76 FR at 33421-33423.
    \191\ See paragraph (d)(4) of Rule 17g-8.
    \192\ Id.
---------------------------------------------------------------------------

    Finally, in adopting the final rule, the Commission has taken into 
account comments from NRSROs that it should not prescribe factors or 
``exercise caution'' in doing so because ``NRSROs should have the 
flexibility to implement whatever control structure suits their size 
and particular business operations'' \193\ and attempting to create a 
``one-size fits all'' rule in ``could result in the creation of an 
anti-competitive environment and the attendant unintended 
consequences.'' \194\ In particular, the Commission notes that, while 
the Commission is prescribing factors an NRSRO must consider, it is not 
mandating that a specific factor be implemented. Consequently, while 
NRSROs must consider the factors identified by the Commission, they can 
tailor their internal control structures to their particular 
circumstances.
---------------------------------------------------------------------------

    \193\ See DBRS Letter.
    \194\ See A.M. Best Letter (``prescribing specific factors 
implies that all NRSROs are the same, which they are not. NRSROs 
vary in size, ownership, business plans, and management. `Specific 
factors' would undoubtedly be designed to apply to the largest 
NRSROs--this scenario would create a disproportionate impact on 
smaller NRSROs, whose internal control structure would be best 
served by designing and implementing policies and procedures that 
apply the law to the specific characteristics of the NRSRO.'').
---------------------------------------------------------------------------

2. Amendment to Rule 17g-2
    Section 15E(c)(3)(A) of the Exchange Act contains a self-executing 
provision that requires an NRSRO, among other things, to document its 
internal control structure.\195\ However, the statute does not 
prescribe how an NRSRO must maintain this record. For example, the 
statute does not prescribe how long the record must be retained or the 
manner in which it must be maintained. Consequently, the Commission 
proposed adding paragraph (b)(12) to Rule 17g-2 to identify the 
internal control structure an NRSRO must document pursuant to 
15E(c)(3)(A) of the Exchange Act as a record that must be 
retained.\196\ As a result, the various retention and production 
requirements of paragraphs (c), (d), (e), and (f) of Rule 17g-2 would 
apply to the record documenting the internal control structure.\197\
---------------------------------------------------------------------------

    \195\ See 15 U.S.C. 78o-7(c)(3)(A).
    \196\ See proposed paragraph (b)(12) of Rule 17g-2; Nationally 
Recognized Statistical Rating Organizations, 76 FR at 33423, 33539.
    \197\ See 17 CFR 240.17g-2(c) through (f).
---------------------------------------------------------------------------

    Two commenters expressed support for the proposal,\198\ whereas 
three other commenters raised concerns which are discussed below.\199\ 
The Commission is adding paragraph (b)(12) to Rule 17g-2 as 
proposed.\200\ Retention of the record will provide a means for the 
Commission to monitor the NRSROs' compliance with 15E(c)(3)(A) of the 
Exchange Act.
---------------------------------------------------------------------------

    \198\ See DBRS Letter; S&P Letter.
    \199\ See AFSCME Letter; A.M.Best Letter; Lambert Letter.
    \200\ See paragraph (b)(12) of Rule 17g-2. Section 17(a)(1) of 
the Exchange Act requires an NRSRO to make and keep such records, 
and make and disseminate such reports, as the Commission prescribes 
by rule as necessary or appropriate in the public interest, for the 
protection of investors, or otherwise in furtherance of the Exchange 
Act. 15 U.S.C. 78q(a)(1).
---------------------------------------------------------------------------

    In addition, the Commission is amending paragraph (c) of Rule 17g-
2. Prior to today's amendments, this paragraph provided that the 
records required to be retained under paragraphs (a) and (b) of Rule 
17g-2 must be retained for three years after the date the record is 
made or received. The modification clarifies that the records 
documenting the internal control structure, the policies and procedures 
discussed in sections II.C., II.F., and II.J. of this release, and the 
standards discussed in section II.I. of this release must all be 
retained until three years after the record is replaced with an updated 
record (that is, when a control, policy, procedure, or standard 
documented in one of these records is replaced with a new control, 
policy, procedure, or standard).\201\
---------------------------------------------------------------------------

    \201\ See paragraph (c) of Rule 17g-2 (providing that the 
records required to be retained pursuant to paragraphs (a) and (b) 
of the rule must be retained for three years after the date the 
record is made or received, except that a record identified in 
paragraph (a)(9), (b)(12), (b)(13), (b)(14), or (b)(15) of the rule 
must be retained until three years after the date the record is 
replaced with an updated record).
---------------------------------------------------------------------------

    The reason for this clarifying amendment is that the text of 
paragraph (c) of Rule 17g-2 prior to today's amendment was intended to 
address records that generally contain historical information. For 
example, the rule requires the retention of records reflecting entries 
to and balances in all general ledger accounts, records indicating the 
identity of any credit analyst(s) that participated in determining a 
credit rating, credit analysis reports, credit assessment reports, and 
private credit rating reports.\202\ The intent of the three-year record 
retention requirement is to preserve these records documenting 
historical information for three years after the fact in order to allow 
Commission examiners the opportunity to review the past activities of 
the NRSRO as reflected in these records. It also provides the NRSRO 
with records that can be used in connection with internal or third-
party audits and for tracking past activities.
---------------------------------------------------------------------------

    \202\ See, e.g., 17 CFR 240.17g-2(a)(1), (a)(2)(i), and (b)(3).
---------------------------------------------------------------------------

    The Commission intended the three-year record retention provision 
in paragraph (c) of Rule 17g-2 as applied to the documentation of the 
internal control structure, the policies and

[[Page 55100]]

procedures, and the standards to also preserve historical information 
for three years after the fact to facilitate Commission examinations 
and NRSRO internal or third party audits of past activities. However, 
the record reflects current rather than historical information until 
there is an update of the internal control structure, policies and 
procedures, or standards documented in the record (that is, the record 
reflects the internal controls, policies and procedures, or standards, 
as applicable, that govern the NRSRO's conduct now and in the future). 
Consequently, because paragraph (c) of Rule 17g-2--prior to today's 
amendments--required a record ``to be retained for three years after 
the date the record is made or received,'' this provision as applied to 
the documentation of the internal control structure, policies and 
procedures, and standards would be ambiguous as to whether the record 
must be retained for three years after the information reflected in the 
record is no longer current.
    For example, section 15E(c)(3)(A) of the Exchange Act requires an 
NRSRO to document its internal control structure.\203\ This means that 
at all times the NRSRO must document the internal control structure 
that is in effect and, consequently, if a given version of an internal 
control structure is in effect for more than three years, the NRSRO 
must continue to maintain the record documenting the internal control 
structure even though three years have elapsed since the record was 
made. The clarifying text being added to paragraph (c) of Rule 17g-2 
addresses an ambiguity in the rule text. This ambiguity could be read 
to establish a three-year retention period that is largely meaningless 
and is inconsistent with the Commission's intent that these records be 
retained for three years after the information in the record is no 
longer current.\204\ Specifically, without the clarifying amendment, 
paragraph (c) of Rule 17g-2 could be read to provide that the three-
year retention period begins to run at the time the internal control 
structure was first documented. Under this reading, the rule would be 
redundant because it would prescribe a retention period that is already 
addressed by the self-executing requirement in section 15E(c)(3)(A) of 
the Exchange Act (that an NRSRO must document its internal control 
structure). In other words, the statutory requirement to document the 
internal control structure acts as a retention requirement for as long 
as the current version of the internal control structure is in effect. 
Further, under this reading of the rule, if an internal control 
structure was in effect for three or more years, an NRSRO could discard 
the record documenting the previous internal control structure as soon 
as it is replaced with an updated record documenting the revised 
internal control structure (as it would have retained the previous 
record of the internal control structure for three or more years). This 
could prevent the Commission from reviewing whether the NRSRO adhered 
to its previous internal control structure, as examinations generally 
review past activities. The appropriate and intended retention period 
is until three years after the internal control structure is updated. 
As a result, the documentation recording the current internal control 
structure and the documentation recording any prior versions of the 
internal control structure that were updated within three years will be 
available to Commission examiners. This will create an audit trail 
between prior versions of the internal control structure and the 
existing internal control structure. For these reasons, the Commission 
is amending paragraph (c) of Rule 17g-2 to make clear that the records 
documenting the internal control structure, the policies and 
procedures, and the standards must be retained until three years after 
the date the record is replaced with an updated record.\205\
---------------------------------------------------------------------------

    \203\ See 15 U.S.C. 78o-7(c)(3)(A).
    \204\ See paragraph (c) of Rule 17g-2 (providing that the 
records must be retained until three years after the date the record 
is replaced with an updated record).
    \205\ See sections II.C.2., II.F.2., II.I.2., and II.J.2. 
(discussion the amendments to Rule 17g-2 to establish record 
retention requirements for the records documenting policies and 
procedures or standards).
---------------------------------------------------------------------------

    One commenter stated that a three-year retention period is 
``insufficient,'' since ``the effects of a credit rating decision may 
not arise until after that retention period expires.'' \206\ The 
Commission believes the three year retention period is sufficient. 
First, as noted above, an NRSRO must maintain a record documenting its 
existing internal control structure for as long as the internal control 
structure is in effect and for an additional three years after the 
record is replaced with an updated record documenting the internal 
control structure. Second, the Commission staff performs an annual 
examination of each NRSRO. Consequently, the record documenting an 
internal control structure that is no longer in effect will be 
available for several exam cycles.
---------------------------------------------------------------------------

    \206\ See Lambert Letter. This commenter also suggested that the 
final amendments mandate record retention requirements of seven 
years, ``similar to section 802 of the Sarbanes-Oxley Act.''
---------------------------------------------------------------------------

    Another commenter suggested requiring that documentation be made 
available to the Commission ``regardless of where the credit rating is 
produced.'' \207\ The Commission notes that under the rules, regardless 
of where a credit rating is produced, an NRSRO must document its 
internal control structure and produce to Commission staff the records 
documenting both its current internal control structure and any prior 
versions of the internal control structure that are within the three-
year retention period.\208\
---------------------------------------------------------------------------

    \207\ See AFSCME Letter.
    \208\ See 15 U.S.C. 78o-7(c)(3)(A). See also paragraph (d) of 
Rule 17g-2, which requires, among other things, that an NRSRO 
maintain each record identified in paragraphs (a) and (b) in a 
manner that makes the original record or copy easily accessible to 
the principal office of the NRSRO. 17 CFR 240.17g-2(d).
---------------------------------------------------------------------------

    A third commenter stated that the requirement to document internal 
controls is burdensome, particularly for smaller NRSROs, and argued 
that documenting policies and procedures ``naturally coincide with the 
establishment of a properly functioning internal controls structure,'' 
which the NRSRO should be allowed to establish on its own, and the 
commenter urged the Commission to exclude ``extensive or overly-
inclusive documentation requirements'' should it adopt new paragraph 
(b)(12) of Rule 17g-2.\209\ In response, the Commission notes that 
section 15E(c)(3)(A)--not Rule 17g-2--requires an NRSRO to document its 
internal control structure.\210\ The amendment to Rule 17g-2 
establishes retention requirements for this documentation.
---------------------------------------------------------------------------

    \209\ See A.M. Best Letter.
    \210\ See 15 U.S.C. 78o-7(c)(3)(A).
---------------------------------------------------------------------------

3. Amendments to Rule 17g-3
    Section 15E(c)(3)(B) of the Exchange Act provides that the 
Commission shall prescribe rules requiring an NRSRO to submit an annual 
internal controls report to the Commission, which must contain: (1) A 
description of the responsibility of management in establishing and 
maintaining an effective internal control structure; (2) an assessment 
of the effectiveness of the internal control structure; and (3) the 
attestation of the CEO or equivalent individual.\211\
---------------------------------------------------------------------------

    \211\ See 15 U.S.C. 78o-7(c)(3)(B)(i) through (iii).
---------------------------------------------------------------------------

    The Commission proposed amending Rule 17g-3 to implement the 
rulemaking mandated by section 15E(c)(3)(B) of the Exchange Act.\212\

[[Page 55101]]

Rule 17g-3 requires an NRSRO to furnish annual reports to the 
Commission.\213\ In particular, before today's amendments, paragraph 
(a) of Rule 17g-3 required an NRSRO to furnish five or, in some cases, 
six separate reports within ninety days after the end of the NRSRO's 
fiscal year and identified the reports that must be furnished.\214\ The 
first report containing the NRSRO's financial statements must be 
audited; the remaining reports on revenues and other matters may be 
unaudited.\215\ Before today's amendments, paragraph (b) of Rule 17g-3 
provided that the NRSRO must attach to the reports a signed statement 
by a duly authorized person that the person has responsibility for the 
reports and, to the best knowledge of the person, the reports fairly 
present, in all material respects, the information contained in the 
reports.\216\
---------------------------------------------------------------------------

    \212\ See Nationally Recognized Statistical Rating 
Organizations, 76 FR at 33423-33425; 15 U.S.C. 78o-7(c)(3)(B)(i) 
through (iii). In addition, as a technical amendment, the Commission 
proposed to amend the title of Rule 17g-3 to replace the words 
``financial reports'' with the words ``financial and other 
reports.'' Nationally Recognized Statistical Rating Organizations, 
76 FR at 33424, n.25. The Commission stated that the report 
identified in paragraph (a)(6) of Rule 17g-3, the proposed internal 
control report that would be required under paragraph (a)(7), and 
the compliance report that would be required under paragraph (a)(8) 
(which is discussed below in section II.K. of this release) are not 
financial in nature. Id. The Commission also proposed adding the 
word ``filed'' in the title of Rule 17g-3 to conform to amendments 
the Dodd-Frank Act made to section 15E of the Exchange Act. See 
Public Law 111-203, 932(a).
    \213\ See 17 CFR 240.17g-3.
    \214\ See Nationally Recognized Statistical Rating 
Organizations, 76 FR at 33423.
    \215\ See id.
    \216\ See id.
---------------------------------------------------------------------------

    The proposed amendments would add paragraph (a)(7) to Rule 17g-3 to 
require an NRSRO to file an additional report--which would be 
unaudited--with its annual submission of reports pursuant to Rule 17g-
3.\217\ The proposed rule text describing the report that would need to 
be filed closely mirrored the statutory text.\218\ In particular, 
proposed paragraph (a)(7) would have required that the internal 
controls report contain: (1) A description of the responsibility of 
management in establishing and maintaining an effective internal 
control structure; and (2) an assessment by management of the 
effectiveness of the internal control structure.\219\
---------------------------------------------------------------------------

    \217\ See paragraph (a)(7) of Rule 17g-3, as proposed; 
Nationally Recognized Statistical Rating Organizations, 76 FR at 
33539. As discussed below, while the report will not be audited, it 
will be reviewed by Commission examination staff.
    \218\ Compare paragraph (a)(7) of Rule 17g-3, as proposed, with 
15 U.S.C. 78o-7(c)(3)(B)(i) through (ii).
    \219\ See paragraph (a)(7) of Rule 17g-3, as proposed; 
Nationally Recognized Statistical Rating Organizations, 76 FR at 
33539.
---------------------------------------------------------------------------

    Section 15E(c)(3)(B)(iii) of the Exchange Act provides that the 
annual internal controls report must contain an attestation of the 
NRSRO's CEO or equivalent individual.\220\ Accordingly, the Commission 
proposed amending paragraph (b) of Rule 17g-3 to require that the NRSRO 
attach to the report a signed statement by the CEO or, if the firm does 
not have a CEO, an individual performing similar functions.\221\
---------------------------------------------------------------------------

    \220\ See 15 U.S.C. 78o-7(c)(3)(B)(iii).
    \221\ See paragraph (b) of Rule 17g-3, as proposed; Nationally 
Recognized Statistical Rating Organizations, 76 FR at 33539. In 
particular, the Commission proposed re-organizing paragraph (b) of 
Rule 17g-3 into paragraphs (b)(1) and (b)(2). As proposed, paragraph 
(b)(1) would contain the current requirement that the NRSRO must 
attach to each of the annual reports required pursuant to paragraphs 
(a)(1) through (6) a signed statement by a duly authorized person 
associated with the NRSRO stating that the person has responsibility 
for the financial reports and, to the best knowledge of the person, 
the reports fairly present, in all material respects, the 
information required to be contained in the reports. As proposed, 
paragraph (b)(2) of Rule 17g-3 would require that the NRSRO attach 
to the report filed pursuant to paragraph (a)(7) a signed statement 
by the CEO of the NRSRO or, if the NRSRO does not have a CEO, an 
individual performing similar functions, stating that the CEO or 
individual has responsibility for the report and, to the best 
knowledge of the CEO or other individual, the report fairly 
presents, in all material respects, a description of the 
responsibility of management in establishing and maintaining an 
effective internal control structure and an assessment of the 
effectiveness of the internal control structure.
---------------------------------------------------------------------------

    The Commission is adding paragraphs (a)(7) and (b)(2) to Rule 17g-3 
with modifications from the proposal in response to comments.\222\ As 
discussed below, the modifications to the text of paragraph (a)(7) are 
designed to provide more guidance to NRSROs on the information that 
must be included in the report compared to the proposed rule text, 
which--as noted above--closely mirrored the statutory text.
---------------------------------------------------------------------------

    \222\ See paragraph (a)(7) of Rule 17g-3. The amendments to Rule 
17g-3 also replace the phrase ``financial reports'' with the phrase 
``financial and other reports'' and replace the phrase ``to be 
furnished'' with the phrase ``to be filed or furnished.'' These 
amendments are being adopted as proposed.
---------------------------------------------------------------------------

    Paragraph (a)(7)--as proposed and adopted--requires an NRSRO to 
include in the report a description of the responsibility of management 
in establishing and maintaining an effective internal control 
structure.\223\ This rule text largely mirrors the statutory text.\224\ 
A number of commenters addressed the level of management that should 
have primary responsibility for establishing and maintaining an 
effective internal control structure and for assessing its 
effectiveness.\225\ An NRSRO stated that the CEO (or equivalent) and 
other management, supervisory, and compliance personnel affiliated with 
the NRSRO should be responsible for designing the structure, and that 
the board of directors should oversee the structure.\226\ Two other 
commenters stated that the board of directors should oversee the 
structure.\227\ An NRSRO stated that the wording in the proposed rule 
was reasonable, but that the Commission should refrain from specifying 
which level of management should be responsible for establishing and 
maintaining the system and that this determination ``is best left to 
each NRSRO based upon its business needs and organization.'' \228\ 
Similarly, another NRSRO stated that management and board oversight of 
the internal control structure will vary greatly between each NRSRO 
and, therefore, such determinations should be left to each NRSRO.\229\ 
On the other hand, a commenter suggested that management should have no 
part in the establishment or maintenance of an internal control 
structure, and that a committee of analysts should assess the 
effectiveness of the NRSRO's internal control structure.\230\
---------------------------------------------------------------------------

    \223\ See paragraph (a)(7)(i)(A) of Rule 17g-3.
    \224\ Compare paragraph (a)(7)(i)(A) of Rule 17g-3, with 15 
U.S.C. 78o-7(c)(3)(B)(i).
    \225\ See AFSCME Letter; CFA/AFR Letter; Harrington Letter; 
Kroll Letter; Morningstar Letter; S&P Letter.
    \226\ See Morningstar Letter.
    \227\ See AFSCME Letter; CFA/AFR Letter.
    \228\ See S&P Letter.
    \229\ See Kroll Letter.
    \230\ See Harrington Letter (suggesting the formation of a 
``Committee Assessment Function'' that would be ``devoted solely to 
evaluating the committee performance over the course of a year of 
all members regardless of title'' and would ``bypass management 
entirely and report directly to a board member tasked with sole 
responsibility for this function'').
---------------------------------------------------------------------------

    In response to these comments, the Commission notes that section 
15E(t)(3)(C) of the Exchange Act prescribes a self-executing 
requirement that the board of directors of the NRSRO shall ``oversee'' 
the ``effectiveness of the internal control system with respect to the 
policies and procedures for determining credit ratings. '' \231\ 
Moreover, as discussed above, the self-executing provision in section 
15E(c)(3)(A) requires an NRSRO to establish, maintain, enforce, and 
document an effective internal control structure.\232\ Further, section 
15E(c)(3)(B) of the Exchange Act refers, in pertinent part, to ``a 
description of the responsibility of the management of the [NRSRO] in 
establishing and maintaining an effective internal control

[[Page 55102]]

structure.'' \233\ Moreover, this section of the statute also provides 
that the annual internal controls report--which must include an 
assessment of the effectiveness of the internal control structure--must 
contain an attestation of the NRSRO's CEO or equivalent 
individual.\234\ Consequently, a reasonable interpretation of these 
statutory provisions is that they allocate responsibility to the 
NRSRO's board to ``oversee'' the effectiveness of the internal control 
structure and responsibility to the NRSRO's management to establish, 
maintain, enforce, and document the internal control structure and to 
report annually on its effectiveness. This interpretation also is 
consistent with the Commission's understanding of how the 
responsibilities of a firm's board and management generally are 
allocated.
---------------------------------------------------------------------------

    \231\ See 15 U.S.C. 78o-7(t)(3)(A).
    \232\ See 15 U.S.C. 78o-7(c)(3)(A).
    \233\ See 15 U.S.C. 78o-7(c)(3)(B)(i).
    \234\ See 15 U.S.C. 78o-7(c)(3)(B)(ii) and (iii).
---------------------------------------------------------------------------

    While it is the responsibility of management to establish, 
maintain, enforce, and document the internal control structure, in 
carrying out this responsibility management could, as a matter of good 
practice, consider the extent to which other persons within the NRSRO 
should be involved.\235\ For example, management could seek input from 
persons within the NRSRO that carry out the day-to-day functions 
related to governing the implementation of and adherence to policies, 
procedures, and methodologies for determining credit ratings. This 
could include input from persons responsible for determining credit 
ratings, developing rating methodologies, and reviewing and monitoring 
the NRSRO's compliance with its policies, procedures, and 
methodologies. In addition, establishing a mechanism for persons within 
the NRSRO to report, on a confidential basis if they choose, directly 
to the board of directors any material weaknesses in the NRSRO's 
internal control structure could be a useful check on management's 
annual assessment of the effectiveness of the internal control 
structure and could assist the board in its responsibility to oversee 
the effectiveness of the internal control structure. Finally, an NRSRO 
could consider developing procedures to identify and address internal 
conflicts of interest that potentially could prevent an independent, 
impartial, and unbiased assessment of the effectiveness of the internal 
control structure. This could promote more accurate reporting by the 
NRSRO on the internal control structure.
---------------------------------------------------------------------------

    \235\ See Harrington Letter; Morningstar Letter.
---------------------------------------------------------------------------

    In addition to the description of the responsibility of management 
in establishing and maintaining an effective internal control 
structure, the proposal required that the internal controls report 
include ``an assessment by management of the effectiveness of the 
internal control structure.'' \236\ As discussed in more detail below, 
several commenters stated that the Commission should strengthen the 
reporting requirement in the rule relating to the assessment of the 
effectiveness of the internal control structure.\237\
---------------------------------------------------------------------------

    \236\ See Nationally Recognized Statistical Rating 
Organizations, 76 FR at 33539. This provision of the proposed 
amendment largely mirrored the statutory text. See 15 U.S.C. 78o-
7(c)(3)(B)(ii).
    \237\ See AFSCME Letter; CFA/AFR Letter. These two commenters 
stated that the rule should require reporting on: (1) The period of 
time to which management's assessment relates, which should be the 
entire year; (2) the benchmark or framework used in assessing 
internal controls, as well as the definition of internal control 
used; (3) the statement that the board of directors is responsible 
for overseeing the system of internal controls; (4) if a material 
weakness was detected during the year, a description of that 
material weakness and whether it has been remediated (and how) as of 
the end of that year; and (5) non-compliance with applicable laws 
and regulations that have been identified, consistent with the 
Yellow Books standard of the General Accounting Office (``GAO'').
---------------------------------------------------------------------------

    The Commission is persuaded that the proposal should be modified to 
provide more clarity on the information that must be reported in the 
internal controls report. In particular, paragraph (a)(7) of Rule 17g-
3, as adopted, requires that the internal controls report include (in 
addition to a description of the responsibility of management in 
establishing and maintaining an effective internal control structure): 
(1) A description of each material weakness in the internal control 
structure identified during the fiscal year, if any, and a description, 
if applicable, of how each identified material weakness was addressed; 
and (2) a statement as to whether the internal control structure was 
effective as of the end of the fiscal year.\238\ Consequently, the 
final amendment provides more specificity as to the information that 
must be included in the internal controls report in terms of assessing 
the effectiveness of the NRSRO's internal control structure.\239\
---------------------------------------------------------------------------

    \238\ See paragraph (a)(7)(i) of Rule 17g-3.
    \239\ See paragraphs (a)(7)(i)(B) and (C) of Rule 17g-3. As 
discussed above, the proposal would have required the report to 
include an ``assessment by management of the effectiveness of the 
internal control report.'' See Nationally Recognized Statistical 
Rating Organizations, 76 FR at 33539. This more general description 
of what must be contained in the internal controls report is being 
moved to the prefatory text of paragraph (a)(7)(i) of Rule 17g-3.
---------------------------------------------------------------------------

    Further, in response to comments that the rule should specify that 
the assessment covers the entire year, the Commission has made several 
modifications to the proposal.\240\ Specifically, the prefatory text of 
paragraph (a)(7)(i) of Rule 17g-3, as amended, provides that the 
internal controls report must contain an assessment by management of 
the effectiveness during the fiscal year of the internal control 
structure.\241\ The amendment further requires that the report must 
include a description of each material weakness in the internal control 
structure identified during the fiscal year, if any, and a description, 
if applicable, of how each identified material weakness was 
addressed.\242\ Consequently, the reporting relating to material 
weaknesses must cover the entire fiscal year. The amendment also 
requires that the internal controls report contain a statement as to 
whether the internal control structure was effective as of the end of 
the fiscal year.\243\ Thus, this statement in the report relates to a 
point in time: The fiscal year end. However, the assessment of whether 
the internal control structure is effective as of the fiscal year end 
will depend on how the NRSRO addressed any material weaknesses 
identified during the fiscal year.\244\
---------------------------------------------------------------------------

    \240\ See AFSCME Letter; CFA/AFR Letter.
    \241\ See paragraph (a)(7)(i) of Rule 17g-3 (emphasis added).
    \242\ See paragraph (a)(7)(i)(B) of Rule 17g-3 (emphasis added). 
The Commission expects the description to include the nature and the 
duration of the material weakness.
    \243\ See paragraph (a)(7)(i)(C) of Rule 17g-3 (emphasis added).
    \244\ As discussed below, paragraph (a)(7)(ii) of Rule 17g-3 
provides that management is not permitted to conclude that the 
internal control structure was effective as of the end of the fiscal 
year if there were one or more material weaknesses in the internal 
control structure as of the end of the fiscal year.
---------------------------------------------------------------------------

    Commenters also addressed how to assess the internal control 
structure. One commenter pointed to the internal control framework 
developed by the Committee of Sponsoring Organizations (``COSO'') of 
the Treadway Commission in 1992 as a model.\245\ Another commenter 
stated that the Commission should establish a framework against which 
the internal controls of an NRSRO can be measured that would identify 
the objectives of the controls, set forth mandatory minimum components, 
and specify how a material weakness would be handled.\246\ Some 
commenters suggested that the Commission clarify how an NRSRO should 
assess whether its internal

[[Page 55103]]

control structure is effective.\247\ One of these commenters suggested 
the Commission lay out a basic definition of internal control and the 
objectives the internal controls are designed to achieve but did not 
provide a suggested definition.\248\ An NRSRO suggested that the 
Commission clarify that ``an `effective' internal control structure is 
one that is `reasonably designed' to achieve its purposes.'' \249\ In 
contrast, another NRSRO stated that the proposed reporting requirement 
is ``sufficiently explicit'' and that ``additional guidance is not 
needed.''\250\ This commenter added that each NRSRO operates in its own 
unique way and that prescribing more detailed rules ``may not be 
appropriate for every NRSRO in every situation.''\251\
---------------------------------------------------------------------------

    \245\ See CFA/AFR Letter (stating that the Commission should use 
the COSO framework as a basis for evaluating and inspecting the 
assessment of internal controls and the control structure on which 
management will report).
    \246\ See Levin Letter.
    \247\ See CFA/AFR Letter; DBRS Letter.
    \248\ See CFA/AFR Letter.
    \249\ See DBRS Letter.
    \250\ See S&P Letter.
    \251\ Id.
---------------------------------------------------------------------------

    The Commission agrees that providing more clarity as to when 
management of the NRSRO is not permitted to conclude that its internal 
control structure is effective would strengthen the requirement and 
provide greater certainty to NRSROs in terms of how to assess the 
effectiveness of the internal control structure.\252\ The Commission 
therefore is modifying the proposal to add a provision specifying when 
the NRSRO is not permitted to conclude that its internal control 
structure is effective.\253\ In particular, the final amendment 
provides that management of the NRSRO is not permitted to conclude that 
the internal control structure of the NRSRO was effective as of the end 
of the fiscal year if there were one or more material weaknesses in the 
internal control structure as of the end of the fiscal year.\254\
---------------------------------------------------------------------------

    \252\ See, e.g., CFA/AFR Letter; DBRS Letter. The Commission 
provided such guidance when it recently adopted a new reporting 
requirement for broker-dealers pursuant to which certain types of 
broker-dealers must file a compliance report that contains, among 
other statements, a statement as to whether the broker-dealer's 
internal control over compliance with certain rules was effective. 
See Broker-Dealer Reports, Exchange Act Release No. 70073 (July 30, 
2013), 78 FR 51910, 51916-51920 (Aug. 21, 2013). See also 17 CFR 
240.17a-5(d)(3). The reporting requirement contains provisions 
prescribing when a broker-dealer is not permitted to conclude that 
its internal control over compliance with these rules was effective.
    \253\ See paragraph (a)(7)(ii) of Rule 17g-3.
    \254\ Id.
---------------------------------------------------------------------------

    Commenters suggested several definitions of the term material 
weakness. For example, one commenter suggested that material weakness 
be defined as a ``serious deficiency that would prevent or in fact did 
prevent the internal controls from achieving their objective.'' \255\ 
Another commenter described a material weakness as ``a serious 
deficiency in an internal control that would prevent it from achieving 
its objective.'' \256\ Similarly, a third commenter stated that a 
definition of material weakness should be one ``which clearly sets out 
what would be a serious deficiency in internal controls that would 
prevent the internal controls from achieving their objective.'' \257\ 
An NRSRO requested that the Commission provide guidance as to what 
constitutes a material weakness and suggested that a material weakness 
be defined as a ``deficiency, or combination of deficiencies, in 
internal controls where it is more likely than not that the integrity 
of the rating process will be compromised by the failure to follow the 
NRSRO's policies, procedures, and methodologies.'' \258\ This commenter 
also stated that it believed that one of the objectives of the internal 
control structure is to ``provide reasonable assurance regarding the 
prevention or timely detection of actions that could have a material 
effect on the integrity of credit ratings.'' \259\ On the other hand, 
another NRSRO stated that the Commission should allow NRSROs to define 
material weakness and other terms.\260\
---------------------------------------------------------------------------

    \255\ See CFA/AFR Letter.
    \256\ See Levin Letter.
    \257\ See COPERA Letter.
    \258\ See Morningstar Letter (also stating that, ``[t]o the 
extent the CEO's report requires a discussion of internal control 
deficiencies, this discussion should be limited to material 
deficiencies that prevent management from concluding its internal 
structure is effective, which is consistent with the Commission's 
requirement for reports related to internal controls over financial 
reporting.'').
    \259\ See Morningstar Letter.
    \260\ See S&P Letter.
---------------------------------------------------------------------------

    The Commission is persuaded that including a description of a 
material weakness in paragraph (a)(7) of Rule 17g-3 will strengthen the 
reporting requirement and provide greater certainty to NRSROs in terms 
of how to assess the effectiveness of the internal control structure. 
Consequently, the paragraph, as adopted, includes a description of when 
a material weakness exists.\261\ This description is based, in part, on 
suggestions by commenters and on recent amendments to the broker-dealer 
reporting rule.\262\ The description of material weakness in the rule 
incorporates the concept of a deficiency in the internal control 
structure of the NRSRO.\263\ Consequently, paragraph (a)(7) of Rule 
17g-3 also includes a description of when a deficiency in the internal 
control structure exists.\264\ Under the requirements of the paragraph, 
the first step is to determine whether there are deficiencies in the 
internal control structure. If so, the second step is to determine 
whether a material weakness exists in light of the identified 
deficiencies.
---------------------------------------------------------------------------

    \261\ See paragraph (a)(7)(iv) of Rule 17g-3.
    \262\ See Broker-Dealer Reports, 78 FR at 51916-51920; 17 CFR 
240.17a-5(d)(3).
    \263\ See paragraph (a)(7)(iv) of Rule 17g-3.
    \264\ See paragraph (a)(7)(iii) of Rule 17g-3.
---------------------------------------------------------------------------

    The description in paragraph (a)(7) of Rule 17g-3 of when a 
deficiency exists is based on the control objectives set forth in 
section 15E(c)(3)(A) of the Exchange Act.\265\ This self-executing 
provision specifies that the internal control structure must 
effectively govern the implementation of and adherence to the NRSRO's 
policies, procedures, and methodologies for determining credit ratings. 
In other words, the controls must be designed to achieve the following 
objectives: (1) That the NRSRO implements policies, procedures, and 
methodologies for determining credit ratings in accordance with its 
policies and procedures; and (2) that the NRSRO determines credit 
ratings in accordance with its policies, procedures, and methodologies 
for determining credit ratings. Given these control objectives, the 
paragraph provides that a deficiency in the internal control structure 
exists when the design or operation of a control does not allow 
management or employees of the NRSRO, in the normal course of 
performing their assigned functions, to prevent or detect a failure of 
the NRSRO to: (1) Implement a policy, procedure, or methodology for 
determining credit ratings in accordance with its policies and 
procedures; or (2) adhere to an implemented policy, procedure, or 
methodology for determining credit ratings.\266\
---------------------------------------------------------------------------

    \265\ See 15 U.S.C. 78-o7(c)(3)(A) (requiring that the internal 
control structure govern the ``implementation of and adherence to 
[the NRSRO's] policies, procedures, and methodologies for 
determining credit ratings'').
    \266\ See paragraph (a)(7)(iii) of Rule 17g-3.
---------------------------------------------------------------------------

    The existence of a deficiency in the internal control structure, 
however, does not necessarily mean that a material weakness exists. 
Even a well-designed internal control structure cannot guarantee that a 
deficiency will never occur. Therefore, paragraph (a)(7) of Rule 17g-3 
provides that a material weakness exists if a deficiency, or a 
combination of deficiencies, in the design or operation of the internal 
control structure creates a reasonable possibility that a failure 
identified in the description of deficiency (that is, a failure of the 
NRSRO to implement a policy, procedure, or methodology for

[[Page 55104]]

determining credit ratings in accordance with its policies and 
procedures or to adhere to a policy, procedure, or methodology for 
determining credit ratings) that is material will not be prevented or 
detected on a timely basis.\267\
---------------------------------------------------------------------------

    \267\ See paragraph (a)(7)(iv) of Rule 17g-3.
---------------------------------------------------------------------------

    In the proposing release, the Commission asked whether the internal 
controls report should be made public.\268\ One commenter stated that 
the internal controls report should be made publicly available.\269\ 
The commenter stated that making the report public would enable users 
of credit ratings ``to evaluate the effectiveness of [the] rating 
agency's internal control structure and consider what impact, if any, 
it may have on the quality of the credit ratings the NRSRO produces.'' 
\270\ On the other hand, three commenters--all NRSROs--stated that the 
report should be kept confidential (as are the other reports submitted 
to the Commission under Rule 17g-3).\271\ One NRSRO stated that 
publicizing the reports could make them less informative and more 
defensive in nature, limiting their effectiveness.\272\ A second NRSRO 
stated that ``[m]anagement reports to the board (including an annual 
report, which would also be filed with the Commission) are likely to be 
key elements of the board's ability to oversee the effectiveness of the 
internal control structure'' and ``[s]ince board oversight will be 
promoted by open and free dialogue with management, the Commission 
should not impede such communication when imposing requirements that 
make some or all parts of such management reports publicly available.'' 
\273\ A third NRSRO stated that the reports may contain proprietary or 
confidential information pertaining to the activities of the 
NRSRO.\274\
---------------------------------------------------------------------------

    \268\ See Nationally Recognized Statistical Rating 
Organizations, 76 FR at 33425.
    \269\ See CII Letter.
    \270\ Id.
    \271\ See DBRS Letter; Kroll Letter; S&P Letter.
    \272\ See DBRS Letter (also arguing that nothing in the Dodd-
Frank Act suggests the intent of Congress was to make the reports 
public and that there is no precedent under federal securities laws 
to force a private company to publicize information of this kind, 
and that users of credit ratings already have access to much 
information on NRSROs on which to make informed use of ratings, 
including how they formulate credit opinions and the historical 
performance of those opinions).
    \273\ See Kroll Letter.
    \274\ See S&P Letter.
---------------------------------------------------------------------------

    The Commission is adopting the amendment as proposed and, 
therefore, is not requiring that the internal controls report be made 
public. The final amendment is intended to assist the Commission in 
examining and monitoring the effectiveness of the internal control 
structures of NRSROs and how the structures evolve and improve over 
time.\275\ Making the reports public--as suggested by one commenter--
could cause NRSROs to make them less detailed and candid.\276\ In 
appropriate cases, if an NRSRO fails to establish, maintain, enforce, 
and document an effective internal control structure, the Commission 
could institute enforcement proceedings, at which point the allegations 
related to the internal control structure would be a matter of public 
record.
---------------------------------------------------------------------------

    \275\ See Nationally Recognized Statistical Rating 
Organizations, 76 FR at 33513.
    \276\ See DBRS Letter.
---------------------------------------------------------------------------

    One commenter suggested the report be subjected to a third-party 
audit attesting to the report's reliability.\277\ As stated above, the 
final amendment does not require that the internal controls report be 
made public. Consequently, the report is not a public document that 
will be relied upon by investors and other users of credit ratings. 
Rather, it is a non-public report that will be used by Commission 
examiners as part of their monitoring of NRSROs' compliance with the 
requirement in section 15E(c)(3)(A) of the Exchange Act to establish, 
maintain, enforce, and document an effective internal control 
structure. The Commission has taken these factors into consideration in 
balancing the benefits of having the internal controls report audited 
by a third party and the costs of such a requirement. The Commission 
examines each of the ten NRSROs currently registered with the 
Commission annually. At this time, the Commission believes that the 
annual examinations by the Commission staff will provide a sufficient 
means for reviewing the accuracy of the internal controls reports filed 
by the NRSROs.
---------------------------------------------------------------------------

    \277\ See Levin Letter.
---------------------------------------------------------------------------

    In order to implement section 15E(c)(3)(B)(iii) of the Exchange 
Act, the Commission is adopting the amendment to paragraph (b) of Rule 
17g-3 with modifications to correspond to the modifications to 
paragraph (a)(7) discussed above.\278\ Specifically, as proposed, 
paragraph (b)(2) of Rule 17g-3 would require that the NRSRO attach to 
the internal controls report filed pursuant to paragraph (a)(7) a 
signed statement by the CEO of the NRSRO or, if the NRSRO does not have 
a CEO, an individual performing similar functions, stating, in 
pertinent part, that the report fairly presents, in all material 
respects, a description of the responsibility of management in 
establishing and maintaining an effective internal control structure 
and an assessment of the effectiveness of the internal control 
structure.\279\ As discussed above, under the final amendments, 
paragraph (a)(7) of Rule 17g-3 provides that the report must contain a 
description of each material weakness in the internal control structure 
identified during the fiscal year, if any, and a description, if 
applicable, of how each material weakness was addressed, and an 
assessment by management of the effectiveness of the internal control 
structure as of the end of the fiscal year.\280\ Consequently, under 
the final amendments, paragraph (b)(2) of Rule 17g-3 provides that the 
CEO or individual performing similar functions must state, in pertinent 
part, that the internal controls report fairly presents, in all 
material respects: An assessment by management of the effectiveness of 
the internal control structure during the fiscal year that includes a 
description of the responsibility of management in establishing and 
maintaining an effective internal control structure; a description of 
each material weakness in the internal control structure identified 
during the fiscal year, if any; a description, if applicable, of how 
each identified material weakness was addressed; and an assessment by 
management of the effectiveness of the internal control structure as of 
the end of the fiscal year.\281\
---------------------------------------------------------------------------

    \278\ See paragraph (b)(2) of Rule 17g-3. See also 15 U.S.C. 
78o-7(c)(3)(B)(iii) (providing, in pertinent part, that the 
Commission shall prescribe rules requiring each NRSRO to submit to 
the Commission an internal controls report, which shall contain the 
attestation of the CEO, or equivalent individual, of the NRSRO).
    \279\ See Nationally Recognized Statistical Rating 
Organizations, 76 FR at 33539.
    \280\ See paragraph (a)(7)(i) of Rule 17g-3.
    \281\ See paragraph (b)(2) of Rule 17g-3.
---------------------------------------------------------------------------

4. Economic Analysis
    This section builds on the economic analysis in section I.B. of 
this release by presenting a focused analysis of the potential economic 
effects that may derive from the specific amendments relating to 
reporting on internal control structures.\282\ The baseline that 
existed before today's amendments was one in which NRSROs must 
establish, maintain, enforce, and document an effective internal 
control structure governing the implementation of and adherence to 
their methodologies for determining credit ratings.\283\ In

[[Page 55105]]

addition, section 15E(t)(3)(C) of the Exchange Act requires the board 
of directors of the NRSRO to ``oversee'' the ``effectiveness of the 
internal control system with respect to policies and procedures for 
determining credit ratings.'' \284\ However, before today's amendments, 
there were no requirements addressing: (1) The factors an NRSRO must 
consider when establishing, maintaining, enforcing, and documenting an 
internal control structure; and (2) the retention of the records 
documenting the NRSRO's internal control structure. In addition, there 
were no requirements to file an annual internal controls report with 
the Commission attested to by the NRSRO's CEO or equivalent individual 
describing the responsibility of the management of the NRSRO in 
establishing and maintaining an effective internal control structure 
and containing an assessment of the effectiveness of the internal 
control structure.
---------------------------------------------------------------------------

    \282\ The economic analysis in section I.B. of this release 
discusses the primary economic impacts that may derive from the 
amendments and new rules being adopted today.
    \283\ See 15 U.S.C. 78o-7(c)(3)(A).
    \284\ See 15 U.S.C. 78o-7(t)(3)(C).
---------------------------------------------------------------------------

    Relative to the baseline, paragraph (d) of Rule 17g-8 requiring an 
NRSRO to consider certain factors when establishing, maintaining, 
enforcing, and documenting an internal control should result in 
benefits. As noted above, the exercise of considering these factors 
will provide the NRSROs with an opportunity to critically evaluate the 
effectiveness of their existing internal control structures and new 
registrants a reference point for designing or modifying existing 
internal control structures to comply with the statutory requirement to 
establish, maintain, enforce, and document an effective internal 
control structure governing the implementation of and adherence to 
their methodologies for determining credit ratings.\285\ This should 
improve the overall effectiveness of the internal control structures of 
the NRSROs.
---------------------------------------------------------------------------

    \285\ See 15 U.S.C. 78o-7(c)(3)(A).
---------------------------------------------------------------------------

    Relative to this baseline, the amendments to Rule 17g-2 requiring 
an NRSRO to retain a record documenting its internal control structure 
should result in benefits. Recordkeeping rules such as Rule 17g-2 are 
integral to the Commission's investor protection function because the 
preserved records are the primary means of monitoring compliance with 
applicable securities laws.\286\ Rule 17g-2 is designed to ensure that 
an NRSRO makes and retains records that will assist the Commission's 
staff in monitoring, through its examination program, whether an NRSRO 
is complying with applicable securities laws, including the provisions 
of section 15E of the Exchange Act and the rules adopted under section 
15E. The amendments to Rule 17g-2 are designed to assist the Commission 
staff in monitoring an NRSRO's compliance with the requirement in 
section 15E(c)(3)(A) of the Exchange Act to establish, maintain, 
enforce, and document an effective internal control structure governing 
the implementation of and adherence to its policies, procedures, and 
methodologies for determining credit ratings.
---------------------------------------------------------------------------

    \286\ See Oversight of Credit Rating Agencies Registered as 
Nationally Recognized Statistical Rating Organizations, 72 FR at 
33582.
---------------------------------------------------------------------------

    Relative to the baseline, the amendments to Rule 17g-3 requiring 
NRSROs to file an internal controls report with the Commission should 
result in benefits. First, the annual report will facilitate the 
Commission's oversight of NRSROs by assisting the Commission in 
monitoring an NRSRO's compliance with the requirement in section 
15E(c)(3)(A) of the Exchange Act 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. Compliance with the 
requirement to file the internal controls report may enhance the 
integrity of credit ratings by increasing the likelihood that NRSROs 
will adhere to their procedures and methodologies for determining 
credit ratings.
    Second, the requirement that an NRSRO describe in the report any 
material weaknesses identified during the fiscal year and how any 
identified material weakness was addressed may incentivize an NRSRO to 
more closely monitor and make appropriate improvements to its internal 
control structure, which could improve the integrity and quality of its 
credit ratings. The requirements also could provide accountability for 
effective governance by the NRSRO's board and management, which also 
may improve the integrity of credit ratings.
    Third, the requirement that the CEO or a person performing similar 
functions attest to the report should help to ensure that the report 
fairly presents the assessment by management of the effectiveness of 
the internal control structure. It also should promote greater focus 
within an NRSRO on establishing, maintaining, enforcing, and 
documenting an effective internal control structure, given the 
involvement of senior level management in attesting to the reported 
information. Further, because the person attesting to the report must 
represent that the person has responsibility for the report, there will 
be senior level accountability for the accuracy and completeness of the 
report, which also should promote greater focus within an NRSRO on 
establishing, maintaining, enforcing, and documenting an effective 
internal control structure.
    Paragraph (d) of Rule 17g-8 and the amendments to Rules 17g-3 and 
17g-2 should promote the objective of ensuring that NRSROs comply with 
section 15E(c)(3)(A) of the Exchange Act (that is, establish, maintain, 
enforce, and document an effective internal control structure).\287\ 
This should mitigate the risk that an NRSRO may use a rating 
methodology that has not been implemented in accordance with its 
policies and procedures or that it issues a credit rating that was not 
determined in accordance with its policies, procedures, and 
methodologies for determining credit ratings. Again, the integrity and 
quality of credit ratings could increase as a result.
---------------------------------------------------------------------------

    \287\ See 15 U.S.C. 78o-7(c)(3)(A).
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    With respect to prescribing factors, commenters stated, in response 
to a question in the proposing release, that the Commission should not 
prescribe factors for an internal control structure because this would 
place a heavy burden on small NRSROs.\288\ The Commission believes the 
manner in which it has prescribed factors will address these concerns 
and, relative to the baseline, paragraph (d) of Rule 17g-8 should not 
result in costs. NRSROs already are required to establish, maintain, 
enforce, and document an effective internal control structure governing 
the implementation of and adherence to their methodologies for 
determining credit ratings.\289\ In doing so, an NRSRO already must 
consider the types of controls that would be necessary to meet this 
statutory requirement. Paragraph (d) of Rule 17g-8 provides reference 
points for engaging in this exercise and may facilitate and focus the 
process. Moreover, while the Commission is prescribing factors an NRSRO 
must consider, it is not mandating that a specific factor be 
implemented. Consequently, while NRSROs must consider the factors 
identified by the Commission, they can tailor and scale their internal 
control structures to their size and business activities.
---------------------------------------------------------------------------

    \288\ See A.M. Best Letter; Kroll Letter.
    \289\ See 15 U.S.C. 78o-7(c)(3)(A).
---------------------------------------------------------------------------

    Relative to the baseline, the amendments to Rule 17g-2 prescribing 
retention requirements for the documentation of the internal control 
structure will result in costs to NRSROs. NRSROs already have 
recordkeeping systems in place to comply with the recordkeeping 
requirements in Rule

[[Page 55106]]

17g-2 before today's amendments. Therefore, the recordkeeping costs of 
this rule will be incremental to the costs associated with these 
existing requirements. Specifically, the incremental costs will consist 
largely of updating their record retention policies and procedures and 
retaining and producing the additional record. Based on analysis for 
purposes of the Paperwork Reduction Act (``PRA''),\290\ the Commission 
estimates that paragraph (b)(12) of Rule 17g-2 and the amendment to 
paragraph (c) of Rule 17g-2 will result in total industry-wide one-time 
costs to NRSROs of approximately $12,000 and total industry-wide annual 
costs to NRSROs of approximately $3,000.\291\
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    \290\ 44 U.S.C. 3501 et seq.
    \291\ See section V.A. of this release (discussing 
implementation and annual compliance considerations). The one-time 
and annual costs are determined by monetizing internal hour burdens 
and adding external costs identified in the PRA analysis in section 
IV.D.3. of this release.
---------------------------------------------------------------------------

    Relative to the baseline, the amendments to Rule 17g-3 requiring 
that NRSROs file an annual internal controls report with the Commission 
will result in costs to NRSROs. An NRSRO will likely incur costs to 
engage outside counsel to analyze the requirements for the report and 
to assist in drafting and reviewing the report. These legal costs are 
expected to be greater for the filing of the first report and are 
expected to depend on the size and complexity of the operations of the 
NRSRO. NRSROs also will need to establish and maintain internal 
processes to gather and retain evidentiary information to support the 
report. However, NRSROs already have processes and controls for 
preparing and submitting the annual reports required by Rule 17g-3 
before today's amendments. Therefore, the reporting costs of this rule 
will be incremental to the costs associated with these existing 
requirements. Based on analysis for purposes of the PRA, the Commission 
estimates that paragraph (a)(7) of Rule 17g-3 and the amendment to 
paragraph (b) of Rule 17g-3 will result in total industry-wide one-time 
costs to NRSROs of approximately $400,000 and total industry-wide 
annual costs to NRSROs of approximately $667,000.\292\
---------------------------------------------------------------------------

    \292\ See section V.A. of this release (discussing 
implementation and annual compliance considerations). The one-time 
and annual costs are determined by monetizing internal hour burdens 
and adding external costs identified in the PRA analysis in section 
IV.D.4. of this release.
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    The amendments to Rule 17g-2 and Rule 17g-3 may result in other 
costs. For example, these requirements may affect the timeliness of 
credit ratings if they result in an NRSRO implementing internal 
controls that increase the time required to produce a credit rating. 
For example, an NRSRO may choose to implement controls which require 
the work of a lead credit analyst to be reviewed by other analysts. As 
a result, users of credit ratings may incur costs associated with 
having credit ratings that are less timely.
    Paragraph (d) of Rule 17g-8 and the amendments to Rule 17g-3 and 
Rule 17g-2 could have a number of effects related to efficiency, 
competition, and capital formation.\293\ As stated above, these 
amendments could improve the integrity and quality of credit ratings. 
Consequently, users of credit ratings could make more efficient 
investment decisions based on this higher-quality information. Market 
efficiency could also improve if this information is reflected in asset 
prices. Consequently, capital formation could improve as capital may 
flow to more efficient uses with the benefit of this enhanced 
information. Alternatively, the timeliness of credit-related 
information may be diminished as discussed above. In this case, users 
of credit ratings may have access to less timely credit-related 
information which could decrease the efficiency of their investment 
decisions and the efficiency of markets as it could delay the updating 
of asset prices to reflect available information. The amendments to 
Rule 17g-3 and Rule 17g-2 also will impose costs, some of which may 
have a component that is fixed in magnitude across NRSROs and does not 
vary with the size of the NRSRO. Therefore, the operating costs per 
rating of smaller NRSROs may increase relative to that of larger 
NRSROs, which could create adverse effects on competition. As a result 
of these amendments, the barriers to entry for credit rating agencies 
to register as NRSROs might be higher for credit rating agencies, while 
some NRSROs, particularly smaller firms, may decide to withdraw from 
registration as an NRSRO.
---------------------------------------------------------------------------

    \293\ See section I.B.3. of this release (providing a broader 
discussion of the potential impacts of the amendments and new rules 
on efficiency, competition, and capital formation).
---------------------------------------------------------------------------

    There are a number of reasonable alternatives to the amendments. 
First, the Commission could have deferred prescribing factors to be 
taken into consideration when establishing, maintaining, enforcing, and 
documenting an effective internal control structure. As explained 
above, the exercise of considering these factors will provide the 
NRSROs with an opportunity to critically evaluate the effectiveness of 
their existing internal control structures and new registrants a 
reference point for designing or modifying existing internal control 
structures to comply with the statutory requirement to establish, 
maintain, enforce, and document an effective internal control structure 
governing the implementation of and adherence to their methodologies 
for determining credit ratings.\294\ This should improve the overall 
effectiveness of the internal control structures of the NRSROs. 
Moreover, the ``catchall'' provisions in the rule will mitigate the 
risk that an NRSRO treats the factors as a checklist or ``safe 
harbor.'' Moreover, as discussed above, the Commission does not believe 
that prescribing factors will result in additional costs to NRSROs.
---------------------------------------------------------------------------

    \294\ See 15 U.S.C. 78o-7(c)(3)(A).
---------------------------------------------------------------------------

    Second, the Commission could require that the annual internal 
controls report be made public, as suggested by one commenter.\295\ 
This alternative could improve the quality of credit ratings by 
providing additional information to issuers, subscribers, investors, 
and other users of credit ratings to assess the quality of an NRSRO's 
internal control structure and, thereby, promote the NRSROs' 
accountability to the market and the issuance of quality credit ratings 
by the NRSRO. However, as stated above, publicly disclosing the 
internal controls reports could cause NRSROs to be less detailed and 
candid. This could diminish the utility of the reports as a means for 
the Commission to monitor compliance with the requirements of section 
15E(c)(3)(A) of the Exchange Act and for the boards of the NRSROs to 
meet their obligations under section 15E(t)(3)(C) of the Exchange Act 
to ``oversee'' the ``effectiveness of the internal control system with 
respect to the policies and procedures for determining credit 
ratings.''
---------------------------------------------------------------------------

    \295\ See CII Letter.
---------------------------------------------------------------------------

    Third, the Commission could require that the internal controls 
report be audited by a third party, as suggested by a commenter.\296\ 
As stated above, the final amendment does not require that the internal 
controls report be made public. Consequently, the report is not a 
public document that will be relied upon by investors and other users 
of credit ratings. Rather, it is a non-public report that will be used 
by Commission examiners. The Commission has taken these factors into 
consideration in balancing the benefits of having the internal controls 
report audited by a third party and the costs of such a requirement. 
The Commission examines each of the ten NRSROs currently

[[Page 55107]]

registered with the Commission annually. At this time, the Commission 
believes that the annual examinations by the Commission staff will 
provide a sufficient means for reviewing the accuracy of the internal 
controls reports filed by the NRSROs.
---------------------------------------------------------------------------

    \296\ See Levin Letter.
---------------------------------------------------------------------------

B. Sales and Marketing Conflict of Interest

    Section 932(a)(4) of the Dodd-Frank Act added paragraph (3) to 
section 15E(h) of the Exchange Act.\297\ Section 15E(h)(3)(A) of the 
Exchange Act provides that the Commission shall issue rules to prevent 
the sales and marketing considerations of an NRSRO from influencing the 
production of credit ratings by the NRSRO.\298\ Section 15E(h)(3)(B)(i) 
of the Exchange Act requires that the Commission's rules shall provide 
for exceptions for small NRSROs with respect to which the Commission 
determines that the separation of the production of credit ratings and 
sales and marketing activities is not appropriate.\299\ Section 
15E(h)(3)(B)(ii) of the Exchange Act requires that the Commission's 
rules shall provide for the suspension or revocation of the 
registration of an NRSRO if the Commission finds, on the record, after 
notice and opportunity for a hearing, that: (1) The NRSRO has committed 
a violation of a rule issued under section 15E(h) of the Exchange Act; 
and (2) the violation affected a rating.\300\
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    \297\ See Public Law 111-203, 932(a)(4); 15 U.S.C. 78o-7(h)(3).
    \298\ 15 U.S.C. 78o-7(h)(3)(A).
    \299\ 15 U.S.C. 78o-7(h)(3)(B)(i).
    \300\ 15 U.S.C. 78o-7(h)(3)(B)(ii).
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    The Commission proposed to implement sections 15E(h)(3)(A), 
15E(h)(3)(B)(i), and 15E(h)(3)(B)(ii) of the Exchange Act by amending 
the NRSRO conflict of interest rule (Rule 17g-5).\301\ The proposal 
would amend Rule 17g-5 by: (1) Identifying a new prohibited conflict in 
paragraph (c) of the rule relating to sales and marketing activities; 
(2) adding paragraph (f) to the rule to set forth the finding the 
Commission would need to make in order to grant a small NRSRO an 
exemption from the prohibition; and (3) adding paragraph (g) to the 
rule to set forth the standard for suspending or revoking an NRSRO's 
registration for violating a rule adopted under section 15E(h) of the 
Exchange Act.\302\
---------------------------------------------------------------------------

    \301\ See Nationally Recognized Statistical Rating 
Organizations, 76 FR at 33425-33429. See also 17 CFR 240.17g-5. The 
Commission adopted and subsequently amended Rule 17g-5 pursuant, in 
part, to authority in section 15E(h)(2) of the Exchange Act (15 
U.S.C. 78o-7(h)(2)). See Oversight of Credit Rating Agencies 
Registered as Nationally Recognized Statistical Rating 
Organizations, 72 FR at 33595-33599 (June 18, 2007); Amendments to 
Rules for Nationally Recognized Statistical Rating Organizations, 74 
FR at 6465-6469 (Feb. 9, 2009); Amendments to Rules for Nationally 
Recognized Statistical Rating Organizations, 74 FR at 63842-63850 
(Dec. 4, 2009).
    \302\ See Nationally Recognized Statistical Rating 
Organizations, 76 FR at 33425-33429.
---------------------------------------------------------------------------

1. New Prohibited Conflict
    Section 15E(h)(3)(A) of the Exchange Act provides that the 
Commission shall issue rules to prevent the sales and marketing 
considerations of an NRSRO from influencing the production of credit 
ratings by the NRSRO.\303\ The Commission proposed to implement this 
provision by identifying a new conflict of interest in paragraph (c) of 
Rule 17g-5.\304\ Paragraph (c) prohibits an NRSRO and a person within 
an NRSRO from having a conflict of interest identified in the paragraph 
under all circumstances (an ``absolute prohibition'').\305\ As 
proposed, paragraph (c)(8) of Rule 17g-5 would identify an additional 
absolute prohibition: Issuing or maintaining a credit rating where a 
person within the NRSRO who participates in sales or marketing of a 
product or service of the NRSRO or a product or service of a person 
associated with the NRSRO also participates in determining or 
monitoring the credit rating, or developing or approving procedures or 
methodologies used for determining the credit rating, including 
qualitative or quantitative models.\306\ In effect, this would prohibit 
persons who participate in sales and marketing activities from 
participating in determining or monitoring credit ratings or developing 
or approving rating procedures or methodologies.
---------------------------------------------------------------------------

    \303\ 15 U.S.C. 78o-7(h)(3)(A).
    \304\ See paragraph (c)(8) of Rule 17g-5, as proposed; 
Nationally Recognized Statistical Rating Organizations, 76 FR at 
33426.
    \305\ See 17 CFR 240.17g-5(c)(1) through (7). These absolute 
prohibitions are distinguished from the types of conflicts 
identified in paragraph (b) of Rule 17g-5, which are prohibited 
unless the NRSRO has taken the steps to address them as set forth in 
paragraph (a) of Rule 17g-5. See 17 CFR 240.17g-5(a) and (b). See 
also 17 CFR 240.17g-5(d) (defining the term person within an NRSRO 
to mean an NRSRO, its credit rating affiliates identified on Form 
NRSRO, and any partner, officer, director, branch manager, and 
employee of the NRSRO or its credit rating affiliates (or any person 
occupying a similar status or performing similar functions)).
    \306\ See paragraph (c)(8) of Rule 17g-5, as proposed; 
Nationally Recognized Statistical Rating Organizations, 76 FR at 
33540.
---------------------------------------------------------------------------

    Several commenters suggested that the requirements in the proposed 
amendment should be stronger.\307\ Commenters raised concerns that the 
amendment as proposed would not prohibit managers from seeking to 
inappropriately influence credit analysts and the personnel who develop 
and approve rating procedures and methodologies.\308\ For example, one 
commenter stated that the proposal could ``be strengthened by barring 
NRSRO management from taking negative actions against analysts due to 
client complaints seeking better ratings, more lenient treatment of 
their products, or relief from providing information about a product 
being rated'' and that such actions ``inevitably lead to inaccurate and 
inflated ratings.'' \309\ A second commenter stated that the 
requirement needs to apply ``more broadly to any action by any rating 
agency employee that has the intent or effect of allowing sales and 
marketing considerations, including concern over building market share, 
to inappropriately influence the rating process or undermine ratings 
accuracy.'' \310\ The commenter stated that this was necessary to 
address practices such as ``basing analysts' performance evaluations or 
compensation on their success in building market share, allowing 
investment bankers to influence the selection of analysts involved in 
rating their deals, and delaying revisions to rating models because of 
concerns about their impact on market share.'' \311\ A third commenter 
stated that motivations by management to increase profits and market 
share can lead to top-down policies and practices that emphasize higher 
credit ratings over improved accuracy and reliability.\312\
---------------------------------------------------------------------------

    \307\ See AFR II Letter; AFSCME Letter; Better Markets Letter; 
CFA/AFR Letter; Levin Letter. See also CFA II Letter (stating that 
the rule should be re-proposed).
    \308\ See, e.g., AFR II Letter; CFA II Letter; Levin Letter.
    \309\ See Levin Letter.
    \310\ See CFA/AFR Letter.
    \311\ See CFA/AFR Letter.
    \312\ See CFA II Letter.
---------------------------------------------------------------------------

    Other commenters suggested that the proposed requirement be less 
restrictive.\313\ These commenters recommended, among other things, 
that the proposed amendment require procedures to manage the 
conflict,\314\ or apply only when sales and marketing considerations 
``influenced'' the production of the credit rating.\315\
---------------------------------------------------------------------------

    \313\ A.M. Best Letter; S&P Letter; TradeMetrics Letter.
    \314\ See S&P Letter; TradeMetrics Letter.
    \315\ See A.M. Best Letter. This commenter suggested that if the 
Commission modified the proposed amendment to require ``influence,'' 
the Commission could, among other things, require an NRSRO to 
establish, maintain, enforce, and document policies and procedures 
reasonably designed to prevent sales and marketing considerations of 
an NRSRO from influencing the production of credit ratings and 
specify that those procedures contain language providing that any 
communications between sales and marketing personnel and ratings 
personnel are subject to the broader recordkeeping requirements of 
Rule 17g-2.

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[[Page 55108]]

    After considering these comments, the Commission is revising the 
rule text to incorporate into the rule language that is both consistent 
with the statutory language and with the requirement in paragraph 
(a)(1)(iii) of Rule 17g-7 \316\ (discussed in section II.G.4. of the 
release), which would address sources of influence with respect to 
sales and marketing considerations in addition to persons involved in 
sales and marketing activities. Accordingly, the final amendment 
modifies the proposal to provide that an NRSRO is prohibited from 
issuing or maintaining a credit rating where a person within the NRSRO 
who participates in determining or monitoring the credit rating, or 
developing or approving procedures or methodologies used for 
determining the credit rating, including qualitative and quantitative 
models, also: (1) Participates in sales or marketing of a product or 
service of the NRSRO or a product or service of an affiliate of the 
NRSRO; or (2) is influenced by sales or marketing considerations.\317\
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    \316\ As discussed below in section II.G.4. of this release, 
paragraph (a)(1)(iii) of Rule 17g-7 provides that an NRSRO must 
attach to the form to accompany certain credit rating actions a 
signed statement by a person within the NRSRO stating that the 
person has responsibility for the rating action and, to the best 
knowledge of the person: (1) no part of the credit rating was 
influenced by any other business activities; (2) the credit rating 
was based solely upon the merits of the obligor, security, or money 
market instrument being rated; and (3) the credit rating was an 
independent evaluation of the credit risk of the obligor, security, 
or money market instrument. Sales and marketing are subparts of 
``business activities'' and including it in paragraph (c)(8) of Rule 
17g-5 is a relevant conforming change.
    \317\ Id.
---------------------------------------------------------------------------

    Under the first prong of the final amendment, an NRSRO is 
prohibited from issuing or maintaining a credit rating where a person 
within the NRSRO who participates in determining or monitoring the 
credit rating, or developing or approving procedures or methodologies 
used for determining the credit rating, including qualitative and 
quantitative models, also participates in sales or marketing of a 
product or service of the NRSRO or a product or service of an affiliate 
of the NRSRO.\318\ As with the proposal, this prong of the absolute 
prohibition is designed to address situations in which, for example, 
individuals within the NRSRO who engage in activities to sell products 
and services (both ratings-related and non-ratings-related) of the 
NRSRO or its affiliates could seek to influence a specific credit 
rating to favor an existing or prospective client or the development of 
a credit rating procedure or methodology to favor a class of existing 
or prospective clients. In practice, the Commission believes the 
amendment will require an NRSRO to prohibit personnel that have any 
role in the determination of credit ratings or the development or 
modification of rating procedures or methodologies from having any role 
in sales and marketing activities. It also will require an NRSRO to 
prohibit personnel that have any role in sales and marketing activities 
from having any role in the determination of credit ratings or the 
development or modification of rating procedures or methodologies. 
Consequently, these functions will need to be separate.
---------------------------------------------------------------------------

    \318\ See paragraph (c)(8)(i) of Rule 17g-5.
---------------------------------------------------------------------------

    Commenters suggested that the proposed requirement be less 
restrictive.\319\ These commenters recommended, among other things, 
that the proposed amendment require procedures to manage the 
conflict,\320\ or apply only when sales and marketing considerations 
``influenced'' the production of the credit rating.\321\ In response, 
the Commission notes that section 15E(h)(3)(A) of the Exchange Act 
provides that the Commission shall issue rules to prevent the sales and 
marketing considerations of an NRSRO from influencing the production of 
ratings by the NRSRO.\322\ Moreover, section 15E(h)(3)(B)(i) of the 
Exchange Act requires that the Commission's rules under section 
15E(h)(3)(A) shall provide for exceptions for small NRSROs with respect 
to which the Commission determines that the separation of the 
production of credit ratings and sales and marketing activities is not 
appropriate.\323\ The Commission therefore believes that it is a 
reasonable interpretation of the statute to adopt a rule that requires 
the separation of the two functions. As stated above, in practice, the 
final amendment will require an NRSRO to prohibit the personnel that 
have any role in sales and marketing activities from having any role in 
the determination of credit ratings or the development or modification 
of rating procedures and methodologies. In addition, this approach 
establishes a particularly strong measure to address the sales and 
marketing conflict because, as discussed above, the final amendment 
establishes an absolute prohibition. Moreover, depending on the facts 
and circumstances, it would also violate the first prong of the rule as 
amended for an individual who participates in sales and marketing 
activities to seek to influence the determination of a credit rating or 
the rating procedures and methodologies used to determine a credit 
rating, even if the individual's conduct did not influence the credit 
rating or rating procedures or methodologies.
---------------------------------------------------------------------------

    \319\ A.M. Best Letter; S&P Letter; TradeMetrics Letter.
    \320\ See S&P Letter; TradeMetrics Letter.
    \321\ See A.M. Best Letter.
    \322\ See 15 U.S.C. 78o-7(h)(3)(A) (emphasis added).
    \323\ See 15 U.S.C. 78o-7(h)(3)(B)(i) (emphasis added).
---------------------------------------------------------------------------

    Further, Commission staff found as part of the examination of the 
activities of the three largest NRSROs in rating RMBS and CDOs linked 
to subprime mortgages that it appeared ``employees responsible for 
obtaining ratings business would notify other employees, including 
those responsible for criteria development, about business concerns 
they had related to the criteria.'' \324\ As the Commission stated in 
the proposing release, the absolute prohibition was designed to 
insulate individuals within the NRSRO responsible for the analytic 
function from such sales and marketing concerns and pressures.\325\
---------------------------------------------------------------------------

    \324\ See Summary Report of Issues Identified in the Commission 
Staff's Examination of Select Credit Rating Agencies, pp. 25-26. 
Commenters pointed to other sources to argue that the proposal 
should be stronger. See, e.g., CFA/AFR Letter; CFA II Letter.
    \325\ See Nationally Recognized Statistical Rating 
Organizations, 76 FR at 33426.
---------------------------------------------------------------------------

    The Commission shares the concerns raised by commenters about the 
potential inappropriate influence that managers may have over employees 
involved in the determination of credit ratings or the development or 
modification of rating procedures and methodologies.\326\ In response, 
the Commission notes that a manager who participates in sales and 
marketing activities and who seeks to influence a credit rating or the 
rating procedures and methodologies used to determine the credit rating 
would be ``participating'' in determining or monitoring the credit 
rating or in developing or approving the rating procedures or 
methodologies used to determine the credit rating under paragraph 
(a)(8) of Rule 17g-5, as adopted.\327\ Consequently, depending

[[Page 55109]]

on the facts and circumstances, the rule as amended would be violated 
if it was established that an NRSRO issued or maintained a credit 
rating in a case in which managers involved in sales and marketing 
activities pressured or otherwise offered incentives to analysts 
working on the credit rating to take commercial concerns into account 
in determining the credit rating. Similarly, depending on the facts and 
circumstances, it would violate the rule as amended for an NRSRO to 
issue or maintain a credit rating that managers involved in sales and 
marketing activities sought to influence by pressuring or offering 
incentives to personnel who developed or approved the rating procedures 
or methodologies used to determine the credit rating to take commercial 
concerns into account in developing or approving the procedures or 
methodologies. Moreover, depending on the facts and circumstances, 
because the rule is an absolute prohibition, this conduct would violate 
the rule, even if a manager did not successfully influence any credit 
rating or the rating procedures or methodologies used to determine the 
credit rating.
---------------------------------------------------------------------------

    \326\ See, e.g., CFA II Letter.
    \327\ One commenter suggested that management ``would not likely 
fall under the Commission's definition of `participants' in either 
sales or marketing activities.'' See CFA II Letter. In response, the 
Commission notes that, as discussed above, a person within an 
NRSRO--including a manager--would participate in sales and marketing 
activities if, for example: the individual contacted a company that 
was about to issue debt and solicited the business of rating the 
issuance or met with company officials for business development 
purposes (for example, to ``pitch'' the NRSRO's services); the 
individual contacted an institutional investor and offered 
subscriptions to the NRSRO's credit ratings or credit analyses; or 
the individual was contacted by an issuer about the cost of rating 
its issuance or by an institutional investor about the cost of a 
subscription to the NRSRO's credit ratings or analyses and the 
individual provided information about these costs.
---------------------------------------------------------------------------

    Commenters stated that the requirements of proposed paragraph 
(c)(8) of Rule 17g-5 are ambiguous and requested that the Commission 
clarify various aspects of the proposal.\328\ Five commenters raised 
concerns as to what it means to participate in sales and marketing 
activities under the proposed rule.\329\ Four of those commenters 
requested that the Commission provide additional guidance on this 
question.\330\ On the other hand, an NRSRO suggested that the 
Commission should not provide additional guidance and should allow the 
NRSRO to define participate.\331\ Similarly, five commenters (including 
NRSROs) requested the Commission clarify what constitutes a sales and 
marketing activity,\332\ while an NRSRO suggested that the Commission 
not provide additional guidance and allow the NRSRO to determine what 
constitutes a sales and marketing activity.\333\ One NRSRO stated that 
the rule should not contain definitions that ``compel large size'' by 
mandating, explicitly or implicitly, minimum numbers of employees or 
layers of management.\334\
---------------------------------------------------------------------------

    \328\ See A.M. Best Letter; COPERA Letter; DBRS Letter; Kroll 
Letter; Moody's Letter; TradeMetrics Letter.
    \329\ See DBRS Letter; Kroll Letter; Kroll II Letter; Moody's 
Letter; S&P Letter; TradeMetrics Letter.
    \330\ See DBRS Letter; Kroll Letter; Kroll II Letter; Moody's 
Letter; TradeMetrics Letter.
    \331\ See S&P Letter.
    \332\ See A.M. Best Letter; COPERA Letter; Kroll Letter; Moody's 
Letter; TradeMetrics Letter. For example, commenters argued that 
that, without clarification of these terms, the scope of the 
amendment could be applied too broadly. See A.M. Best Letter; Kroll 
Letter.
    \333\ See S&P Letter.
    \334\ See Kroll Letter.
---------------------------------------------------------------------------

    In response to these comments requesting clarification of terms 
used in the amendment, the Commission notes that sales and marketing 
activities involve efforts by an NRSRO to sell or in any manner market 
its products and services to prospective customers.\335\ Participating 
in sales and marketing activities would clearly include certain 
actions. For example, a person within an NRSRO would participate in a 
sales and marketing activity if: (1) The individual contacted a company 
that was about to issue debt and solicited the business of rating the 
issuance or met with company officials for business development 
purposes (for example, to ``pitch'' the NRSRO's services); (2) the 
individual contacted an institutional investor and offered 
subscriptions to the NRSRO's credit ratings or credit analyses; (3) the 
individual was contacted by an issuer about the cost of rating its 
issuance or by an institutional investor about the cost of a 
subscription to the NRSRO's credit ratings or analyses and the 
individual provided information about these costs.
---------------------------------------------------------------------------

    \335\ The examples of what it means to participate in sales and 
marketing activities discussed in this section of the release are 
intended to assist NRSROs in understanding those terms as they are 
used in paragraph (c)(8) of Rule 17g-5.
---------------------------------------------------------------------------

    The Commission recognizes that certain scenarios posed by 
commenters may not be as clear-cut as these examples in terms of 
whether the activities would be considered participating in sales and 
marketing activities; each scenario will have to be evaluated based on 
the particular facts and circumstances.\336\ For example, if rating 
personnel engage in analytical discussions with persons outside the 
NRSRO, including with obligors and issuers who purchase credit rating 
services from the NRSRO or with investors and others who purchase 
subscriptions to the NRSRO's credit ratings, that would not constitute 
participating in a sales and marketing activity as long as the 
discussions do not involve commercial matters related to selling or 
marketing the NRSRO's services; however, if the discussions with 
ratings analysts involved such commercial matters, the analysts may be 
considered to be participating in sales and marketing activities.\337\ 
Similarly, if an issuer agrees to have only one meeting with an NRSRO 
to discuss both analytical matters relating to, and fees for, obtaining 
credit ratings for the securities it issues, the NRSRO could bring a 
team of analysts and a team of sales and marketing personnel to the 
meeting.\338\ If the sales and marketing team does not attend the 
portion of the meeting in which analytical matters are discussed, they 
would not have participated in the determination of a credit rating. 
Similarly, if the analytical team does not attend the portion of the 
meeting in which commercial matters are discussed, they would not have 
participated in a sales and marketing activity. Further, an analyst 
would not necessarily participate in a sales or marketing activity if 
the analyst gives a presentation at a conference attended by persons 
who could be prospective purchasers of the NRSRO's services.\339\ For 
example, the analyst would generally not be considered to be 
participating in a sales or marketing activity if the presentation 
avoided marketing the services offered by the NRSRO and focused solely 
on topics involving credit analysis (for example, the analytical 
process used by the NRSRO to determine credit ratings, an analysis of 
the creditworthiness of one or more obligors or issuers, or a credit 
forecast for a particular industry sector).\340\ Similarly, the analyst 
would not participate in a sales or marketing activity if the analyst 
gave this type of presentation in the context of an interview with a 
news outlet. In each case, the determination whether the analytical 
team is participating in sales and marketing activity would turn on the 
facts and circumstances.
---------------------------------------------------------------------------

    \336\ See A.M. Best Letter; DBRS Letter; Moody's Letter.
    \337\ See Moody's Letter.
    \338\ See DBRS Letter.
    \339\ See A.M. Best Letter.
    \340\ As discussed throughout this release, one of the 
objectives of the amendments and new rules being adopted today is to 
increase the transparency of the credit rating activities of NRSROs 
to promote competition among NRSROs on the basis of the quality of 
the credit ratings they produce and the procedures and methodologies 
they use to determine credit ratings. The persons within an NRSRO 
responsible for determining credit ratings and developing the 
procedures and methodologies used to determine credit ratings can 
promote this transparency, given their responsibilities and 
expertise. Consequently, the Commission does not intend the new 
absolute prohibition in paragraph (c)(8) of Rule 17g-5 to constrain 
them from helping market participants better understand the quality 
of an NRSRO's credit ratings and procedures and methodologies an 
NRSRO uses to determine credit ratings.
---------------------------------------------------------------------------

    As noted above, the first prong of the absolute prohibition 
requires an NRSRO to separate its analytical functions from its sales 
and marketing functions. While

[[Page 55110]]

this is a strong measure to address the sales and marketing conflict, 
the Commission also believes that it is appropriate to revise the rule 
text to incorporate language about persons participating in production 
of a credit rating being ``influenced'' by sales and marketing 
considerations.\341\ Section 15E(h)(3)(A) of the Exchange Act provides 
that the Commission shall issue rules to prevent the sales and 
marketing considerations of an NRSRO from influencing the production of 
credit ratings by the NRSRO.\342\ Given the concerns raised by 
commenters, this statutory language, the language in section 
15E(q)(2)(F) of the Exchange Act,\343\ and Rule 17 g-7, the Commission 
is modifying the proposal to add a second prong to the absolute 
prohibition. Under the second prong, an NRSRO is prohibited from 
issuing or maintaining a credit rating where a person within the NRSRO 
who participates in determining or monitoring the credit rating, or 
developing or approving procedures or methodologies used for 
determining the credit rating, including qualitative and quantitative 
models, also is influenced by sales or marketing considerations.\344\ 
Thus, this prong of the absolute prohibition is consistent with the 
provision of Rule 17g-7 that specifically requires a statement that no 
part of the rating was ``influenced'' by business activities.
---------------------------------------------------------------------------

    \341\ See AFR II Letter; AFSCME Letter; Better Markets Letter; 
CFA/AFR Letter; Levin Letter. See also CFA II Letter (stating that 
the rule should be re-proposed).
    \342\ 15 U.S.C. 78o-7(h)(3)(A) (emphasis added). See also 
section 15E(q)(2)(F).
    \343\ Section 15(E)(q)(2)(F) provides that the Commission's 
rules must require an NRSRO to include an attestation with any 
credit rating it issues affirming that no part of the rating was 
influenced by any other business activities, that the rating was 
based solely on the merits of the instruments being rated, and that 
such rating was an independent evaluation of the risks and merits of 
the instrument). ``Sales'' and ``marketing'' are a subparts of 
``business activities.''
    \344\ See paragraph (c)(8)(ii) of Rule 17g-5.
---------------------------------------------------------------------------

    In connection with making the evaluation necessary for the second 
prong of the absolute prohibition, the Commission believes there are a 
number of possible channels of influence that should be considered, 
such as compensation arrangements that may incentivize analysts to 
produce inflated credit ratings to increase or retain the NRSRO's 
market share, performance evaluation systems that reward analysts who 
produce inflated credit ratings to increase or retain the NRSRO's 
market share, compliance personnel who unduly influence credit analysts 
to inflate credit ratings in response to complaints by clients, clients 
such as rated entities who pressure analysts to produce inflated credit 
ratings to retain their business, or managers who are not involved in 
sales and marketing activities but may seek to pressure analysts to 
produce inflated credit ratings to increase or retain the NRSRO's 
market share.
    In addition, the Commission notes that the sales and marketing 
prohibition is being added to a comprehensive set of existing 
requirements that address NRSRO conflicts and, as discussed below, the 
Commission is adopting additional measures to address conflicts.\345\ 
Consequently, the sales and marketing prohibition should not be viewed 
in isolation but rather as part of a set of requirements (both 
statutory and regulatory) pursuant to which NRSROs must disclose and 
manage conflicts of interest and, in some cases, avoid them altogether. 
For example, paragraph (b)(1) of Rule 17g-5 identifies the conflict of 
being paid by issuers or underwriters to determine credit ratings (the 
issuer-pay conflict), and under paragraph (a)(2) of Rule 17g-5 and 
section 15E(h)(1) of the Exchange Act, an NRSRO with this conflict must 
establish, maintain and enforce written policies and procedures 
reasonably designed to address and manage the conflict.\346\ An NRSRO 
that permits a corporate culture in which managers seek to 
inappropriately influence analysts and the personnel who develop and 
approve rating procedures and methodologies could not be viewed as 
having or enforcing policies and procedures reasonably designed to 
address the issuer-pay conflict and, consequently, this type of conduct 
would violate section 15E(h)(1) of the Exchange Act and Rule 17g-5.
---------------------------------------------------------------------------

    \345\ See 15 U.S.C. 78o-7(h); 17 CFR 240.17g-5.
    \346\ See 15 U.S.C. 78o-7(h); 17 CFR 240.17g-5.
---------------------------------------------------------------------------

    Further, as discussed below in section II.G.4. of this release, the 
Commission is adopting a requirement that an NRSRO must attach to the 
form to accompany certain credit rating actions a signed statement by a 
person within the NRSRO stating that the person has responsibility for 
the rating action and, to the best knowledge of the person: (1) No part 
of the credit rating was influenced by any other business activities; 
(2) the credit rating was based solely upon the merits of the obligor, 
security, or money market instrument being rated; and (3) the credit 
rating was an independent evaluation of the credit risk of the obligor, 
security, or money market instrument.\347\ If any of these requirements 
are not satisfied, such person would not be able to truthfully make 
this attestation.
---------------------------------------------------------------------------

    \347\ See paragraph (a)(1)(iii) of Rule 17g-7.
---------------------------------------------------------------------------

    The Commission made another modification to the proposal in 
response to a comment suggesting that the text of the amendment be 
revised to reference the ``products or services of the NRSRO's 
affiliated entities'' in place of the proposed reference to a ``product 
or service of a person associated with the [NRSRO].'' \348\ A ``person 
associated'' with the NRSRO includes natural persons.\349\ The 
commenter stated that, as proposed, the amendment could preclude a 
natural person from participating in the credit rating process ``if he 
or she operates a completely different business (such as a photography 
studio on the side).'' \350\ This would be an overly broad application 
of the amendment, as it is designed to prevent sales and marketing of 
products and services of the NRSRO or its affiliated companies from 
influencing the credit rating process. Consequently, the final 
amendment has been modified from the proposal to apply to products and 
services of the affiliates of the NRSRO (rather than persons associated 
with the NRSRO).\351\ However, the Commission notes that outside 
businesses of employees can raise potential conflicts.\352\ 
Consequently, pursuant to section 15E(h)(1) of the Exchange Act and 
Rule 17g-5, an NRSRO must have policies, procedures, and controls to 
address employees engaging in outside businesses if the NRSRO permits 
employees to operate outside businesses.\353\
---------------------------------------------------------------------------

    \348\ See DBRS Letter.
    \349\ See 15 U.S.C. 78c(a)(63).
    \350\ See DBRS Letter.
    \351\ See paragraph (c)(8) of Rule 17g-5.
    \352\ For example, an analyst operating an outside business 
could seek to solicit business from persons employed by an obligor 
that the analyst rates or an issuer of securities the analyst rates.
    \353\ See 15 U.S.C. 78o-7(h)(1) (requiring each NRSRO to 
establish, maintain, and enforce written policies and procedures 
reasonably designed, taking into consideration the nature of the 
business of the NRSRO and affiliated persons and affiliated 
companies thereof, to address and manage any conflicts of interest 
that can arise from such business); 17 CFR 240.17g-5 (prohibiting 
NRSROs from having conflicts of interest unless they disclose and 
manage the conflicts or, in some cases, absolutely prohibiting the 
conflict).
---------------------------------------------------------------------------

    Two commenters stated that paragraph (c)(8) of Rule 17g-5 may be 
redundant, given the existing absolute prohibition in paragraph (c)(6) 
of Rule 17g-5.\354\ In response, the Commission

[[Page 55111]]

believes it is appropriate to retain paragraph (c)(6) because it 
complements paragraph (c)(8) of Rule 17g-5, as adopted. In particular, 
paragraph (c)(6) of Rule 17g-5 addresses the conflict that arises when 
persons within an NRSRO involved in determining credit ratings or 
developing or approving rating methodologies also negotiate, discuss, 
or arrange the fees paid for determining credit ratings.\355\ Thus, it 
focuses on preventing persons within the NRSRO responsible for credit 
analysis from being influenced by business considerations (for example, 
issuing ratings favorable to a client with whom they negotiated a 
substantial fee). Paragraph (c)(8) of Rule 17g-5, as adopted, addresses 
the conflict that arises when persons within an NRSRO involved in sales 
and marketing activities also participate in determining credit ratings 
or developing or approving rating procedures and methodologies. Thus, 
it focuses on preventing the persons within the NRSRO responsible for 
generating business for the NRSRO from influencing the work of the 
persons responsible for credit analysis (for example, pressuring them 
to develop rating procedures and methodologies that favor the NRSRO's 
clients or prospective clients).
---------------------------------------------------------------------------

    \354\ See DBRS Letter; Kroll Letter. Under paragraph (c)(6) of 
Rule 17g-5, an NRSRO is prohibited from issuing or maintaining a 
credit rating where the fee paid for the rating was negotiated, 
discussed, or arranged by a person within the NRSRO who has 
responsibility for participating in determining credit ratings or 
for developing or approving procedures or methodologies used for 
determining credit ratings, including qualitative and quantitative 
models.
    \355\ See Summary Report of Issues Identified in the Commission 
Staff's Examination of Select Credit Rating Agencies, p. 25 (``there 
were indications that analysts were involved in fee discussions with 
employees of the rating agency's billing department'').
---------------------------------------------------------------------------

    Finally, several commenters stated that the proposed amendment 
would negatively impact smaller NRSROs.\356\ As discussed below, the 
final amendments to Rule 17g-5 provide a mechanism for small NRSROs to 
apply for an exemption from the absolute prohibition.\357\ Under the 
final amendment, the Commission may grant an exemption if it finds that 
due to the small size of the NRSRO it is not appropriate to require the 
separation within the NRSRO of the production of credit ratings from 
sales and marketing activities and such exemption is in the public 
interest.\358\
---------------------------------------------------------------------------

    \356\ See A.M. Best Letter; Kroll Letter.
    \357\ See paragraph (f) of Rule 17g-5.
    \358\ Id.
---------------------------------------------------------------------------

    For all of the reasons discussed above, the Commission is adopting 
the amendment with the modifications discussed above. Moreover, for 
those reasons, the Commission is not persuaded that it is necessary to 
re-propose the rule as suggested by one commenter.\359\ However, the 
Commission may consider further rulemaking to address conflicts of 
interest inherent in the NRSRO industry as appropriate and as 
circumstances warrant.
---------------------------------------------------------------------------

    \359\ See CFA II Letter (recommending that the Commission re-
propose the rule).
---------------------------------------------------------------------------

2. Exemption for ``Small'' NRSROs
    Section 15E(h)(3)(B)(i) of the Exchange Act requires that the 
Commission's rules under section 15E(h)(3)(A) shall provide for 
exceptions for small NRSROs with respect to which the Commission 
determines that the separation of the production of credit ratings and 
sales and marketing activities is not appropriate.\360\ To implement 
this provision, the Commission proposed to amend Rule 17g-5 by adding 
paragraph (f).\361\ As proposed, paragraph (f) would provide a 
mechanism for a small NRSRO to apply in writing for an exemption from 
the absolute prohibition that would be established by adding paragraph 
(c)(8) to Rule 17g-5.\362\ In particular, the proposed amendment 
provided that upon written application by an NRSRO, the Commission may 
exempt, either conditionally or unconditionally or on specified terms 
and conditions, such NRSRO from the provisions of paragraph (c)(8) of 
Rule 17g-5 if the Commission finds that due to the small size of the 
NRSRO it is not appropriate to require the separation within the NRSRO 
of the production of credit ratings from sales and marketing activities 
and such exemption is in the public interest.\363\
---------------------------------------------------------------------------

    \360\ See 15 U.S.C. 78o-7(h)(3)(B)(i).
    \361\ See paragraph (f) of Rule 17g-5, as proposed; Nationally 
Recognized Statistical Rating Organizations, 76 FR at 33426-33427.
    \362\ See paragraph (f) of Rule 17g-5, as proposed; Nationally 
Recognized Statistical Rating Organizations, 76 FR at 33540. Section 
36 of the Exchange Act provides that the Commission, by rule, 
regulation, or order, may conditionally or unconditionally exempt 
any person, security, or transaction, or any class or classes of 
persons, securities, or transactions from any provision or 
provisions of the Exchange Act or any rule or regulation thereunder, 
to the extent that such exemption is necessary or appropriate in the 
public interest and is consistent with the protection of investors. 
17 U.S.C. 78mm. Consequently, an NRSRO could request to be exempt 
from the sales and marketing prohibition pursuant to this more 
general authority in section 36. The Commission has established 
rules providing mechanisms for registrants--such as broker-dealers--
to request an exemption from specific rule requirements. See, e.g., 
17 CFR 240.15c3-1(b)(3); 17 CFR 240.15c3-3(k)(3); 17 CFR 240.17a-
5(m)(3). The proposed amendment was modeled after these provisions. 
See Nationally Recognized Statistical Rating Organizations, 76 FR at 
33540.
    \363\ See paragraph (f) of Rule 17g-5, as proposed; Nationally 
Recognized Statistical Rating Organizations, 76 FR at 33540.
---------------------------------------------------------------------------

    The Commission stated in the proposing release that in some cases 
the small size of an NRSRO could make a complete separation of the 
sales and marketing function from the credit rating analytical function 
inappropriate.\364\ For example, the NRSRO may not have enough staff 
(or the resources to hire additional staff) to establish separate 
functions.\365\ In this case, the Commission stated that it would 
entertain requests for relief, although it may impose conditions 
designed to preserve as much of the separation between these two 
functions as possible.\366\
---------------------------------------------------------------------------

    \364\ Nationally Recognized Statistical Rating Organizations, 76 
FR at 33427.
    \365\ Id.
    \366\ Id.
---------------------------------------------------------------------------

    The Commission is adding paragraph (f) to Rule 17g-5 substantially 
as proposed, but with a technical modification to the rule text in 
response to comments.\367\ In particular, the final amendment provides 
that, upon written application by an NRSRO, the Commission may exempt, 
either unconditionally or on specified terms and conditions, such NRSRO 
from the provisions of paragraph (c)(8) of Rule 17g-5 if the Commission 
finds that due to the small size of the NRSRO it is not appropriate to 
require the separation within the NRSRO of the production of credit 
ratings from sales and marketing activities and such exemption is in 
the public interest.\368\
---------------------------------------------------------------------------

    \367\ See paragraph (f) of Rule 17g-5. The Commission is 
modifying the proposal to remove redundant text, as suggested by a 
commenter. See DBRS Letter. The Commission originally proposed that 
``[u]pon written application by a [NRSRO], the Commission may 
exempt, either conditionally or unconditionally or on specified 
terms and conditions, such [NRSRO] from the provisions of paragraph 
(c)(8) of [Rule 17g-5].'' The modification removes the phrase 
``conditionally or'' as it is redundant of the phrase ``on specified 
terms and conditions.'' See paragraph (f) of Rule 17g-5.
    \368\ See paragraph (f) of Rule 17g-5.
---------------------------------------------------------------------------

    Several commenters expressed support for the objective of the 
proposed amendment.\369\ Supporters argued that it could be difficult 
for smaller NRSROs to maintain the strict separation of sales and 
marketing activities from the production of credit ratings, as would be 
required under paragraph (c)(8) of Rule 17g-5, as proposed.\370\ In 
contrast, several commenters expressed concerns with the proposed 
amendment, generally arguing that the proposed amendment should be 
narrowed or eliminated altogether because the size of an NRSRO does not 
affect whether the potential conflict could influence a

[[Page 55112]]

credit rating.\371\ For example, one of these commenters stated that 
``if a credit rating agency is too small to separate its rating process 
from its marketing process, it should not qualify as an NRSRO.''\372\
---------------------------------------------------------------------------

    \369\ See A.M. Best Letter; CFA/AFR Letter; DBRS Letter; Kroll 
Letter; Morningstar Letter; TradeMetrics Letter.
    \370\ See CFA/AFR Letter; TradeMetrics Letter.
    \371\ See AFSCME Letter; Barnard Letter; Better Markets Letter; 
Levin Letter; S&P Letter.
    \372\ See Levin Letter.
---------------------------------------------------------------------------

    In response to concerns about providing for exemptions for small 
NRSROs, the Commission notes that section 15E(h)(3)(B)(i) of the 
Exchange Act provides that the Commission's rules issued under section 
15E(h)(3)(A) shall provide for exceptions for small NRSROs with respect 
to which the Commission determines that the separation of the 
production of credit ratings and sales and marketing activities is not 
appropriate.\373\ The final amendment implements this statutory 
requirement but in a manner that will require the Commission to make a 
specific finding before granting an exemption; namely, that due to the 
small size of the NRSRO it is not appropriate to require the separation 
within the NRSRO of the production of credit ratings from sales and 
marketing activities and such exemption is in the public interest.\374\
---------------------------------------------------------------------------

    \373\ See 15 U.S.C. 78o-7(h)(3)(B)(i) (emphasis added).
    \374\ See paragraph (f) of Rule 17g-5.
---------------------------------------------------------------------------

    The Commission considered the concerns expressed by commenters 
about granting any relief to small NRSROs in considering whether to 
adopt a self-executing exemption, which was suggested by a 
commenter.\375\ Under the final amendment, exemptions will be granted 
on a case-by-case basis, after analyzing the facts and circumstances 
the applying NRSRO presents in its request for relief and any other 
relevant facts and circumstances. Any exemptive relief granted can be 
tailored to the specific circumstances of the NRSRO and can include 
specific terms and conditions designed to mitigate the sales and 
marketing conflict and help ensure that any relief that may be provided 
to a small NRSRO does not undermine the overarching purpose of section 
of 15E(h)(3)(A) of the Exchange Act. The ability to tailor exemptive 
relief on a case-by-case basis will allow the Commission the 
flexibility to specify conditions that address the conflict in a way 
that takes into account the specific circumstances of the NRSRO 
requesting the relief (including its size, business model, and the 
steps it has taken to mitigate sales and marketing conflicts). For 
these reasons, the Commission does not believe it would be appropriate 
to establish a self-executing exemption.
---------------------------------------------------------------------------

    \375\ See Kroll Letter.
---------------------------------------------------------------------------

    Commenters addressed various aspects of potential exemption orders 
the Commission might grant under the proposed amendment. For example, 
several NRSROs commented on how the Commission should determine 
``small'' for purposes of granting exemptions.\376\ Two commenters 
stated that all NRSROs that are smaller than the three largest NRSROs 
should be considered small.\377\ Three commenters suggested that annual 
revenue should be the metric for determining if an NRSRO is small.\378\ 
Two commenters stated that the Commission should make the size 
determination on a case-by-case basis,\379\ while one commenter 
suggested a self-executing exemption under which an NRSRO would be 
automatically exempt if its total revenue falls below a certain 
threshold.\380\ On the other hand, one opponent of the proposal stated 
that revenue is not an appropriate measure for granting an exemption 
and suggested, if the Commission proceeds with an exemption, that it be 
based on other metrics.\381\
---------------------------------------------------------------------------

    \376\ See A.M. Best Letter; DBRS Letter; Kroll Letter; 
Morningstar Letter; S&P Letter.
    \377\ See A.M. Best Letter; Morningstar Letter (requesting that 
the Commission consider defining smaller NRSROs as it did in the 
proposing release for purposes of the Regulatory Flexibility Act).
    \378\ See A.M. Best Letter (suggesting a $250 million revenue 
threshold); Kroll Letter (suggesting a $100 million revenue 
threshold); Morningstar Letter.
    \379\ See A.M. Best Letter; DBRS Letter.
    \380\ See Kroll Letter.
    \381\ See S&P Letter (``Other metrics, such as the number of 
personnel, or number of ratings issued in a practice area, may 
provide a more meaningful metric for the granting of any 
exemption'').
---------------------------------------------------------------------------

    Commenters also addressed the duration of an exemption.\382\ One 
supporter of granting exemptions under the proposal suggested that the 
Commission periodically re-evaluate whether the NRSRO continued to be 
small and provide it with a transition period in the event the 
Commission determines it is no longer small.\383\ Another commenter, 
opposing the proposal, suggested that if the Commission does grant an 
exemption, it should be very limited, and that if the Commission later 
determines the NRSRO is not small, it should have only a short 
transition period.\384\ This commenter added that an exempted NRSRO 
should have to publicly disclose the rules from which it is 
exempt.\385\
---------------------------------------------------------------------------

    \382\ See Morningstar Letter; S&P Letter.
    \383\ See Morningstar Letter.
    \384\ See S&P Letter.
    \385\ Id.
---------------------------------------------------------------------------

    Several commenters addressed the conditions that should be part of 
an exemption order under the proposal.\386\ Some stated that even if an 
NRSRO is exempt, the amendments to Rule 17g-5 should make clear that 
NRSROs remain subject to the overarching prohibition against allowing 
sales and marketing considerations to influence credit ratings.\387\ 
Two commenters suggested that any exemption should be contingent upon 
the NRSRO adhering to certain requirements.\388\ Another commenter 
suggested that any NRSRO that is granted an exemption under the 
proposal should be required to indicate on the homepage of its Web site 
that it is a recipient of the exemption.\389\ One commenter that 
opposed the proposed exemption identified additional conditions the 
Commission should consider if it adopts the proposal.\390\
---------------------------------------------------------------------------

    \386\ See AFSCME Letter; Better Markets Letter; CFA/AFR Letter; 
Fitch Letter; S&P Letter.
    \387\ See Better Markets Letter; CFA/AFR Letter.
    \388\ See AFSCME Letter (suggesting that the NRSRO should submit 
a detailed explanation of why it should be exempt and ``concrete 
evidence, not just assertions'' to support its claims that it cannot 
function under the requirement); CFA/AFR Letter (suggesting that the 
application should include a section on what steps the NRSRO is 
taking to ensure sales and marketing considerations do not influence 
rating decisions).
    \389\ See Fitch Letter.
    \390\ See S&P Letter (suggesting that the Commission should 
``specify the terms of the activities permitted and require that the 
NRSRO have policies to address the potential conflict, that the 
policies be transparent, and that compliance of the policies be well 
documented.'').
---------------------------------------------------------------------------

    In making its finding for purposes of determining whether to grant 
an exemption, the Commission will evaluate the particular facts and 
circumstances of the application. In addition, the Commission may 
specify conditions designed to mitigate the sales and marketing 
conflict without imposing an absolute prohibition. Although the 
Commission is not modifying the exemption process from the proposal, 
suggestions by commenters may be helpful to the Commission in 
undertaking the analysis of whether a particular NRSRO should be 
considered ``small'' and in considering how to tailor the exemptive 
relief to mitigate the sales and marketing conflict.
3. Suspending or Revoking a Registration
    Section 15E(h)(3)(B)(ii) of the Exchange Act provides that the 
Commission's rules under section 15E(h) of the Exchange Act shall 
provide for suspension or revocation of the registration of an NRSRO if 
the Commission finds, on the record, after notice and opportunity for a 
hearing, that the NRSRO has committed a violation of ``a rule issued 
under this

[[Page 55113]]

subsection'' and the violation of the rule affected a credit 
rating.\391\ While section 15E(h)(3)(A) relates only to the conflict 
arising from sales and marketing activities, section 15E(h)(3)(B)(ii)--
by using the term ``subsection''--has a broader scope in that it refers 
to all rules issued under section 15E(h) of the Exchange Act. 
Consequently, the proposed amendment implementing section 
15E(h)(3)(B)(ii) addressed violations of any rule adopted under section 
15E(h). Section 15E(h)(3)(B)(ii) does not require that the violation of 
the rule under section 15E(h) be ``willful.''
---------------------------------------------------------------------------

    \391\ See 15 U.S.C. 78o-7(h)(3)(B)(ii).
---------------------------------------------------------------------------

    Currently, the Commission can seek to suspend or revoke the 
registration of an NRSRO, in addition to other potential sanctions, 
under section 15E(d) of the Exchange Act.\392\ In particular, section 
15E(d) provides that the Commission shall, by order, censure, place 
limitations on the activities, functions, or operations of, suspend for 
a period not exceeding twelve months, or revoke the registration of an 
NRSRO if the Commission finds, ``on the record after notice and 
opportunity for a hearing,'' that such sanction is ``necessary for the 
protection of investors and in the public interest'' and the NRSRO, or 
a person associated with the NRSRO (whether prior to or subsequent to 
becoming so associated), has engaged in one or more of six categories 
of conduct specified in sections 15E(d)(1)(A) through (F) of the 
Exchange Act.\393\ Section 15E(d)(1)(A) specifies the first category of 
conduct: That the NRSRO or an associated person has committed or 
omitted any act, or has been subject to an order or finding, enumerated 
in subparagraphs (A), (D), (E), (G), or (H) of section 15(b)(4) of the 
Exchange Act; has been convicted of any offense identified in section 
15(b)(4)(B) of the Exchange Act; or has been enjoined from any action, 
conduct, or practice identified in section 15(b)(4)(C) of the Exchange 
Act.\394\ The acts enumerated in section 15(b)(4)(D) of the Exchange 
Act include that the person has willfully violated any provision of the 
Exchange Act or the rules or regulations under the Exchange Act.\395\ 
Therefore, the Commission has the authority, if it makes the finding 
under section 15E(d)(1)(A), to suspend or revoke the registration of an 
NRSRO for a willful violation of Rule 17g-5, but does not have the 
authority to do so under section 15E(d)(1)(A) for violations of Rule 
17g-5 that are not willful.\396\
---------------------------------------------------------------------------

    \392\ See 15 U.S.C. 78o-7(d).
    \393\ See 15 U.S.C. 78o-7(d)(1)(A) through (F).
    \394\ See 15 U.S.C. 78o-7(d)(1)(A); see also 15 U.S.C. 
78o(b)(4)(A), (B), (C), (D), (E), (G), and (H). Section 15E(d)(1)(B) 
specifies the second category of conduct: that the NRSRO or an 
associated person has been convicted during the ten-year period 
preceding the date on which an application for registration is filed 
with the Commission, or at any time thereafter, of: (1) Any crime 
that is punishable by imprisonment for one or more years, and that 
is not described in section 15(b)(4)(B); or (2) a substantially 
equivalent crime by a foreign court of competent jurisdiction. See 
15 U.S.C. 78o-7(d)(1)(B). Section 15E(d)(1)(C) specifies the third 
category of conduct: That the NRSRO or an associated person is 
subject to any order of the Commission barring or suspending the 
right of the person to be associated with an NRSRO. See 15 U.S.C. 
78o-7(d)(1)(C). Section 15E(d)(1)(D) specifies the fourth category 
of conduct: That the NRSRO or an associated person fails to file the 
annual certification required under section 15E(b)(2) of the 
Exchange Act. See 15 U.S.C. 78o-7(d)(1)(D). Section 15E(d)(1)(E) 
specifies the fifth category of conduct: That the NRSRO or an 
associated person fails to maintain adequate financial and 
managerial resources to consistently produce credit ratings with 
integrity. See 15 U.S.C. 78o-7(d)(1)(E). Finally, section 
15E(d)(1)(F) specifies the sixth category of conduct: That the NRSRO 
or an associated person has failed reasonably to supervise, with a 
view to preventing a violation of the securities laws, an individual 
who commits such a violation, if the individual is subject to the 
supervision of that person. See 15 U.S.C. 78o-7(d)(1)(F).
    \395\ See 15 U.S.C. 78o(b)(4)(D).
    \396\ See 15 U.S.C. 78o-7(d)(1)(A); 15 U.S.C. 78o(b)(4)(D).
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    In addition to proceedings under section 15E(d)(1) of the Exchange 
Act, the Commission can take action under section 15E(d)(2).\397\ This 
section provides that the Commission may temporarily suspend or 
permanently revoke the registration of an NRSRO with respect to a 
particular class or subclass of securities, if the Commission finds, on 
the record after notice and opportunity for a hearing, that the NRSRO 
does not have adequate financial and managerial resources to 
consistently produce credit ratings with integrity.\398\ Furthermore, 
section 21C of the Exchange Act provides the Commission with authority, 
among other things, to enter an order requiring, among other things, 
that a person cease and desist from continuing to violate, or future 
violations of, a provision of the Exchange Act or any rule or 
regulation thereunder.\399\
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    \397\ See 15 U.S.C. 78o-7(d)(2).
    \398\ See 15 U.S.C. 78o-7(d)(2)(A). Section 15E(d)(2)(B) 
provides that, in making any determination under section 
15E(d)(2)(A), the Commission shall consider whether the NRSRO has 
failed over a sustained period of time, as determined by the 
Commission, to produce ratings that are accurate for that class or 
subclass of securities and such other factors as the Commission may 
determine. See 15 U.S.C. 78o-7(d)(2)(B).
    \399\ See 15 U.S.C. 78u-3.
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    In the proposing release, the Commission stated its preliminary 
belief that a rule implementing section 15E(h)(3)(B)(ii) of the 
Exchange Act should work in conjunction with sections 15E(d) and 21C of 
the Exchange Act.\400\ Consequently, the Commission proposed adding 
paragraph (g) to Rule 17g-5.\401\ This paragraph provided that in a 
proceeding pursuant to section 15E(d) or section 21C of the Exchange 
Act, the Commission shall suspend or revoke the registration of an 
NRSRO if the Commission finds in such proceeding that the NRSRO has 
violated a rule issued under section 15E(h) of the Exchange Act, the 
violation affected a credit rating, and that suspension or revocation 
is necessary for the protection of investors and in the public 
interest.\402\ This provision was proposed to be placed in Rule 17g-5, 
given that it is the predominant rule issued under section 15E(h) of 
the Exchange Act.\403\
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    \400\ See Nationally Recognized Statistical Rating 
Organizations, 76 FR at 33428. See also 15 U.S.C. 78o-7(d); 15 
U.S.C. 78u-3.
    \401\ See paragraph (g) of Rule 17g-5, as proposed; Nationally 
Recognized Statistical Rating Organizations, 76 FR at 33427-33428.
    \402\ See paragraph (g) of Rule 17g-5, as proposed; Nationally 
Recognized Statistical Rating Organizations, 76 FR at 33540. See 
also 15 U.S.C. 78o-7(d); 15 U.S.C. 78o-7(h); 15 U.S.C. 78u-3.
    \403\ See Nationally Recognized Statistical Rating 
Organizations, 76 FR at 33428. See also Oversight of Credit Rating 
Agencies Registered as Nationally Recognized Statistical Rating 
Organizations, 72 FR at 33595-33599; Amendments to Rules for 
Nationally Recognized Statistical Rating Organizations, 74 FR at 
6465-6469; Amendments to Rules for Nationally Recognized Statistical 
Rating Organizations, 74 FR at 63842-63850.
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    The first two findings in the proposed amendment mirrored the text 
of section 15E(h)(3)(B)(ii) of the Exchange Act.\404\ The final 
finding--that the suspension or revocation is necessary for the 
protection of investors and in the public interest--is a common finding 
that the Commission must make to take disciplinary action against a 
registered person or entity.\405\ It is not, however, a finding that 
the Commission must make in a proceeding under section 21C.\406\ 
Further, unlike section 15E(d) of the Exchange Act, the Commission can 
take action under section 21C for violations of the securities laws 
even if the violations are not willful.\407\ Moreover, section 
15E(h)(3)(B)(ii) of the Exchange Act does not prescribe the maximum 
amount of time for which an NRSRO could be suspended, whereas section 
15E(d) provides that a suspension shall not exceed twelve

[[Page 55114]]

months.\408\ Consequently, a proceeding pursuant to paragraph (g) of 
Rule 17g-5 brought under section 21C could result in a suspension that 
exceeds twelve months. Given that section 21C of the Exchange Act has a 
lower threshold for intent to establish a violation, and given the 
substantial consequences of suspending or revoking a registration, the 
Commission stated a preliminarily belief in the proposing release that 
the public interest finding would be an appropriate predicate to a 
suspension or revocation of an NRSRO's registration under section 21C 
of the Exchange Act.\409\
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    \404\ See paragraph (g) of Rule17g-5, as proposed; 15 U.S.C. 
78o-7(h)(3)(B)(ii)(I) and (II).
    \405\ See paragraph (g) of Rule 17g-5, as proposed; Nationally 
Recognized Statistical Rating Organizations, 76 FR at 33540. For 
example, the Commission must make this finding to take action under 
section 15E(d) of the Exchange Act. See 15 U.S.C. 78o-7(d).
    \406\ See 15 U.S.C. 78u-3.
    \407\ Compare 15 U.S.C. 78o-7(d), with 15 U.S.C. 78u-3.
    \408\ Compare 15 U.S.C. 78o-7(h)(3)(B)(ii), with 15 U.S.C. 78o-
7(d).
    \409\ See Nationally Recognized Statistical Rating 
Organizations, 76 FR at 33428.
---------------------------------------------------------------------------

    Two commenters addressed whether the Commission should adopt, 
pursuant to section 15E(h)(3)(B)(ii) of the Exchange Act, an 
independent and alternative process for suspending or revoking an 
NRSRO's registration beyond the processes set forth in sections 15E(d) 
and 21C of the Exchange Act.\410\ Both commenters agreed with the 
Commission's proposal that the processes for suspension or revocation 
currently available under the Exchange Act are sufficient.\411\ One 
commenter stated that section 15E(h)(3)(B)(iii) of the Exchange Act 
should work in conjunction with proceedings already available under 
sections 15E(d) and 21C of the Exchange Act.\412\ Similarly, a second 
commenter stated that proceedings currently available under the 
Exchange Act are adequate and that no alternative process is necessary, 
but stated that if the Commission does implement a separate process, 
there should be certain prerequisites to its decision to suspend or 
revoke a registration.\413\
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    \410\ See Morningstar Letter; S&P Letter.
    \411\ See Morningstar Letter; S&P Letter.
    \412\ See Morningstar Letter.
    \413\ See S&P Letter.
---------------------------------------------------------------------------

    The Commission is persuaded that it is appropriate to adopt an 
amendment to Rule 17g-5 that incorporates the statutory provisions 
governing the suspension or revocation of an NRSRO's registration 
(rather than a stand-alone rule). Consequently, the Commission is 
incorporating the statutory provisions into paragraph (g) of Rule 17g-
5, as proposed, but with modifications from the proposal.\414\ Two 
commenters stated that the proposed rule should incorporate only 
section 15E(d) of the Exchange Act in response to the Commission's 
requests for comment on whether the amendment should incorporate 
section 15E(d) and section 21C.\415\ One of these commenters added that 
the section 21C standard is ``too low and its consequences too high'' 
and is therefore inappropriate to use in considering suspension or 
revocation of an NRSRO's registration.\416\ The other commenter stated 
that authority under section 15E(d) is ``adequate,'' making it 
unnecessary for the Commission to incorporate section 21C into the 
rule, and that not all of the provisions of section 21C are applicable 
to NRSROs.\417\
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    \414\ The Commission is making one technical modification to the 
proposal by adding the word ``credit'' before the word ``rating.'' 
See paragraph (g) of Rule 17g-5.
    \415\ See A.M. Best Letter; S&P Letter.
    \416\ See A.M. Best Letter (stating that the process under 
section 21C is inappropriate because it has no requirement of a 
public interest finding and provides no suspension limits).
    \417\ See S&P Letter (stating that certain provisions of section 
21C are applicable to brokers, dealers, and investment advisors, 
among others, but not to NRSROs).
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    The Commission believes that it is not necessary to incorporate 
section 21C of the Exchange Act into the provision governing the 
suspension or revocation of an NRSRO's registration for violating a 
rule issued under section 15E(h) of the Exchange Act, but not for the 
reasons stated by the commenters. The Commission believes the rule can 
be modified in a way that achieves one objective of the proposal--
providing for the suspension or revocation of the registration of an 
NRSRO for violations that are not willful--without incorporating 
section 21C. Instead, the rule can be modified from the proposal so 
that it includes a finding that the Commission must make in the context 
of a proceeding under section 15E(d)(1) of the Exchange Act that is in 
lieu of the findings specified in sections 15E(d)(1)(A) through (F) of 
the Exchange Act. As discussed above, the finding specified in section 
15E(d)(1)(A) is that the NRSRO or an associated person committed or 
omitted any act, or has been subject to an order or finding, enumerated 
in section 15(b)(4)(D) of the Exchange Act, among other sections.\418\ 
The acts enumerated in section 15(b)(4)(D) of the Exchange Act include 
that the person has willfully violated any provision of the Exchange 
Act or the rules or regulations under the Exchange Act.\419\ Therefore, 
the Commission has the authority, if it makes a finding under section 
15E(d)(1)(A) of the Exchange Act, to suspend or revoke the registration 
of an NRSRO for a violation of Rule 17g-5, but only if the violation is 
willful.\420\ The alternative finding does not require a finding that 
the violation was willful, and the Commission can therefore suspend or 
revoke the registration of an NRSRO using this alternative without a 
finding of willfulness and without the need to institute the proceeding 
under section 21C.
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    \418\ See 15 U.S.C. 78o-7(d)(1)(A). See also 15 U.S.C. 
78o(b)(4)(A), (B), (C), (D), (E), (G), and (H).
    \419\ See 15 U.S.C. 78o(b)(4)(D).
    \420\ See 15 U.S.C. 78o-7(d)(1)(A); 15 U.S.C. 78o(b)(4)(D).
---------------------------------------------------------------------------

    For these reasons, the Commission is modifying the rule from the 
proposal to establish a finding that must be made in the context of a 
proceeding under section 15E(d)(1) of the Exchange Act that is in lieu 
of the findings specified in sections 15E(d)(1)(A) through (F).\421\ In 
particular, paragraph (g) of Rule 17g-5, as adopted, provides that in a 
proceeding pursuant to section 15E(d)(1) of the Exchange Act, the 
Commission shall suspend or revoke the registration of an NRSRO if the 
Commission finds, in lieu of a finding required under sections 
15E(d)(1)(A), (B), (C), (D), (E), or (F) of the Exchange Act, that the 
NRSRO has violated a rule issued under section 15E(h) of the Exchange 
Act (for example, Rule 17g-5) and that the violation affected a credit 
rating.\422\
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    \421\ The Commission does not intend the final amendment to 
affect in any manner the Commission's ability to suspend or revoke 
the registration of an NRSRO under section 15E(d)(1) of the Exchange 
Act based upon a finding specified under sections 15E(d)(1)(A), (B), 
(C), (D), (E), or (F).
    \422\ See paragraph (g) of Rule 17g-5.
---------------------------------------------------------------------------

    The alternative finding includes the first two prongs of the 
proposed finding: (1) That the NRSRO has violated a rule issued under 
section 15E(h) of the Exchange Act; and (2) that the violation affected 
a credit rating. As discussed above and in the proposing release, these 
two prongs of the finding mirror the text of section 15E(h)(3)(B)(ii) 
of the Exchange Act.\423\ In addition, the alternative finding must be 
made in the context of a proceeding under section 15E(d)(1). 
Consequently, the Commission must find, ``on the record after notice 
and opportunity for a hearing,'' that suspension or revocation is 
``necessary for the protection of investors and in the public 
interest.'' \424\ In this way, the alternative finding also 
incorporates the public interest finding that was part of the proposed 
finding, which the Commission continues to

[[Page 55115]]

believe is appropriate given the severity of the sanction of suspending 
or revoking an NRSRO's registration.\425\
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    \423\ 15 U.S.C. 78o-7(h)(3)(B)(ii) (providing that the 
Commission's rules under section 15E(h) of the Exchange Act shall 
provide for suspension or revocation of the registration of an NRSRO 
if the Commission finds, on the record, after notice and opportunity 
for a hearing, that the NRSRO has committed a violation of ``a rule 
issued under this subsection'' and the violation of the rule 
affected a credit rating).
    \424\ 15 U.S. C. 78o-7(d).
    \425\ A number of commenters addressed whether the Commission 
should be required to make a public interest finding to suspend or 
revoke an NRSRO's registration in a proceeding under proposed 
paragraph (g) of Rule 17g-5 pursuant to section 21C of the Exchange 
Act. See AFSCME Letter; A.M. Best Letter; Better Markets Letter; FSR 
Letter; Morningstar Letter; S&P Letter. Four commenters supported 
the requirement. See A.M. Best Letter; FSR Letter; Morningstar 
Letter; S&P Letter. One commenter that supported this aspect of the 
proposal stated that a public interest finding is necessary ``to 
consider whether, in fact, a violation had any impact on the 
public.'' See A.M. Best Letter. A second commenter added that a 
public interest finding is appropriate because a sanction of 
suspension or revocation is significant and that NRSROs play an 
important role in the financial markets. See S&P Letter. In 
contrast, two commenters opposed the proposed required public 
interest finding. See AFSCME Letter; Better Markets Letter. One of 
these commenters stated that the finding could make it more 
difficult for the Commission to sanction an NRSRO, and that it 
provides NRSROs with additional defenses to potential sanctions. See 
Better Markets Letter. The other commenter suggested that the 
standard be changed from ``necessary for the protection of investors 
and in the public interest'' to ``consistent with the public 
interest'' to give the Commission more flexibility in the 
enforcement remedy. See AFSCME Letter. Both commenters suggested the 
increased threshold in the proposal to suspend or revoke an NRSRO's 
registration was not the intent of Congress. See AFSCME Letter; 
Better Markets Letter. In response to these comments, the Commission 
believes--as indicated above--that the public interest finding is 
appropriate given the severity of the sanctions. In response to the 
commenter that suggested the standard be changed from ``necessary 
for the protection of investors and in the public interest'' to 
``consistent with the public interest'' to give the Commission more 
flexibility in the enforcement remedy, the Commission notes that the 
standard ``necessary for the protection of investors and in the 
public interest'' is a standard used consistently throughout the 
Commission's rules and the Exchange Act. The Commission is not 
persuaded it is necessary to use a different standard in this 
instance. Consequently, because the finding required under the final 
amendment must be made in the context of a proceeding under section 
15E(d) of the Exchange Act, the final amendment incorporates the 
public interest finding in that section.
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    The final amendment--because it incorporates section 15E(d) only--
is different from the proposed amendment in that the Commission is 
limited to suspending a registration for a period not exceeding twelve 
months.\426\ The Commission does not view this as a significant 
difference. To the extent the Commission believes a credit rating 
agency should stop operating as an NRSRO for a period longer than 
twelve months, the Commission can seek to revoke its registration.\427\
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    \426\ 15 U.S.C. 78o-7(d)(1).
    \427\ Commenters addressed whether the rule should limit the 
length of a suspension under section 21C of the Exchange Act. See 
A.M. Best Letter; Morningstar Letter; S&P Letter. Two commented that 
the ability to suspend the registration of an NRSRO for up to twelve 
months under section 15E(d) was sufficient and, therefore, a 
suspension proceeding under section 21C is unnecessary. See A.M. 
Best Letter; S&P Letter. One commenter stated that there should be a 
time limit for a suspension under section 21C and, while stating 
that the twelve month limit under section 15E(d) is sufficient, 
suggested an alternative approach based on the time horizon of the 
associated credit rating. See Morningstar Letter (suggesting, as an 
alternative, that the Commission ``could use a multiple of the 
intended time horizon associated with the rating'' as a maximum 
suspension). As discussed above, the finding required under the 
final amendment must be made in a proceeding under section 
15E(d)(1), which limits suspensions to a period not to exceed twelve 
months. See 15 U.S.C. 78o-7(d)(1).
---------------------------------------------------------------------------

    Finally, three commenters addressed the factual predicate necessary 
to support a finding that the violation affected a credit rating.\428\ 
The commenters generally stated that a finding that a rule violation 
affected a credit rating is only part of the appropriate analysis and 
is not, by itself, enough to suspend or revoke an NRSRO's 
registration.\429\ One commenter added that any suspension or 
revocation proceeding must ``take into account all relevant factors of 
the particular circumstance at issue.'' \430\ The other two commenters 
recommended additional findings that should be considered in making a 
determination that a violation of a rule affected a credit rating.\431\ 
In response, the Commission notes that to suspend or revoke an NRSRO's 
registration under section 15E(d)(1) of the Exchange Act the Commission 
must find, among other things, that doing so is necessary for the 
protection of investors and in the public interest.\432\ This will 
entail consideration of the particular facts and circumstances of each 
case in crafting an appropriate remedy.
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    \428\ See A.M. Best Letter; Morningstar Letter; S&P Letter.
    \429\ See A.M. Best Letter; Morningstar Letter; S&P Letter.
    \430\ See A.M. Best Letter.
    \431\ See Morningstar Letter (stating that the findings should 
be ``supported by Commission evidence that the undue influence . . . 
resulted in the NRSRO issuing a credit rating without conforming to 
its documented procedures and methodologies and that investors who 
relied on those ratings were harmed.''); S&P Letter (stating that 
the following factors should be a factual predicate to support the 
finding that the violation affected a rating: ``(i) there was an 
appropriate attempt to influence the rating decision; (ii) the NRSRO 
did not adhere in material respects to its applicable policies and 
procedures; and (iii) the rating decision was not honestly held by 
the rating committee analysts who voted for it at the time it was 
issued.'').
    \432\ See 15 U.S.C. 78o-7(d)(1).
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4. Economic Analysis
    This section builds on the economic analysis in section I.B. of 
this release by presenting a focused analysis of the potential economic 
effects that may derive from the amendments relating to the sales and 
marketing conflict of interest.\433\ The baseline that existed before 
today's amendments was one in which an NRSRO was not explicitly 
prohibited from issuing or maintaining a credit rating where a person 
within the NRSRO who participates in determining or monitoring the 
credit rating, or developing or approving procedures or methodologies 
used for determining the credit rating, including qualitative and 
quantitative models, also: (1) Participates in sales or marketing of a 
product or service of the NRSRO or a product or service of an affiliate 
of the NRSRO; or (2) is influenced by sales or marketing 
considerations. However, section 15E(h)(1) of the Exchange Act and Rule 
17g-5, thereunder, require NRSROs to establish, maintain, and enforce 
written policies and procedures reasonably designed to address and 
manage any conflicts of interest that can arise from the business of 
the NRSRO.\434\ In addition, paragraph (c)(6) of Rule 17g-5 prohibits 
an NRSRO from issuing or maintaining a credit rating where the fee paid 
for the rating was negotiated, discussed, or arranged by a person 
within the NRSRO who has responsibility for participating in 
determining credit ratings or for developing or approving procedures or 
methodologies used for determining credit ratings, including 
qualitative and quantitative models. Rule 17g-6 prohibits an NRSRO from 
engaging in certain unfair, coercive, or abusive practices such as 
conditioning the issuance of a credit rating on the purchase of other 
services or products of the NRSRO.\435\
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    \433\ The economic analysis in section I.B. of this release 
discusses the primary economic impacts that may derive from the 
amendments and new rules being adopted today.
    \434\ See 15 U.S.C. 78o-7(h)(1); 17 CFR 240.17g-5.
    \435\ See 17 CFR 240.17g-5(c)(6); 17 CFR 240.17g-6(a)(1).
---------------------------------------------------------------------------

    Relative to this baseline, paragraph (c)(8) of Rule 17g-5, as 
amended, should result in benefits. For example, the amendment should 
decrease the probability that undue influences on credit analysts based 
on sales and marketing considerations could impact the objectivity of 
an NRSRO's credit rating process.\436\ Certain academic studies suggest 
that NRSROs may have engaged in ``ratings catering'' in which an NRSRO 
will deliberately inflate a

[[Page 55116]]

credit rating in order to induce the purchase of the credit rating by 
the issuer, sponsor, or underwriter of the rated security.\437\ 
Involving credit analysts in sales and marketing activities (which are 
designed to obtain business) could potentially influence them to 
inappropriately take business considerations into account when 
determining credit ratings. Such influence may also arise from other 
channels, such as compensation arrangements that may incentivize 
analysts to produce inflated credit ratings to increase or retain the 
NRSRO's market share, performance evaluation systems that reward 
analysts who produce inflated credit ratings to increase or retain the 
NRSRO's market share, clients such as rated entities who pressure 
analysts to produce inflated credit ratings to retain their business, 
or managers that are not involved in sales and marketing activities but 
may seek to pressure analysts to produce inflated credit ratings to 
increase or retain the NRSRO's market share. The two-pronged absolute 
prohibition is designed to insulate credit analysts from sales and 
marketing concerns and pressures that may arise through any channel. 
This could enhance the integrity and quality of credit ratings.
---------------------------------------------------------------------------

    \436\ See Oversight of Credit Rating Agencies Registered as 
Nationally Recognized Statistical Rating Organizations, 72 FR at 
33598-33599, 33613 (discussing objectives and benefits of paragraph 
(c) of Rule 17g-5 when it was adopted); see also Amendments to Rules 
for Nationally Recognized Statistical Rating Organizations, 74 FR at 
6465-6469, 6474-6475 (discussing objectives and benefits of 
paragraph (c) of Rule 17g-5 when it was amended).
    \437\ See Griffin, Nickerson, and Tang, Rating Shopping or 
Catering? An Examination of the Response to Competitive Pressure for 
CDO Ratings, Bolton, Freixas, and Shapiro, The Credit Ratings Game.
---------------------------------------------------------------------------

    Relative to the baseline, paragraph (c)(8) of Rule 17g-5 will 
result in costs to NRSROs. For example, some NRSROs may incur costs for 
hiring additional personnel, given the need to separate the analytical 
and sales and marketing functions. Commenters did not provide data for 
this specific cost. However, some NRSROs may choose to reallocate 
responsibilities among existing staff in order to meet the requirement. 
This cost of hiring additional personnel will likely vary significantly 
with the size of the NRSRO and the degree of existing separation 
between analytical staff and sales and marketing personnel.\438\ NRSROs 
may also incur costs to make other operational changes, such as changes 
to communication policies, to ensure that credit analysts are not 
influenced by sales or marketing considerations from other channels. 
These incremental costs may vary based on the current operational 
structure of NRSROs. It is also possible that NRSROs may incur costs 
related to changes in the compensation arrangements of credit 
analysts.\439\
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    \438\ The Commission estimates the cost of hiring an additional 
credit analyst to be $55,600 on a one-time basis and $591,000 per 
year thereafter (2080 work hours per year x $284 for a fixed income 
research analyst (intermediate) = $591,000; 200 hours x $278 for a 
senior human resources representative = $55,600). The Commission 
estimates the cost of hiring an additional sales and marketing staff 
member to be $55,600 on a one-time basis and $528,000 per year 
thereafter (2080 work hours per year x $254 for a marketing manager 
= $528,000; 200 hours x $278 for a senior human resources 
representative = $55,600). The salary figures provided in this 
release are from SIFMA's Management & Professional Earnings in the 
Securities Industry 2013, modified by Commission staff to account 
for a 1,800-hour work-year and multiplied by 5.35 to account for 
bonuses, firm size, employee benefits, and overhead.
    \439\ The cost of changes to operational and compensation 
arrangements have been reflected in the PRA burdens discussed in 
section IV.D.5. and section IV.D.6. of this release.
---------------------------------------------------------------------------

    An NRSRO also will incur costs for updating its written policies 
and procedures to address and manage conflicts of interest required 
under section 15E(h) of the Exchange Act and Rule 17g-5 and to file 
with the Commission an update of its registration on Form NRSRO to 
account for the updated policies and procedures. Based on analysis for 
purposes of the PRA, the Commission estimates that paragraph (c)(8) of 
Rule 17g-5 will result in total industry-wide one-time costs to NRSROs 
of approximately $354,000.\440\
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    \440\ See section V.B. of this release (discussing 
implementation and annual compliance considerations). The one-time 
costs are determined by monetizing internal hour burdens and adding 
external costs identified in the PRA analysis in section IV.D.5. of 
this release.
---------------------------------------------------------------------------

    Relative to the baseline, paragraph (f) of Rule 17g-5 will result 
in costs to NRSROs to the extent they expend resources to draft and 
submit a written request for an exemption under paragraph (f) of Rule 
17g-5. The Commission believes that an NRSRO would likely engage 
outside counsel to assist in drafting the request. Based on analysis 
for purposes of the PRA, the Commission estimates that paragraph (f) of 
Rule 17g-5 will result in costs to NRSROs of approximately $62,000 per 
request.\441\ However, if a small NRSRO is granted an exemption from 
the absolute prohibition, it could avoid having to hire additional 
personnel to undertake sales and marketing activities that were 
otherwise undertaken by individuals involved in the production of 
credit ratings.
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    \441\ See section V.B. of this release (discussing 
implementation and annual compliance considerations). The cost per 
request is determined by monetizing internal hour burdens and adding 
external costs identified in the PRA analysis in section IV.D.5. of 
this release.
---------------------------------------------------------------------------

    Relative to the baseline, paragraph (g) of Rule 17g-5 should not 
result in additional costs to NRSROs. NRSROs already are subject to the 
remedy of suspension or revocation under section 15E(d) the Exchange 
Act.
    The amendments to Rule 17g-5 also may result in other costs. For 
example, prohibiting persons within an NRSRO who participate in 
determining or monitoring the credit ratings, or developing or 
approving rating procedures or methodologies from participating in 
sales and marketing activities may diminish the effectiveness of an 
NRSRO's sales and marketing efforts. For example, the revenues of an 
NRSRO may decrease if existing sales and marketing staff lack the 
expertise to communicate technical information about the NRSRO's rating 
procedures and methodologies to clients and potential clients. However, 
as discussed above, the final amendment does not preclude credit 
analysts from having these discussions with clients as long as the 
analysts do not discuss commercial matters and are not influenced by, 
for example, any pressure imposed by clients to produce inflated credit 
ratings.
    The amendments to Rule 17g-5 should have a number of effects 
related to efficiency, competition, and capital formation.\442\ First, 
these amendments could improve the quality of credit-related 
information. As a result, users of credit ratings could make more 
efficient investment decisions based on this better-quality 
information. Market efficiency also could improve if this information 
is reflected in asset prices. Consequently, capital formation could 
improve as capital may flow to more efficient uses with the benefit of 
this enhanced information. These amendments also provide for an 
exemption based on size, which may decrease the burden of these 
requirements on small NRSROs. However, these amendments could still 
create adverse effects on competition as exempted NRSROs potentially 
may be more prone to engage in ``ratings catering'' and, thereby, 
obtain more business as a result.\443\ More specifically, exempted 
NRSROs may be more likely to produce credit ratings that favor their 
clients as a result of allowing persons involved in sales and marketing 
activities to participate in analytical processes.
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    \442\ See section I.B.3. of this release (providing a broader 
discussion of the potential impacts of the amendments and new rules 
on efficiency, competition, and capital formation).
    \443\ As part of its 2012-2013 NRSRO examinations, Commission 
staff found that four smaller NRSROs did not have sufficient 
procedures and controls for separating business and analytical 
functions or for preventing rating analysts from being involved in 
fee discussions and from having access to rating fee information. 
See 2013 Annual Staff Inspection Report, pp. 11-12.
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    As explained above, commenters suggested a number of alternatives 
to

[[Page 55117]]

the proposed amendments to Rule 17g-5. Several commenters suggested 
that the amendments be less restrictive. One reasonable alternative 
suggested by commenters would be for the Commission not to adopt an 
absolute prohibition but rather to require an NRSRO to disclose and 
have procedures to manage the conflict.\444\ This alternative might 
reduce costs for NRSROs related to, for example, hiring additional 
personnel. However, as explained above, the absolute prohibition was 
designed to insulate individuals within the NRSRO responsible for the 
analytic function from any sales and marketing concerns and pressures. 
Another less restrictive alternative would be, as proposed, to adopt 
only the first prong of the prohibition. This alternative may reduce 
the scope of policies and procedures that an NRSRO may need to revise 
to ensure compliance with the amendments. However, as discussed above, 
there are several potential channels through which sales and marketing 
considerations could influence credit analysts that would not be 
addressed by the first prong of the prohibition. Any less restrictive 
alternative may reduce the benefit of improved credit ratings quality 
if this alternative fails to mitigate conflicts of interest as 
effectively as the requirements of the final amendment.
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    \444\ See S&P Letter; TradeMetrics Letter.
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    One commenter suggested a self-executing exemption where an NRSRO 
would be automatically exempt if its total revenue falls below a 
certain threshold.\445\ This alternative would eliminate the need and 
associated cost for certain NRSROs to apply to the Commission for 
exemptive relief. However, this alternative would eliminate the 
flexibility of the Commission to tailor exemptive relief. Under the 
final amendment, exemptions will be granted on a case-by-case basis, 
after analyzing the facts and circumstances concerning the NRSRO 
seeking the relief. Any exemptive relief granted can be tailored to the 
specific circumstances of the NRSRO requesting the relief and include 
specific terms and conditions designed to mitigate the sales and 
marketing conflict. The ability to tailor exemptive relief on a case-
by-case basis will allow the Commission the flexibility to specify 
conditions that address the conflict in a way that takes into account 
the specific circumstances of the NRSRO requesting the relief 
(including its size and business model). For this reason, the 
Commission does not believe it would be appropriate to establish an 
automatic self-executing exemption.
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    \445\ See Kroll Letter.
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    Commenters also suggested that the rule not require that the 
Commission make a public interest finding to suspend or revoke an 
NRSRO's registration for violating a rule issued under section 15E(h) 
of the Exchange Act, as this would weaken the enforcement remedy.\446\ 
This alternative might benefit users of credit ratings by improving the 
quality of credit ratings. In particular, NRSROs may have higher 
incentives to conform to these requirements as a result of a lower 
threshold for revoking or suspending their registration. However, this 
alternative may result in costs for NRSROs by subjecting them to more 
frequent suspensions and revocations, which could reduce the number of 
NRSROs producing credit ratings. In addition, as stated above, among 
other things, the Commission believes that the public interest finding 
is appropriate given the severity of the sanctions.
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    \446\ See AFSCME Letter; Better Markets Letter.
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C. ``Look-Back'' Review

    Section 932(a)(4) of the Dodd-Frank Act amended section 15E(h) of 
the Exchange Act to add a paragraph (4).\447\ Section 15E(h)(4)(A) 
provides that an NRSRO must establish, maintain, and enforce policies 
and procedures reasonably designed to ensure that, in any case in which 
an employee of a person subject to a credit rating of the NRSRO, or the 
issuer, underwriter, or sponsor of a security or money market 
instrument subject to a credit rating of the NRSRO, was employed by the 
NRSRO and participated in any capacity in determining credit ratings 
for the person or the securities or money market instruments during the 
1-year period preceding the date an action was taken with respect to 
the credit rating, the NRSRO shall: (1) Conduct a review (a ``look-back 
review'') to determine whether any conflicts of interest of the 
employee influenced the credit rating \448\; and (2) take action to 
revise the credit rating, if appropriate, in accordance with such rules 
as the Commission shall prescribe.\449\
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    \447\ See Public Law 111-203, 932(a)(4); 15 U.S.C. 78o-7(h)(4).
    \448\ See 15 U.S.C. 78o-7(h)(4)(A)(i).
    \449\ See 15 U.S.C. 78o-7(h)(4)(A)(ii).
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    Section 15E(h)(4)(A) of the Exchange Act contains a self-executing 
provision requiring an NRSRO to establish, maintain, and enforce 
policies and procedures reasonably designed to ensure that the NRSRO 
will conduct look-back reviews.\450\ The Commission proposed paragraph 
(c) of new Rule 17g-8 and proposed adding paragraph (a)(9) to Rule 17g-
2 to implement rulemaking required in section 15E(h)(4)(A)(ii) of the 
Exchange Act.\451\ The Commission is adopting paragraph (c) of Rule 
17g-8, with modifications, and adding paragraph (a)(9) to Rule 17g-2 as 
proposed.\452\
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    \450\ See 15 U.S.C. 78o-7(h)(4)(A)(i).
    \451\ See Nationally Recognized Statistical Rating 
Organizations, 76 FR at 33429-33432.
    \452\ See paragraph (c) of Rule 17g-8, and paragraph (a)(9) of 
Rule 17g-2. In addition, Rule 17g-8 consolidates requirements that 
NRSROs have policies and procedures in a number of areas. As 
discussed in section II.F.1. of this release, paragraph (a) of Rule 
17g-8 requires an NRSRO to establish policies and procedures with 
respect to credit rating procedures and methodologies. See paragraph 
(a) of Rule 17g-8. Further, as discussed in section II.J.1. of this 
release, paragraph (b) of Rule 17g-8 requires an NRSRO to establish 
policies and procedures with respect to the use of credit rating 
symbols, numbers, and scores. See paragraph (b) of Rule 17g-8.
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1. Paragraph (c) of New Rule 17g-8
    As proposed, paragraph (c) of Rule 17g-8 provided that the policies 
and procedures an NRSRO establishes, maintains, and enforces pursuant 
to section 15E(h)(4)(A) of the Exchange Act must address instances in 
which a look-back review conducted pursuant to those policies and 
procedures determines that a conflict of interest influenced a credit 
rating assigned to an obligor, security, or money market 
instrument.\453\
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    \453\ See paragraph (c) of Rule 17g-8, as proposed; Nationally 
Recognized Statistical Rating Organizations, 76 FR at 33543.
---------------------------------------------------------------------------

    Specifically, paragraph (c)(1) of Rule 17g-8, as proposed, provided 
that an NRSRO must have procedures reasonably designed to ensure that, 
upon the NRSRO's discovery that a former employee's conflict influenced 
a credit rating, it immediately publishes a rating action placing the 
applicable credit ratings of the obligor, security, or money market 
instrument on credit watch or review.\454\ Proposed paragraph (c)(1) 
also provided that the policies and procedures must be reasonably 
designed to ensure the NRSRO includes the information required by 
proposed paragraph (a)(1)(ii)(J)(3)(i) of Rule 17g-7 in the form to 
accompany a credit rating with the publication of the rating action 
placing the credit rating on credit watch.\455\ Specifically, paragraph 
(a)(1)(ii)(J)(3)(i) of Rule 17g-7, as proposed, would have required the 
NRSRO to provide in the form published with the rating action an

[[Page 55118]]

explanation that the reason for the action is the discovery that a 
credit rating assigned to the obligor, security, or money market 
instrument in one or more prior rating actions was influenced by a 
conflict of interest and the date and associated credit rating of each 
prior rating action the NRSRO currently has determined was influenced 
by the conflict.\456\
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    \454\ See paragraph (c)(1) of Rule 17g-8, as proposed; 
Nationally Recognized Statistical Rating Organizations, 76 FR at 
33543.
    \455\ See paragraph (c)(1) of Rule 17g-8, as proposed; 
Nationally Recognized Statistical Rating Organizations, 76 FR at 
33543.
    \456\ See paragraph (a)(1)(ii)(J)(3)(i) of Rule 17g-7, as 
proposed; Nationally Recognized Statistical Rating Organizations, 76 
FR at 33541.
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    Paragraph (c)(2) of Rule 17g-8, as proposed, provided that the 
NRSRO must have procedures reasonably designed to ensure that it 
promptly determines whether the current credit rating assigned to the 
obligor, security, or money market instrument must be revised so that 
it no longer is influenced by a conflict of interest and is solely a 
product of the documented procedures and methodologies the NRSRO uses 
to determine credit ratings.\457\ The proposed approach was intended to 
ensure that, as soon as possible, the assigned credit rating will 
become solely a product of the NRSRO's procedures and methodologies for 
determining credit ratings (that is, no longer influenced by the 
conflict).\458\
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    \457\ See paragraph (c)(2) of Rule 17g-8, as proposed; 
Nationally Recognized Statistical Rating Organizations, 76 FR at 
33543.
    \458\ See Nationally Recognized Statistical Rating 
Organizations, 76 FR at 33430.
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    Paragraph (c)(3) of Rule 17g-8, as proposed, provided that the 
NRSRO must have procedures reasonably designed to ensure it promptly 
publishes a revised credit rating, if appropriate, or an affirmation of 
the credit rating, if appropriate, based on the determination of 
whether the current credit rating assigned to the obligor, security, or 
money market instrument must be revised.\459\ Paragraph (c)(3), as 
proposed, also provided that the NRSRO's procedures must be reasonably 
designed to ensure that information required pursuant to paragraphs 
(a)(1)(ii)(J)(3)(ii) and (iii) of Rule 17g-7, as proposed, is included 
in the form to accompany the publication of a revised credit rating or 
a credit rating affirmation.\460\ In the case of a revised credit 
rating, paragraph (a)(1)(ii)(J)(3)(ii) of Rule 17g-7, as proposed, 
would require the NRSRO to provide in the form an explanation that the 
reason for the action is the discovery that a credit rating assigned to 
the obligor, security, or money market instrument in one or more prior 
rating actions was influenced by a conflict of interest, the date and 
associated credit rating of each prior rating action the NRSRO has 
determined was influenced by the conflict, and an estimate of the 
impact the conflict had on each such prior rating action.\461\ 
Similarly, in the case of an affirmed credit rating, paragraph 
(a)(1)(ii)(J)(3)(iii) of Rule 17g-7, as proposed, would require the 
NRSRO to provide an explanation of why no rating action was taken to 
revise the credit rating notwithstanding the conflict, the date and 
associated credit rating of each prior rating action the NRSRO has 
determined was influenced by the conflict, and an estimate of the 
impact the conflict had on each such prior rating action.\462\
---------------------------------------------------------------------------

    \459\ See paragraphs (c)(3)(i) and (ii) of Rule 17g-8, as 
proposed; Nationally Recognized Statistical Rating Organizations, 76 
FR at 33543.
    \460\ See paragraphs (c)(3)(i) and (ii) of Rule 17g-8, as 
proposed; Nationally Recognized Statistical Rating Organizations, 76 
FR at 33543. See also paragraphs (a)(1)(ii)(J)(3)(ii) and (iii) of 
Rule 17g-7, as proposed; Nationally Recognized Statistical Rating 
Organizations, 76 FR at 33541.
    \461\ See paragraph (a)(1)(ii)(J)(3)(ii) of Rule 17g-7, as 
proposed; Nationally Recognized Statistical Rating Organizations, 76 
FR at 33541.
    \462\ See paragraph (a)(1)(ii)(J)(3)(iii) of Rule 17g-7, as 
proposed; Nationally Recognized Statistical Rating Organizations, 76 
FR at 33541.
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    As discussed in more detail below, the Commission is adopting 
paragraph (c) of Rule 17g-8, with modifications from the proposal in 
response to comments.\463\ The modifications eliminate the requirement 
to immediately place the credit rating on credit watch or review and 
make certain technical changes. The Commission is adopting paragraph 
(a)(1)(ii)(J)(3) of Rule 17g-7 with modifications from the proposal in 
response to comments.\464\ The modifications eliminate the required 
disclosure that would have accompanied the placement of the credit 
rating on credit watch, revise the disclosure requirement with respect 
to estimating the impact of the conflict, and make certain technical 
changes.\465\
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    \463\ See paragraph (c) of Rule 17g-8.
    \464\ See paragraph (a)(1)(ii)(J)(3) of Rule 17g-7.
    \465\ As discussed below in section II.G.1. of this release, the 
form to accompany a rating action need not be published when a 
credit rating is put on watch or review.
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    The Commission is adopting the prefatory language to paragraph (c) 
of Rule 17g-8 as proposed.\466\ Consequently, the final rule provides, 
in pertinent part, that the policies and procedures an NRSRO is 
required to establish, maintain, and enforce pursuant to section 
15E(h)(4)(A) of the Exchange Act must address instances in which a 
review conducted pursuant to those policies and procedures determines 
that a conflict of interest influenced a credit rating assigned to an 
obligor, security, or money market instrument by including, at a 
minimum, procedures that are reasonably designed to ensure that the 
NRSRO will take the steps discussed below.\467\
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    \466\ See prefatory paragraph (c) of Rule 17g-8.
    \467\ See paragraph (c) of Rule 17g-8.
---------------------------------------------------------------------------

    Two commenters stated that the Commission should define what it 
means for a conflict of interest to influence a credit rating.\468\ One 
of these commenters stated that any definition should not require 
``proof of subjective intent or motivation on the part of the NRSRO 
employee'' since it would be difficult to discern.\469\ On the other 
hand, two NRSROs stated that the Commission should not provide a 
definition.\470\ One stated that a finding of influence should only be 
required ``where the NRSRO determines that, absent the conflict, the 
NRSRO would have issued a different rating'' because this is the only 
``influence'' that has ``practical consequences for the users of the 
affected credit rating.'' \471\ The other NRSRO stated that any 
definition should ``include situations where a primary analyst or 
voting member of a credit rating committee succeeded in persuading 
other committee members to agree to a ratings determination that was 
inconsistent with the NRSRO's ratings criteria, procedures and 
methodologies.'' \472\
---------------------------------------------------------------------------

    \468\ See AFSCME Letter; Harrington Letter.
    \469\ See AFSCME Letter.
    \470\ See DBRS Letter; S&P Letter.
    \471\ See DBRS Letter.
    \472\ See S&P Letter.
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    The Commission does not believe it is necessary at this time to 
define in the rule what it means to influence a credit rating because 
the provisions of the rule provide sufficient guidance in this respect. 
In particular, the rule provides that the NRSRO must determine whether 
a conflicted credit rating must be revised so that it no longer is 
influenced by a conflict of interest and is solely a product of the 
documented procedures and methodologies the NRSRO uses to determine 
credit ratings.\473\ Thus, the rule contains a standard that can be 
used for purposes of making the influence determination required by 
section 15E(h)(4)(A) of the Exchange Act: Namely, whether the credit 
rating is solely a product of the documented procedures and 
methodologies the NRSRO uses to determine credit ratings. As one 
commenter stated, a finding of influence should only be required 
``where the NRSRO determines that, absent the conflict, the NRSRO would 
have issued a different rating.'' \474\ The Commission believes that 
this is an appropriate framework for assessing whether a conflict 
influenced a credit rating under

[[Page 55119]]

section 15E(h)(4)(A). Moreover, it is consistent with the standard to 
be used in paragraph (c) of Rule 17g-8, as adopted, for determining 
whether the credit rating must be revised.\475\
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    \473\ See paragraph (c)(1) of Rule 17g-8.
    \474\ See DBRS Letter.
    \475\ See paragraph (c)(1) of Rule 17g-8.
---------------------------------------------------------------------------

    One commenter stated that the rule should require the NRSRO to 
review whether a conflict influenced the determination of its rating 
methodologies or procedures.\476\ This suggestion is outside the scope 
of the proposal. However, section 15E(h)(1) of the Exchange Act 
requires an NRSRO to establish, maintain, and enforce written policies 
and procedures reasonably designed, taking into consideration the 
nature of the business of such NRSRO and affiliated persons and 
affiliated companies thereof, to address and manage any conflicts of 
interest that can arise from such business.\477\ Further, Rule 17g-5, 
among other things, prohibits an NRSRO from having conflicts of 
interest unless they are disclosed and managed through policies and 
procedures.\478\ Thus, the statute and rule cover the conflict that 
arises when the prospective employment of an NRSRO's employee 
influenced a credit rating methodology (as opposed to a credit rating). 
For these reasons, an NRSRO would need to address the conflict pursuant 
to section 15E(h)(1) and Rule 17g-5 if it concluded in connection with 
a look-back review conducted pursuant to section 15E(h)(4)(A) of the 
Exchange Act that the prospect of future employment inappropriately 
influenced a credit rating procedure or methodology of the NRSRO.
---------------------------------------------------------------------------

    \476\ See CFA/AFR Letter.
    \477\ See 15 U.S.C. 78o-7(h)(1).
    \478\ See also 17 CFR 240.17g-5.
---------------------------------------------------------------------------

    One commenter stated that the Commission should specify minimum 
steps that the NRSRO must follow to determine if a former employee's 
conflict of interest influenced a credit rating because an ``NRSRO's 
initial review'' to determine whether a conflict influenced a rating is 
``at least as important as the process for revising a rating.'' \479\ 
One NRSRO stated that the NRSRO should review credit ratings ``upon a 
discovery that they may have been influenced by a conflict'' but that 
convening a new rating committee each time a potential conflict is 
discovered should not be required because it could impact the 
timeliness of ratings determinations.\480\
---------------------------------------------------------------------------

    \479\ See Better Markets Letter.
    \480\ See S&P Letter.
---------------------------------------------------------------------------

    These comments address the self-executing provisions of section 
15E(h)(4)(A)(i) of the Exchange Act.\481\ The Commission did not 
propose rules to implement this part of the statute as the statute 
itself directly prescribes specific requirements for NRSROs.\482\ 
However, the Commission notes that the statute requires the look-back 
review policies and procedures to be reasonably designed. Consequently, 
while the Commission is not prescribing by rule how an NRSRO must 
conduct a look-back review, an NRSRO must establish, maintain, and 
enforce policies and procedures that are reasonably designed to achieve 
the objectives set forth in the statute.
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    \481\ See 15 U.S.C. 78o-7(h)(4)(A)(i) (requiring an NRSRO to 
establish, maintain, and enforce policies and procedures reasonably 
designed to ensure that, in any case in which an employee of a 
person subject to a credit rating of the NRSRO or the issuer, 
underwriter, or sponsor of a security or money market instrument 
subject to a credit rating of the NRSRO, was employed by the NRSRO 
and participated in any capacity in determining credit ratings for 
the person or the securities or money market instruments during the 
1-year period preceding the date an action was taken with respect to 
the credit rating, the NRSRO shall conduct a look-back review to 
determine whether any conflicts of interest of the employee 
influenced the credit rating).
    \482\ As discussed throughout this section, the Commission is 
implementing the part of the statute that addresses the steps to be 
taken if the look-back review determines that a conflict of interest 
of the employee influenced the credit rating. See 15 U.S.C. 78o-
7(h)(4)(A)(ii) (providing that the NRSRO must take action to revise 
the credit rating, if appropriate, in accordance with such rules as 
the Commission shall prescribe).
---------------------------------------------------------------------------

    A number of commenters addressed proposed paragraph (c)(1) of Rule 
17g-8, which would have required NRSROs to immediately publish a rating 
action placing applicable credit ratings on credit watch or review 
based on the discovery that a former employee's conflict influenced a 
credit rating.\483\ Several commenters, including NRSROs, stated that 
the proposed requirements may cause volatility, confusion, or 
disruption in the market,\484\ and one NRSRO stated that the placement 
of credit ratings on credit watch may force investment managers to sell 
securities, pursuant to investment guidelines.\485\ Two NRSROs stated 
that the NRSRO should be allowed to determine whether and when to place 
a credit rating on credit watch, in accordance with its analytical 
criteria and procedures.\486\ One of these NRSROs stated that mandating 
that the NRSRO place a credit rating on credit watch may impact the 
timeliness of credit rating determinations and may constitute 
regulating the substance of credit ratings or the procedures and 
methodologies by which an NRSRO determines credit ratings in violation 
of section 15E(c)(2) of the Exchange Act.\487\ Another NRSRO suggested 
that the Commission ``provide a timeframe for the NRSRO to revise and 
affirm the rating when a conflict arises'' before requiring it to place 
the credit rating on credit watch.\488\ Several commenters stated that 
a credit rating should be placed on credit watch only after the NRSRO 
determines that a conflict of interest has influenced the credit 
rating.\489\
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    \483\ See A.M. Best Letter; AFSCME Letter; DBRS Letter; FSR 
Letter; Moody's Letter; Morningstar Letter; S&P Letter.
    \484\ See A.M. Best Letter; DBRS Letter; FSR Letter; Morningstar 
Letter; S&P Letter.
    \485\ See S&P Letter.
    \486\ See DBRS Letter; S&P Letter.
    \487\ See S&P Letter.
    \488\ See Morningstar Letter.
    \489\ See A.M. Best Letter; AFSCME Letter; DBRS Letter; FSR 
Letter; Moody's Letter; S&P Letter. The rule, as proposed, required 
the NRSRO to place the credit rating on watch only after the NRSRO 
determined based on a look-back review that the credit rating was 
influenced by the conflict of interest.
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    The Commission is persuaded that the proposed requirement to 
immediately place the credit rating on watch or review could lead to 
potential market disruption and confusion, possibly harming investors 
and issuers, at a time when it is not clear that the credit rating will 
be changed. However, the Commission also believes that investors and 
other users of an NRSRO's credit ratings should be notified that a 
prior credit rating was influenced by a conflict of interest within a 
reasonable period of time. As discussed below, an NRSRO must promptly 
determine whether the credit rating must be revised or affirmed and 
promptly revise or affirm the credit rating and include with the 
publication of the rating action revising or affirming the credit 
rating information about the existence of the conflict. In most cases, 
this process should provide investors and other users of the NRSRO's 
credit ratings with notice of the existence of the conflict in a timely 
manner.
    However, if there is a delay in publishing the revised or affirmed 
credit rating, the Commission believes the NRSRO should provide notice 
of the existence of the conflict of interest through another means. 
Accordingly, paragraph (c) of Rule 17g-8, as adopted, has been modified 
to eliminate the requirement to immediately place credit ratings on 
credit watch or review based on the discovery of the conflict.\490\ 
Instead, the rule provides that the NRSRO must place the credit rating 
on

[[Page 55120]]

watch or review if the credit rating is not revised or affirmed in 
accordance with the rule within fifteen calendar days of the date of 
the discovery that the credit rating was influenced by a conflict of 
interest.\491\ This is designed to provide notice to users of the 
NRSRO's credit ratings of the existence of the conflict in a case where 
the NRSRO delays publishing a revision or affirmation of the credit 
rating. However, by prescribing a deadline of fifteen calendar days, 
the Commission is not suggesting that an NRSRO can meet its obligation 
to promptly revise or affirm a credit rating by waiting fifteen 
calendar days. As discussed below, an NRSRO must promptly revise or 
affirm the credit rating. The question of whether an NRSRO has met this 
standard will depend on the facts and circumstances.
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    \490\ The rule, as adopted, does not preclude an NRSRO from 
immediately placing credit ratings on credit watch or review based 
on the discovery of a conflict if such action is in accordance with 
the NRSRO's policies and procedures.
    \491\ See paragraph (c)(2)(ii) of Rule 17g-8. See also 
Morningstar Letter (suggesting that the Commission ``provide a 
timeframe for the NRSRO to revise and affirm the rating when a 
conflict arises'' before requiring it to place the credit rating on 
credit watch).
---------------------------------------------------------------------------

    Consistent with modifications to Rule 17g-7 discussed below in 
section II.G.1. of this release, the Commission is eliminating the 
related disclosure requirement in proposed paragraph 
(a)(1)(ii)(J)(3)(i) of Rule 17g-7 that would need to have been made 
when the credit rating is put on watch or review.\492\ Instead, 
paragraph (c)(2)(ii) of Rule 17g-8 provides that, if an NRSRO is 
required to place the credit rating on watch or review because it did 
not revise or affirm the credit rating within fifteen calendar days, 
the NRSRO must include with the publication an explanation that the 
reason for the action is the discovery that the credit rating was 
influenced by a conflict of interest.
---------------------------------------------------------------------------

    \492\ As discussed below in section II.G.1. of this release, the 
Commission is eliminating the requirement to publish the form 
containing the required information about the rating action when an 
NRSRO places a credit rating on watch or review.
---------------------------------------------------------------------------

    The Commission is adopting the requirement in proposed paragraph 
(c)(2) of Rule 17g-8 substantially as proposed, but is redesignating it 
as paragraph (c)(1) of Rule 17g-8.\493\ As adopted, the final rule 
requires that the NRSRO's policies and procedures under section 
15E(h)(4)(A) of the Exchange Act be reasonably designed to ensure that 
the NRSRO will promptly determine whether the current credit rating 
assigned to the obligor, security, or money market instrument must be 
revised so that it is no longer influenced by a conflict of interest 
and is solely a product of the documented procedures and methodologies 
the NRSRO uses to determine credit ratings.\494\
---------------------------------------------------------------------------

    \493\ See paragraph (c)(1) of Rule 17g-8. The final rule 
modifies the proposal by re-designating paragraph (c)(2) as 
paragraph (c)(1) because the requirement to place a credit rating on 
credit watch, which would have been codified in paragraph (c)(1) 
under the proposal, is being eliminated.
    \494\ See paragraph (c)(1) of Rule 17g-8.
---------------------------------------------------------------------------

    In the proposing release, the Commission asked whether the rule 
should be more prescriptive in terms of how an NRSRO would be required 
to determine whether to revise a credit rating by, for example, 
requiring an NRSRO to apply a de novo review of the rated obligor, 
security, or money market instrument using its rating procedures and 
methodologies.\495\ Three NRSROs stated that the Commission should not 
prescribe more requirements for how NRSROs must determine whether a 
rating must be revised.\496\ Two of these NRSROs stated that doing so 
may constitute regulating the substance of the credit ratings or the 
procedures and methodologies by which an NRSRO determines credit 
ratings in contravention of section 15E(c)(2) of the Exchange Act,\497\ 
and one of these NRSROs stated that the NRSRO ``should retain the 
flexibility to conduct whatever analysis a particular situation calls 
for.'' \498\ On the other hand, one commenter stated that the 
Commission should be ``more prescriptive in this area'' and ``require 
the NRSRO to apply de novo its procedures and methodologies'' to 
determine whether a credit rating must be revised.\499\ Another 
commenter stated that it is ``essential'' to require the NRSRO to 
``conduct a de novo analysis of the credit rating using its 
methodologies and procedures.'' \500\ In implementing section 
15E(h)(4)(A)(i) of the Exchange Act through Rules 17g-8 and 17g-7, the 
Commission has sought to strike an appropriate balance between adopting 
a measure designed to address the employment conflict with the 
prohibition in section 15E(c)(2) of the Exchange Act under which the 
Commission may not regulate the substance of credit ratings or the 
procedures and methodologies by which any NRSRO determines credit 
ratings.\501\ To strike this balance, the Commission believes that the 
rule should provide flexibility for the NRSRO to make this 
determination by applying procedures and methodologies that it designs 
to ensure that the credit rating is no longer influenced by the 
conflict of interest. Such procedures and methodologies could but may 
not necessarily require a de novo review of the rated obligor or 
obligation.
---------------------------------------------------------------------------

    \495\ See Nationally Recognized Statistical Rating 
Organizations, 76 FR at 33432.
    \496\ See DBRS Letter; Moody's Letter; S&P Letter.
    \497\ See Moody's Letter; S&P Letter.
    \498\ See DBRS Letter.
    \499\ See AFSCME Letter.
    \500\ See Better Markets Letter.
    \501\ See 15 U.S.C. 78o-7(c)(2).
---------------------------------------------------------------------------

    Two NRSROs stated that a conflict of interest may impact a number 
of other credit ratings, which would need to be revised and 
published.\502\ Accordingly, one of these NRSROs suggested that the 
words ``immediately'' and ``promptly'' in the proposed requirements be 
replaced with ``as soon as practicable'' given that certain procedures 
may have to be followed.\503\ The other NRSRO suggested that paragraph 
(c)(2) of proposed Rule 17g-8 include a ``reasonableness standard'' for 
the term ``promptly.'' \504\ A third NRSRO suggested that a 
``reasonable amount of time'' be given to the NRSRO to ``investigate 
the conflict and determine whether the rating must be revised.'' \505\
---------------------------------------------------------------------------

    \502\ See Moody's Letter; S&P Letter.
    \503\ See Moody's Letter.
    \504\ See S&P Letter.
    \505\ See Morningstar Letter.
---------------------------------------------------------------------------

    In response, the Commission believes it is important that the NRSRO 
not delay completing the process that it will use to determine whether 
the credit rating must be revised to ensure that it is solely a product 
of the NRSRO's procedures and methodologies for determining credit 
ratings (that is, not influenced by the conflict of interest). The 
longer the determination takes the longer that investors and other 
users of credit ratings will remain unaware of the important fact that 
the credit rating was influenced by a conflict. Consequently, the final 
rule retains the requirement that the NRSRO must ``promptly determine'' 
whether a credit rating must be revised.\506\ The Commission recognizes 
that the amount of time necessary to complete the determination will 
depend on facts and circumstances, including the number of credit 
ratings impacted, the degree to which the conflict influenced the 
credit ratings, and the complexity of the rating procedures and 
methodologies used to determine the credit ratings.\507\ However, the 
Commission expects that in each instance, the NRSRO will complete the 
process promptly in order to satisfy the ``promptly determine'' 
requirement and that the process, in many cases, will be expedited by 
the fact that much of the work to determine the impact, if any, and, if 
necessary, revise the credit rating would already be accomplished at 
the time an NRSRO determines that the credit rating was in

[[Page 55121]]

fact influenced by a conflict. In such cases, the Commission would 
expect the revision or affirmation, as appropriate, to be issued 
promptly after the existence of the conflict was determined. The 
Commission notes that, as part of the annual examinations of each 
NRSRO, Commission staff reviews the policies of the NRSRO governing the 
post-employment activities of former staff of the NRSRO.
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    \506\ See paragraph (c)(1) of Rule 17g-8.
    \507\ See Moody's Letter; Morningstar Letter; S&P Letter.
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    The Commission is adopting the requirements in proposed paragraph 
(c)(3) of Rule 17g-8 substantially as proposed, with technical 
modifications, and is redesignating it as paragraph (c)(2)(i) of Rule 
17g-8.\508\ As adopted, the final rule provides that the NRSRO must 
promptly publish, based on the determination of whether a current 
credit rating referred to in paragraph (c)(1) of Rule 17g-8 must be 
revised: (1) A revised credit rating, if appropriate, and include with 
the publication of the revised credit rating the information required 
by paragraph (a)(1)(ii)(J)(3)(i) of Rule 17g-7; or (2) an affirmation 
of the credit rating, if appropriate, and include with the publication 
of the affirmation the information required by paragraph 
(a)(1)(ii)(J)(3)(ii) of Rule 17g-7.\509\ As discussed below, the 
Commission also is adopting the corresponding disclosure requirements 
to accompany the publication of a revised credit rating and an 
affirmation of a credit rating in paragraphs (a)(1)(ii)(J)(3)(i) and 
(ii) of Rule 17g-7, respectively, with modifications in response to 
comments.
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    \508\ See paragraph (c)(2)(i) of Rule 17g-8. The final rule 
modifies the proposal by re-designating paragraph (c)(3) as 
paragraph (c)(2)(i) because, as discussed above, the requirement in 
paragraph (c)(1) of Rule 17g-8, as proposed, is being eliminated. In 
addition, the final rule modifies the proposal by revising the text 
to specifically reference the credit rating ``in paragraph (c)(1)''.
    \509\ See paragraph (c)(2) of Rule 17g-8.
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    One commenter stated that the NRSRO should publish a revised credit 
rating or affirmation, as appropriate, ``as soon as practicable'' 
instead of ``promptly.'' \510\ As discussed above, paragraph (c)(1) of 
Rule 17g-8, as adopted, requires the NRSRO to promptly determine 
whether a credit rating discovered through a look-back review to have 
been influenced by a conflict of interest must be revised so that it is 
no longer influenced by the conflict and is solely a product of the 
documented procedures and methodologies the NRSRO uses to determine 
credit ratings. Having made the determination, paragraph (c)(2) of Rule 
17g-8, as adopted, sets forth the next steps the NRSRO must take: 
Promptly publish a revised credit rating or an affirmation of the 
credit rating and provide users of the NRSRO's credit ratings 
information about the reasons for taking either action. These steps are 
an important component of the look-back review process. They are 
designed to ensure that the NRSRO promptly addresses any impact the 
conflict had on the credit rating and alerts the users of its credit 
ratings about the existence of the conflict and its resolution. As 
stated above, failing to act when a conflict has influenced a credit 
rating creates the risk that investors and other users of credit 
ratings will use a conflicted credit rating when making an investment 
or other credit-related decision. Thus, paragraph (c)(2) of Rule 17g-8, 
as adopted, retains the requirement that the NRSRO must act promptly.
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    \510\ See Moody's Letter.
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    Commenters addressed whether the NRSRO should be required to 
publish a rating affirmation,\511\ including whether such a requirement 
would constitute regulating the substance of credit ratings or the 
procedures and methodologies by which an NRSRO determines credit 
ratings in contravention of section 15E(c)(2) of the Exchange Act.\512\ 
The Commission does not expect (and the final rule does not require) an 
NRSRO to revise a credit rating in every circumstance in which an 
earlier rating action was influenced by a conflict of interest. Section 
15E(h)(4)(A)(ii) of the Exchange Act provides that the NRSRO's policies 
and procedures shall be reasonably designed to, among other things, 
ensure that the NRSRO takes action to revise the credit rating ``if 
appropriate.'' \513\ It is possible, for example, that in the period 
since the NRSRO published the conflicted credit rating, events 
unrelated to the conflict occurred that, when taken into account by the 
NRSRO's procedures and methodologies for determining credit ratings, 
would produce a credit rating at the same notch in the rating scale of 
the NRSRO as the credit rating that was influenced by the 
conflict.\514\ A requirement that the NRSRO nonetheless revise the 
credit rating could interfere with the NRSRO's procedures and 
methodologies for determining credit ratings in that it would force the 
NRSRO to change the credit rating assigned to the obligor, security, or 
money market instrument to a different notch in the rating scale than 
would be the case if the credit rating were solely a product of the 
NRSRO's procedures and methodologies. Consequently, a mandatory 
revision requirement could, in effect, require the NRSRO to publish a 
credit rating that was not consistent with those procedures and 
methodologies. Accordingly, the final rule permits the NRSRO to publish 
an affirmation of the credit rating as an alternative to revising the 
credit rating, if appropriate. As discussed below, the Commission is 
requiring that an NRSRO publish an affirmation if the credit rating is 
not going to be revised because this will be the mechanism for 
disclosing the fact that a conflict at one time influenced the credit 
rating.
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    \511\ See DBRS Letter; S&P Letter.
    \512\ See Moody's Letter. See also 15 U.S.C. 78o-7(c)(2).
    \513\ 15 U.S.C. 78o-7(h)(4)(A)(ii).
    \514\ For example, assume that nine months ago an analyst 
upgraded the credit rating assigned to an issuer's securities from 
the BBB to AA. The analyst leaves the NRSRO to work for the issuer. 
The analyst's new employment triggers a look-back review of the 
rating action upgrading the credit rating from BBB to AA pursuant to 
section 15E(h)(4)(A)(i) of the Exchange Act. The look-back review 
determines the credit rating should not have been upgraded from BBB 
to AA at that point in time and the analyst's action in upgrading 
the credit rating was influenced by the prospect of employment with 
the issuer. The NRSRO performs a de novo review of the credit rating 
assigned to the issuer by applying its procedures and methodologies 
for determining credit ratings. This review--as required by the 
procedures and methodologies--takes into consideration favorable 
financial results the issuer reported three months ago. 
Consequently, the process of re-rating the issuer's securities 
determines that the current credit rating should remain AA.
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    Commenters suggested that if the credit rating is not going to be 
revised there should not be a requirement to publish an 
affirmation.\515\ One commenter stated that such a requirement 
constitutes regulating the substance of credit ratings or the 
procedures and methodologies by which an NRSRO determines credit 
ratings in contravention of section 15E(c)(2) of the Exchange Act.\516\ 
The Commission is not persuaded that the rule should require only the 
publication of a revised credit rating. If the rule did not require 
publication of an affirmation, the users of the NRSRO's credit ratings 
would not learn of the existence of the conflict. One of the goals of 
the registration and oversight program for NRSROs is to increase the 
transparency of their activities so that users of credit ratings can 
understand how they operate and can compare NRSROs. Disclosing the

[[Page 55122]]

existence of the conflict with the publication of the revised credit 
rating or affirmation of the credit rating will provide users of the 
NRSRO's credit ratings with information to assess the adequacy of the 
NRSRO's policies, procedures, and controls designed to manage conflicts 
of interest and, more generally, the integrity of the NRSRO's credit 
rating process. Moreover, the required disclosures could be useful to 
users of the NRSRO's credit ratings in considering the potential risk 
of using the NRSRO's credit ratings to make investment or other credit-
based decisions. Furthermore, in light of the prohibition against 
regulating the substance of credit ratings and rating procedures and 
methodologies in section 15E(c)(2) of the Exchange Act, the final rule 
has been carefully tailored to avoid interfering with the NRSRO's 
analytical process.\517\ It is the NRSRO that will determine--using its 
own procedures and methodologies--whether the credit rating should be 
revised or affirmed. For these reasons, the Commission is adopting the 
requirement to publish an affirmation of the credit rating if the 
credit rating does not need to be revised.
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    \515\ See, e.g., DBRS Letter (supporting the proposed 
requirement that NRSROs ``promptly publish'' a revised rating, but 
stating that an affirmation of a credit rating that was influenced 
by a conflict of interest should be published ``only where the NRSRO 
has determined . . . to place the existing rating on credit 
watch''); S&P Letter (``we also support elimination of proposed Rule 
17g-8(c)(3), to the extent that it would require NRSROs to publish 
ratings affirmations or other actions following a CreditWatch action 
required by proposed Rule 17g-8(c)(1).'').
    \516\ See Moody's Letter.
    \517\ See 15 U.S.C. 78o-7(c)(2).
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    The Commission is adopting the disclosure requirements in proposed 
paragraphs (a)(1)(ii)(J)(3)(ii) and (iii) of Rule 17g-7 with 
modifications and is redesignating them as paragraphs 
(a)(1)(ii)(J)(3)(i) and (ii).\518\ Commenters raised concerns about the 
proposed requirement to disclose an estimate of the impact of the 
conflict on each applicable prior credit rating.\519\ One commenter 
stated that estimating the impact of a conflict on a credit rating may 
``create inefficiencies.'' \520\ A second NRSRO stated that it may be 
``unduly burdensome,'' delaying publication of a corrective 
rating.\521\ A third NRSRO stated that it would be ``practically 
impossible'' to estimate the impact of a conflict on a prior rating and 
that the Commission should not require disclosure of the reasons for 
revising or affirming a credit rating.\522\
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    \518\ See paragraphs (a)(1)(ii)(J)(3)(i) and (ii) of Rule 17g-7. 
Because the disclosure requirement with respect to placing a 
conflicted credit rating on credit watch is being eliminated, the 
final amendments modify the proposed rule text by re-designating 
paragraph (a)(1)(ii)(J)(3)(ii) as paragraph (a)(1)(ii)(J)(3)(i), and 
re-designating paragraph (a)(1)(ii)(J)(3)(iii) as paragraph 
(a)(1)(ii)(J)(3)(ii). Further, because paragraph (c)(3) of Rule 17g-
8, as proposed, is being re-designated as paragraph (c)(2), the 
final amendments modify the references in paragraphs 
(a)(1)(ii)(J)(3)(ii) and (iii) of Rule 17g-7, as proposed, to refer 
to paragraph (c)(2) of Rule 17g-8. The final amendments modify the 
proposed rule text to make other minor changes to improve 
readability.
    \519\ See DBRS Letter; Moody's Letter; S&P Letter.
    \520\ See S&P Letter.
    \521\ See DBRS Letter.
    \522\ See Moody's Letter.
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    The Commission is persuaded by commenters that precisely 
quantifying the impact of the conflict could be difficult and that a 
more narrative disclosure would be appropriate. Consequently, the final 
amendments to Rule 17g-7 require the NRSRO to provide a description of 
the impact the conflict had on the prior rating action or actions.\523\ 
The Commission expects the description to be sufficient to provide 
investors and users of credit ratings with insight into the nature of 
the impact the conflict had on the credit rating. The Commission 
recognizes that this may entail a degree of judgment on the part of the 
NRSRO in terms of estimating the degree of the impact.
---------------------------------------------------------------------------

    \523\ See paragraphs (a)(1)(ii)(J)(3)(i) and (ii) of Rule 17g-7.
---------------------------------------------------------------------------

    In addition, the text of paragraph (a)(1)(ii)(J)(3)(iii) of Rule 
17g-7, as proposed, has been modified to reflect that the requirement 
to place the credit rating on watch and make a corresponding disclosure 
has been eliminated.\524\ As proposed, this paragraph would govern the 
disclosure to be made with an affirmation of the credit rating. The 
disclosure requirement was intended to follow the initial disclosure 
that would have been made when the credit rating was placed on watch. 
The initial disclosure would have included an explanation that the 
credit rating was placed on watch because of the discovery that the 
credit rating was influenced by a conflict of interest. Because this 
disclosure will not be required, the disclosure that accompanies an 
affirmation of a credit rating will need to include an explanation that 
the reason for the action is the discovery that a credit rating 
assigned to the obligor, security, or money market instrument in one or 
more prior rating actions was influenced by a conflict of 
interest.\525\ This will provide context for why the NRSRO is issuing 
the affirmation.\526\
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    \524\ Id.
    \525\ Id.
    \526\ A similar modification is not necessary for the disclosure 
that must accompany a revised credit rating because, as proposed, 
that disclosure would have needed to include an explanation that the 
reason for the action is the discovery that the credit rating was 
influenced by a conflict of interest, thus providing the necessary 
context. See Nationally Recognized Statistical Rating Organizations, 
76 FR at 33541. The final amendments retain this disclosure 
requirement. See paragraph (a)(1)(ii)(J)(3)(i) of Rule 17g-7.
---------------------------------------------------------------------------

    One commenter stated that the rule should require disclosure about 
the nature of the conflict.\527\ In response, the Commission notes that 
the rule requires the NRSRO to include with a revised credit rating an 
explanation that the reason for the action is the discovery that a 
credit rating assigned to the obligor, security, or money market 
instrument in one or more prior rating actions was influenced by a 
conflict of interest.\528\ Similarly, the rule requires an NRSRO to 
include with an affirmation of a credit rating an explanation that the 
credit rating was influenced by a conflict of interest.\529\ The 
Commission agrees with the commenter that the disclosure should provide 
some context for these explanations. Consequently, the Commission is 
modifying the rule text from the proposal to provide that the 
explanation of the conflict to be made with a revision of a credit 
rating or an affirmation of a credit rating must include a description 
of the nature of the conflict.\530\ For example, the description could 
disclose that a former employee was unduly influenced by the prospect 
of working for the issuer of the rated security and, as a consequence, 
did not adhere to the NRSRO's rating methodology in order to make the 
credit rating more favorable to the issuer.
---------------------------------------------------------------------------

    \527\ See Better Markets Letter.
    \528\ See paragraph (a)(1)(ii)(J)(3)(i) of Rule 17g-7.
    \529\ See paragraph (a)(1)(ii)(J)(3)(ii) of Rule 17g-7.
    \530\ See paragraphs (a)(1)(ii)(J)(3)(i) and (ii) of Rule 17g-7.
---------------------------------------------------------------------------

    Finally, two commenters stated that information regarding a credit 
rating influenced by a conflict of interest should be provided to 
former subscribers.\531\ As discussed above, the disclosures are 
required to be made in the form to accompany a rating action under 
paragraph (a) of Rule 17g-7, as amended.\532\ This form--as discussed 
below in section II.G.1. of this release--must be published in the same 
manner as the credit rating that is the result or subject of the rating 
action and made available to the same persons who can receive or access 
the credit rating that is the result or subject of the rating 
action.\533\ This provision thereby accommodates both the issuer-pay 
business model in which rating actions generally are made publicly 
available and the subscriber-pay business model in which rating actions 
generally are made available to current subscribers only.\534\ 
Consequently, if the NRSRO makes its rating actions available only to 
current subscribers, former subscribers will not have access to the 
form and the

[[Page 55123]]

disclosure it contains about the conflict of interest. In considering 
the comments about disclosing the information to former subscribers, 
the Commission balanced the interest in providing users of credit 
ratings with information about a given NRSRO's credit ratings with the 
interest in promulgating rules that accommodate and integrate with the 
two predominant NRSRO business models. For example, since the final 
amendments to Rule 17g-7 require the disclosure to be made in the same 
manner as the disclosure of the credit rating that is the result or 
subject of the rating action, a requirement that the disclosure must be 
made to former subscribers (who normally would not have access to a 
rating action that was published after their subscription expired) 
would necessarily require a different process for the disclosure. For 
example, the disclosure could be made through publication on the 
NRSRO's Web site, but this method of disclosure may not be effective if 
former subscribers no longer view the Web site. Alternatively, the 
NRSRO could send the disclosure to former subscribers, but this could 
be burdensome and present practical difficulties. Because former 
subscribers are no longer using the NRSRO's credit ratings, the 
Commission believes at this time that it is not necessary to add a 
requirement that an NRSRO operating under the subscriber-pay model must 
make this disclosure to former subscribers.
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    \531\ See AFSCME Letter; DBRS Letter.
    \532\ See paragraph (a)(1)(ii)(J)(3) of Rule 17g-7.
    \533\ See paragraph (a) of Rule 17g-7.
    \534\ See 15 U.S.C 78c(a)(61) (defining a credit rating agency, 
in pertinent part, as any person engaged in the business of issuing 
credit ratings on the Internet or through another readily accessible 
means, for free or a reasonable fee).
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2. Amendment to Rule 17g-2
    The Commission proposed adding paragraph (a)(9) to Rule 17g-2 to 
require NRSROs to make and retain a record documenting the policies and 
procedures an NRSRO is required to establish, maintain, and enforce 
pursuant to section 15E(h)(4)(A) of the Exchange Act and paragraph (c) 
of proposed Rule 17g-8.\535\ As a result, the policies and procedures 
would need to be documented and the record documenting them would be 
subject to the record retention and production requirements in 
paragraphs (c) through (f) of Rule 17g-2.\536\ One NRSRO stated that it 
``supports the Commission's proposal to include look-back policies and 
procedures as records that an NRSRO must retain under Rule 17g-
2(a)(9).'' \537\ The Commission is adding paragraph (a)(9) to Rule 17g-
2 as proposed.\538\ This will provide a means for the Commission to 
monitor the NRSROs' compliance with section 15E(h)(4)(A) of the 
Exchange Act and paragraph (c) of Rule 17g-8. The record must be 
retained until three years after the date the record is replaced with 
an updated record in accordance with the amendment to paragraph (c) of 
Rule 17g-2 discussed above in section II.A.2. of this release.\539\
---------------------------------------------------------------------------

    \535\ See section 17(a)(1) of the Exchange Act, which requires 
an NRSRO to make and keep such records, and make and disseminate 
such reports, as the Commission prescribes by rule as necessary or 
appropriate in the public interest, for the protection of investors, 
or otherwise in furtherance of the Exchange Act. 15 U.S.C. 
78q(a)(1).
    \536\ See 17 CFR 240.17g-2(c) through (f).
    \537\ See DBRS Letter.
    \538\ See paragraph (a)(9) of Rule 17g-2.
    \539\ See paragraphs (a)(9) and (c) of Rule 17g-2.
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3. Economic Analysis
    This section builds on the economic analysis in section I.B. of 
this release by presenting a focused analysis of the potential economic 
effects that may derive from the amendments and new rule with respect 
to look-back reviews.\540\ The baseline that existed before today's 
amendments and new rule was one in which section 15E(h)(4)(A)(i) of the 
Exchange Act, added by the Dodd-Frank Act, required NRSROs to 
establish, maintain, and enforce policies and procedures reasonably 
designed to ensure that the NRSRO conducts look-back reviews in any 
case in which an employee of a person subject to a credit rating of the 
NRSRO or the issuer, underwriter, or sponsor of a security or money 
market instrument subject to a credit rating of the NRSRO, was employed 
by the NRSRO and participated in any capacity in determining credit 
ratings for the person or the securities or money market instruments 
during the one-year period preceding the date an action was taken with 
respect to the credit rating.\541\ The Commission staff found during 
its 2013 examinations of NRSROs that all NRSROs had established written 
policies and procedures to address the look-back requirement.\542\ 
However, the staff found that two larger and six smaller NRSROs did not 
consistently, in the staff's view, conduct adequate look-back searches 
or did not have adequate policies governing the searches.\543\
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    \540\ The economic analysis in section I.B. of this release 
discusses the primary economic impacts that may derive from the 
amendments and new rules being adopted today.
    \541\ See 15 U.S.C. 78o-7(h)(4)(A)(i).
    \542\ See 2013 Annual Staff Inspection Report, p. 22. The 2013 
examinations generally focused on NRSRO activities for the period 
October 1, 2011 through December 31, 2012.
    \543\ See 2013 Annual Staff Inspection Report, pp. 22-23.
---------------------------------------------------------------------------

    Section 15E(h)(4)(A)(ii) provides that an NRSRO must establish, 
maintain, and enforce policies and procedures reasonably designed to 
ensure that the NRSRO will take action to revise the credit rating if 
appropriate, in accordance with such rules as the Commission shall 
prescribe.\544\ Before today's amendments and new rule, if the NRSRO 
found, after conducting the look-back review, that the credit rating 
was influenced by a conflict, the NRSRO would have needed to ensure 
that the credit rating was determined in accordance with the procedures 
and methodologies the NRSRO uses to determine credit ratings. However, 
the NRSRO was not required to ``promptly'' determine whether the 
current credit rating must be revised or ``promptly'' publish a revised 
credit rating or an affirmation of the credit rating, as appropriate. 
Further, there was no requirement that the NRSRO disclose information 
about the existence of the conflict with the publication of a revised 
credit rating, affirmation of the existing credit rating, or placement 
of the credit rating on watch or review if the credit rating is not 
revised or affirmed within fifteen calendar days of the discovery that 
the credit rating was influenced by a conflict. Finally, an NRSRO was 
not required to make and retain a record documenting the policies and 
procedures required under section 15E(h)(4)(A).
---------------------------------------------------------------------------

    \544\ See 15 U.S.C. 78o-7(h)(4)(A)(ii).
---------------------------------------------------------------------------

    The baseline that existed before today's amendments and new rule 
was one in which, pursuant to paragraph (c)(4) of Rule 17g-5, an NRSRO 
is prohibited from issuing or maintaining a credit rating where a 
credit analyst who participated in determining the credit rating is an 
officer or director of the person that is subject to the credit 
rating.\545\ Also, section 15E(h)(1) of the Exchange Act and Rule 17g-5 
require NRSROs to establish, maintain, and enforce written policies and 
procedures reasonably designed to address and manage any conflicts of 
interest that can arise from the business of the NRSRO.\546\
---------------------------------------------------------------------------

    \545\ See 17 CFR 240.17g-5(c)(4).
    \546\ See 15 U.S.C. 78o-7(h)(1).
---------------------------------------------------------------------------

    In addition, section 15E(h)(5)(A) of the Exchange Act requires 
NRSROs to report to the Commission any case in which a person 
associated with the NRSRO within the previous five years obtains 
employment with a rated entity or the issuer, underwriter, or sponsor 
of a rated instrument for which the NRSRO issued a credit rating during 
the twelve-month period prior to the employment if the employee was a 
senior officer of the NRSRO or participated, or supervised an employee 
that participated, in determining credit

[[Page 55124]]

ratings for the new employer.\547\ Section 15E(h)(5)(B) requires that 
the Commission make the reports publicly available.\548\ The Commission 
received 244 of these reports between January 24, 2006 and December 31, 
2013.\549\ One academic study examined these transition reports for 
three NRSROs (Fitch, Moody's, and S&P), which submitted 167 of these 
reports during that period.\550\ The study suggests that the credit 
ratings assigned to the future employer by the NRSRO employing the 
transitioning employee were more likely to be upgraded and less likely 
to be downgraded than the ratings assigned to that future employer by 
other NRSROs in the year prior to the transition.\551\
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    \547\ See 15 U.S.C. 78o-7(h)(5)(A).
    \548\ See 15 U.S.C. 78o-7(h)(5)(B).
    \549\ The reports are available at http://www.sec.gov/divisions/marketreg/nrsro_etr.htm.
    \550\ See Jess Cornaggia, Kimberly J. Cornaggia, and Han Xia, 
Revolving Doors on Wall Street (2014), available at http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2150998.
    \551\ These authors state that ``the difference between the 
ratings awarded by transitioning analysts and their benchmarks 
changes by an average of 0.23 notches during the last five quarters 
leading up to a transition.'' Id.
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    Relative to this baseline, the amendments and new rule should 
result in benefits. They are designed to require the NRSRO to evaluate 
whether a credit rating has been influenced by a conflict of interest 
and, if so, promptly address the conflicted credit rating. This could 
limit the potential risk that users of credit ratings might make 
investment or other credit-based decisions using incomplete, biased, or 
inaccurate information. As stated above, the disclosures also will 
increase transparency and provide users of NRSRO credit ratings with 
information to assess an NRSRO's ability to address conflicts and to 
compare NRSROs with respect to their ability to manage the conflicts. 
Further, the amendments and new rule--because they are designed to 
integrate with an NRSRO's existing policies and procedures for taking 
rating actions--could mitigate potential inefficiencies associated with 
the requirements. For example, the amendments and new rule are designed 
to work within the existing framework of an NRSRO's policies and 
procedures for taking rating actions but not to regulate the substance 
of the credit rating or the procedures and methodologies for 
determining credit ratings.
    The records NRSROs must make and keep under the amendment to Rule 
17g-2 will be used by Commission examiners to assess whether a given 
NRSRO's policies and procedures are reasonably designed and whether it 
appears that the NRSRO is complying with them. Recordkeeping 
requirements are integral to the Commission's investor protection 
function because the preserved records are the primary means of 
monitoring compliance with applicable securities laws.\552\ Compliance 
by an NRSRO with its policies and procedures for look-back reviews and 
the oversight exercised by the Commission may benefit users of credit 
ratings by mitigating conflicts of interest, which may increase the 
integrity and quality of credit ratings.
---------------------------------------------------------------------------

    \552\ See Oversight of Credit Rating Agencies Registered as 
Nationally Recognized Statistical Rating Organizations, 72 FR at 
33582.
---------------------------------------------------------------------------

    Relative to the baseline, the amendments and new rule relating to 
look-back reviews will result in costs for NRSROs. NRSROs will need to 
expend resources to establish, make a record of, enforce, and 
periodically review and update (if necessary) the procedures they 
establish pursuant to section 15E(h)(4)(A) of the Exchange Act to 
ensure they comply with paragraph (c) of Rule 17g-8. They also will 
need to develop and periodically modify processes and systems for 
ensuring that, if the look-back review determines that a conflict of 
interest influenced the credit rating, a revised credit rating or an 
affirmation of the credit rating is promptly published (as appropriate) 
along with the corresponding disclosures required under paragraph 
(a)(1)(ii)(J)(3) of Rule 17g-7, or that the credit rating is placed on 
watch or review if the credit rating is not revised or affirmed within 
fifteen calendar days of the discovery that the credit rating was 
influenced by a conflict of interest. Based on analysis for purposes of 
the PRA, the Commission estimates that paragraph (c) of Rule 17g-8 will 
result in total industry-wide one-time costs to NRSROs of approximately 
$295,000 and total industry-wide annual costs to NRSROs of 
approximately $71,000.\553\
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    \553\ See section V.C. of this release (discussing 
implementation and annual compliance considerations). These costs 
are derived by monetizing internal hour burdens identified in the 
PRA analysis in section IV.D.7. of this release. The one-time and 
annual costs are determined by monetizing internal hour burdens and 
adding external costs identified in the PRA analysis in section 
IV.D.7. of this release.
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    Relative to the baseline, the amendments to Rule 17g-2 prescribing 
retention requirements for the documentation of the policies and 
procedures will result in costs to NRSROs. NRSROs already have 
recordkeeping systems in place to comply with the recordkeeping 
requirements in Rule 17g-2 before today's amendments. Therefore, the 
recordkeeping costs of this rule will be incremental to the costs 
associated with these existing requirements. Specifically, the 
incremental costs will consist largely of updating their record 
retention policies and procedures and retaining and producing the 
additional record. Based on analysis for purposes of the PRA, the 
Commission estimates that paragraph (a)(9) of Rule 17g-2 and the 
amendment to paragraph (c) of Rule 17g-2 will result in total industry-
wide one-time costs to NRSROs of approximately $12,000 and total 
industry-wide annual costs to NRSROs of approximately $3,000.\554\
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    \554\ See section V.C. of this release (discussing 
implementation and annual compliance considerations). The one-time 
and annual costs are determined by monetizing internal hour burdens 
and adding external costs identified in the PRA analysis in section 
IV.D.3. of this release.
---------------------------------------------------------------------------

    The amendments and new rule by increasing the scrutiny of the work 
of former analysts could potentially decrease the quality of credit 
ratings in circumstances where the subjective judgment of participants 
in the rating process can improve the quality of ratings. In 
particular, an NRSRO may establish credit rating methodologies that 
diminish the ability of analysts to exercise subjective judgment in 
order to minimize the chance that in exercising judgment an analyst may 
be influenced by this conflict, which, in turn, will trigger the 
requirements in the amendments and new rule, including the requirement 
to disclose the existence of the conflict. If the ability to apply 
subjective analysis is diminished, the credit ratings issued by an 
NRSRO may not benefit fully from the expertise of the analysts.
    The amendments and new rule should have a number of effects related 
to efficiency, competition, and capital formation.\555\ First, they 
could improve the quality of credit-related information. As a result, 
users of credit ratings may make more efficient investment decisions 
based on this higher-quality information. Market efficiency also could 
improve if this information is reflected in asset prices. Consequently, 
capital formation could improve as capital may flow to more efficient 
uses with the benefit of this enhanced information. Alternatively, the 
quality of credit ratings may decrease in certain circumstances if an 
NRSRO establishes credit rating methodologies that diminish the ability 
of participants in the rating process to exercise subjective judgment. 
In this case, the efficiency of investment decisions, market 
efficiency,

[[Page 55125]]

and capital formation may also be adversely impacted if lower quality 
information is reflected in asset prices, which may impede the flow of 
capital to efficient uses. These amendments also will result in costs, 
some of which may have a component that is fixed in magnitude across 
NRSROs and does not vary with the size of the NRSRO. Therefore, the 
operating costs per rating of smaller NRSROs may increase relative to 
that of larger NRSROs, which could create adverse effects on 
competition. As a result of these amendments, the barriers to entry for 
credit rating agencies to register as NRSROs might be higher for credit 
rating agencies, while some NRSROs, particularly smaller firms, may 
decide to withdraw from registration as an NRSRO.
---------------------------------------------------------------------------

    \555\ See section I.B.3. of this release (providing a broader 
discussion of the potential impacts of the amendments and new rules 
on efficiency, competition, and capital formation).
---------------------------------------------------------------------------

    There are a number of reasonable alternatives to the amendments and 
new rule, as adopted. First, the Commission could require that NRSROs 
immediately place on credit watch or review credit ratings that are 
determined by a look-back review to have been influenced by a conflict 
of interest (as was proposed). This alternative might further benefit 
users of credit ratings by alerting them sooner of conflicted credit 
ratings, limiting the potential risk that investors and users of credit 
ratings might make credit-based decisions using incomplete, biased, or 
inaccurate information, and thereby reduce the risk of mispricing due 
to the use of such incomplete, biased, or inaccurate information. It 
also might increase the incentives of NRSROs to develop and adhere to 
rating policies and procedures that further decrease the chance that 
conflicts of interest may influence credit ratings. The quality of 
credit ratings could increase as a result. This alternative also might 
decrease the quality of credit ratings in certain circumstances if it 
causes NRSROs to further reduce the use of subjective judgment in 
rating methodologies relative to the amendments and new rule. This 
alternative might also result in additional costs for NRSROs and users 
of credit ratings. First, the NRSRO would need to expend resources to 
develop, modify, and enforce policies and procedures ensuring that it 
immediately places such conflicted ratings on credit watch or review in 
addition to documenting and retaining these policies and procedures 
pursuant to the amendments to Rule 17g-2. Second, if a look-back review 
determined that a conflict influenced a credit rating, the NRSRO would 
need to expend resources to place the credit rating on watch or review. 
In addition, a number of academic studies indicate that both stock and 
bond prices of an issuer react adversely when credit ratings are placed 
on negative credit watch.\556\ Therefore, this alternative might also 
create mispricing and confusion in the market. In particular, a 
placement of a credit rating on credit watch creates uncertainty in the 
credit rating that is resolved when the credit rating is either revised 
or affirmed. As a result of unfamiliarity, users of credit ratings 
might not react rationally in the short term to the uncertainty 
introduced by placements of credit ratings on credit watch resulting 
from look-back reviews. Consequently, this alternative might result in 
costs for issuers and on market participants who may make non-optimal 
investment decisions as a result of mispricing and confusion. Several 
comment letters discussed these potential adverse consequences.\557\ 
However, these costs could arise if the NRSRO is required to place the 
credit rating on credit watch or review because it does not revise or 
affirm the credit rating within fifteen calendar days of the discovery 
of the conflict.
---------------------------------------------------------------------------

    \556\ See Kee H. Chung, Carol Ann Frost, and Myungsun Kim, 
Characteristics and Information Value of Credit Watches, Financial 
Management 119-158 (2012); Sugato Chakravarty, Chiraphol N. 
Chiyachantana, & Yen Teik Lee, On the Informativeness of Credit 
Watch Placements (2009), available at http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1252542; Christina E. Bannier and 
Christian W. Hirsch, The Economic Function of Credit Rating 
Agencies--What Does the Watchlist Tell Us?, J. of Banking and 
Finance 3037-3049 (2010); John R.M. Hand, Robert W. Holthausen, 
Richard W. Leftwich, The Effect of Bond Rating Agency Announcements 
on Bond and Stock Prices, J. of Finance 733-752 (1992); Robert W. 
Holthausen and Richard W. Leftwich, The Effect of Bond Rating 
Changes on Common Stock Prices, J. of Fin. Economics 57-89 (1986).
    \557\ See A.M. Best Letter; DBRS Letter; FSR Letter; Morningstar 
Letter; S&P Letter.
---------------------------------------------------------------------------

    Other alternatives include those that would apply standards other 
than acting ``promptly'' with respect to the required timing of review 
and rating actions after a rating is determined to have been conflicted 
in a look-back review. For example, an NRSRO could be required to take 
these actions ``as soon as practicable'' rather than ``promptly,'' as 
suggested by one commenter.\558\ However, the Commission believes it is 
important that the NRSRO not delay completing the process that it will 
use to determine whether the credit rating must be revised to ensure 
that it is solely a product of the NRSRO's procedures and methodologies 
for determining credit ratings and to publish a revised credit rating 
or an affirmation of the credit rating with the required disclosure of 
information about the existence of the conflict. The longer the NRSRO 
takes to complete these steps the greater the risk that investors and 
other users of credit ratings will rely on a conflicted credit rating 
when making an investment or credit-related decision. Consequently, the 
final amendment retains the requirement that the NRSRO must ``promptly 
determine'' whether a credit rating must be revised. At the same time, 
the Commission recognizes that the amount of time necessary to complete 
the determination will depend on the facts and circumstances, including 
the number of credit ratings impacted, the degree to which the conflict 
influenced the credit ratings, and the complexity of the rating 
methodologies used to determine the credit ratings.\559\
---------------------------------------------------------------------------

    \558\ See Moody's Letter.
    \559\ See Moody's Letter; Morningstar Letter; S&P Letter.
---------------------------------------------------------------------------

    There are a number of other alternatives that would impose 
additional requirements for addressing a credit rating that is found 
through a look-back review to be influenced by a conflict of interest. 
One alternative suggested by commenters would be to require a de novo 
review of a credit rating that was determined through a look-back 
review to have been influenced by a conflict of interest.\560\ This 
alternative could produce higher-quality credit ratings because a de 
novo review may provide a higher level of assurance that the credit 
rating is no longer influenced by the conflict as the entire rating 
process would be undertaken (this time without the conflicted analyst 
participating). In other words, de novo reviews may be more likely to 
result in credit ratings that are in accordance with the NRSRO's 
procedures and methodologies for determining credit ratings.
---------------------------------------------------------------------------

    \560\ See AFSCME Letter; Better Markets Letter.
---------------------------------------------------------------------------

    On the other hand, this alternative might impose further costs as 
NRSROs may be able to conduct a sufficient review without taking all 
the steps necessary to perform a de novo review (for example, some of 
the prior work could have been undertaken by a credit analyst that was 
not influenced by the conflict). Requiring a de novo review also may 
implicate the prohibition in section 15E(c)(2) of the Exchange Act 
under which the Commission may not regulate the substance of credit 
ratings or the procedures and methodologies by which any NRSRO 
determines credit ratings.\561\ Further, this alternative might 
decrease the quality of credit ratings in certain circumstances if it 
caused NRSROs to eliminate or reduce the use of subjective judgment in 
rating procedures or methodologies as

[[Page 55126]]

discussed earlier. In addition, the amendments and new rule provide 
flexibility for the NRSRO to make this determination by applying 
procedures and methodologies that it designs to ensure that the credit 
rating is no longer influenced by the conflict of interest, which could 
include procedures and methodologies that require a de novo review of 
the rated obligor or obligation in all or certain cases.
---------------------------------------------------------------------------

    \561\ See 15 U.S.C. 78o-7(c)(2).
---------------------------------------------------------------------------

    Commenters also proposed alternatives which would make the 
amendments and new rule less restrictive. One alternative suggested by 
commenters would be to not require publication of an affirmation after 
a credit rating has been determined to have been conflicted in a look-
back review if, for example, in the period since the NRSRO published 
the credit rating, events unrelated to the conflict occurred that, when 
taken into account by the NRSRO's procedures and methodologies for 
determining credit ratings, would produce a credit rating at the same 
notch in the rating scale as the credit rating that was influenced by 
the conflict.\562\ This alternative could benefit NRSROs by reducing 
the potential costs associated with publishing affirmations such as the 
cost of composing text to appear in the NRSRO's publications and press 
releases. This alternative also might increase the quality of credit 
ratings in certain circumstances if not having to disclose the 
existence of the conflict caused NRSROs to allow greater use of 
subjective judgment in rating methodologies as discussed earlier.
---------------------------------------------------------------------------

    \562\ See DBRS Letter; S&P Letter.
---------------------------------------------------------------------------

    However, as discussed above, if the rule did not require 
publication of an affirmation, it would result in costs as users of the 
NRSRO's credit ratings would not learn of the existence of the 
conflict. Disclosing the existence of the conflict with the publication 
of the revised credit rating or affirmation of the credit rating will 
provide users of the NRSRO's credit ratings with information to assess 
the adequacy of the NRSRO's policies, procedures, and controls designed 
to manage conflicts of interest and, more generally, the integrity of 
the NRSRO's credit rating process. Moreover, the required disclosures 
could be useful to users of the NRSRO's credit ratings in considering 
the potential risk of using the NRSRO's credit ratings to make 
investment or other credit-based decisions in comparison to other 
NRSROs.

D. Fines and Other Penalties

1. Final Rule
    Section 932(a)(8) of the Dodd-Frank Act amended section 15E of the 
Exchange Act to add subsection (p), which contains four paragraphs: 
(1), (2), (3), and (4).\563\ Section 15E(p)(4)(A) provides that the 
Commission shall establish, by rule, fines and other penalties 
applicable to any NRSRO that violates the requirements of section 15E 
of the Exchange Act and the rules under the Exchange Act.\564\
---------------------------------------------------------------------------

    \563\ See Public Law 111-203, 932(a)(8); 15 U.S.C. 78o-7(p)(1) 
through (4).
    \564\ See 15 U.S.C. 78o-7(p)(4)(A).
---------------------------------------------------------------------------

    The Exchange Act already provides a wide range of fines, penalties, 
and other sanctions applicable to NRSROs for violations of any section 
of the Exchange Act (including section 15E) and the rules under the 
Exchange Act (including the rules under section 15E).\565\ For example, 
section 15E(d)(1) of the Exchange Act provides that the Commission 
shall censure an NRSRO, place limitations on the activities, functions, 
or operations of an NRSRO, suspend an NRSRO for a period not exceeding 
twelve months, or revoke the registration of an NRSRO if, among other 
reasons, the NRSRO violates section 15E of the Exchange Act or the 
Commission's rules under the Exchange Act.\566\ In addition, section 
932(a)(3) of the Dodd-Frank Act amended section 15E(d) to explicitly 
provide additional potential sanctions.\567\ First, it provided the 
Commission with the authority to seek sanctions against persons 
associated with, or seeking to become associated with, an NRSRO.\568\ 
The Commission can censure such persons, place limitations on the 
activities or functions of such persons, suspend such persons for a 
period not exceeding one year, or bar such persons from being 
associated with an NRSRO.\569\ Second, section 932(a)(3) of Dodd-Frank 
Act amended section 15E(d) to provide the Commission with explicit 
authority to temporarily suspend or permanently revoke the registration 
of an NRSRO in a particular class or subclass of credit ratings if the 
NRSRO does not have adequate financial and managerial resources to 
consistently produce credit ratings with integrity.\570\ Furthermore, 
sections 21, 21A, 21B, 21C, and 32 of the Exchange Act provide 
additional sanctions if an NRSRO violates the Exchange Act, including 
the self-executing provisions in section 15E of the Exchange Act, or 
rules under the Exchange Act.\571\
---------------------------------------------------------------------------

    \565\ See 15 U.S.C. 78o-7(d); 15 U.S.C. 78u; 15 U.S.C. 78u; 15 
U.S.C. 78u-2; 15 U.S.C. 78u-3; 15 U.S.C. 78ff.
    \566\ See section 15E(d)(1)(A) through (F) of the Exchange Act 
(15 U.S.C. 78o-7(d)(1)(A) through (F)), as amended by the Dodd-Frank 
Act.
    \567\ See Public Law 111-203, 932(a)(3); 15 U.S.C. 78o-7(d).
    \568\ 15 U.S.C. 78o-7(d)(1).
    \569\ Id.
    \570\ See Public Law 111-203, 932(a)(3); 15 U.S.C. 78o-7(d)(2). 
Prior to this amendment, the Commission had the authority to suspend 
or revoke the registration of an NRSRO if it failed to maintain 
adequate financial and managerial resources to consistently produce 
credit ratings with integrity. See section 15E(d)(5) of the Exchange 
Act (15 U.S.C 78o-7(d)(5)) before being amended by the Dodd-Frank 
Act, which re-designated paragraph (d)(5) of section 15E as 
paragraph (d)(1)(E) (15 U.S.C 78o-7(d)(1)(E)). Section 15E(d)(2) of 
the Exchange Act, however, provides explicit authority to target a 
suspension or registration revocation to a specific class or 
subclass of security. See 15 U.S.C. 78o-7(d)(2).
    \571\ See 15 U.S.C. 78o-7; 15 U.S.C. 78u; 15 U.S.C. 78u-1; 15 
U.S.C. 78u-2; 15 U.S.C. 78u-3; 15 U.S.C. 78ff. In fact, the Dodd-
Frank Act amended section 21B of the Exchange Act (15 U.S.C. 78u-2) 
to provide the Commission with the authority to assess money 
penalties in cease-and-desist proceedings under section 21C (15 
U.S.C. 78u-3). See section 929P(a)(2) of the Dodd-Frank Act.
---------------------------------------------------------------------------

    In the proposing release, the Commission stated its preliminarily 
belief that these provisions of the Exchange Act, as amended by the 
Dodd-Frank Act, provide a sufficiently broad range of means to impose 
fines, penalties, and other sanctions on an NRSRO for violations of 
section 15E of the Exchange Act and the rules under the Exchange 
Act.\572\ For example, the fines, penalties, and sanctions applicable 
to NRSROs are similar in scope to the fines, penalties, and sanctions 
applicable to other registrants under the Exchange Act, such as broker-
dealers. Moreover, since enactment of the Rating Agency Act of 2006, 
the Commission has not identified a specific need for a fine or penalty 
applicable to NRSROs not otherwise provided for in the Exchange Act. 
Consequently, in the proposing release, the Commission stated its 
preliminary belief that it would be appropriate at that time to defer 
establishing new fines or penalties in addition to those provided for 
in the Exchange Act.\573\ However, the Commission stated that, in the 
future, it may use the authority in section 15E(p)(4)(A) of the 
Exchange Act if a specific need to do so is identified.\574\
---------------------------------------------------------------------------

    \572\ See Nationally Recognized Statistical Rating 
Organizations, 76 FR at 33433.
    \573\ Id.
    \574\ Id.
---------------------------------------------------------------------------

    For the foregoing reasons, to implement section 15E(p)(4)(A) of the 
Exchange Act, the Commission proposed to amend the instructions to Form 
NRSRO by adding Instruction

[[Page 55127]]

A.10.\575\ This instruction would provide notice to credit rating 
agencies applying for registration as an NRSRO and to NRSROs that an 
NRSRO is subject to applicable fines, penalties, and other available 
sanctions set forth in sections 15E, 21, 21A, 21B, 21C, and 32 of the 
Exchange Act (15 U.S.C. 78o-7, 78u, 78u-1, 78u-2, 78u-3, and 78ff, 
respectively) for violations of the securities laws.\576\
---------------------------------------------------------------------------

    \575\ Id. at 33552.
    \576\ See Nationally Recognized Statistical Rating 
Organizations, 76 FR at 33552.
---------------------------------------------------------------------------

    Several comment letters addressed the proposal.\577\ Most 
commenters generally supported the Commission's proposal to defer 
establishing new fines or penalties in addition to those currently 
provided for in the Exchange Act,\578\ with one commenter specifically 
noting that it supports the Commission's proposal to add the new 
instruction to Form NRSRO.\579\ Commenters stated that the fines, 
penalties, and other sanctions currently applicable to NRSROs under the 
Exchange Act are ``sufficient,'' \580\ and that no other additional 
fines or penalties are necessary or warranted.\581\ However, one 
commenter suggested that, while other sections of the Exchange Act 
provide for appropriate penalties and sanctions, it is not appropriate 
to consider suspension or revocation of an NRSRO's registration under 
section 21C of the Exchange Act.\582\
---------------------------------------------------------------------------

    \577\ See A.M. Best Letter; DBRS Letter; Morningstar Letter; S&P 
Letter.
    \578\ See A.M. Best Letter; DBRS Letter; Morningstar Letter; S&P 
Letter.
    \579\ See DBRS Letter.
    \580\ See Morningstar Letter.
    \581\ See A.M. Best Letter; DBRS Letter; Morningstar Letter; S&P 
Letter.
    \582\ See A.M. Best Letter. As discussed above in section 
II.B.3. of this release, the Commission has modified the final 
amendments relating to suspending or revoking an NRSRO's 
registration from the proposal so that it no longer incorporates 
section 21C of the Exchange Act.
---------------------------------------------------------------------------

    The Commission is adopting Instruction A.10 to Form NRSRO \583\ as 
proposed. As stated above, certain commenters agreed that the fines, 
penalties, and other sanctions currently applicable to NRSROs under the 
Exchange Act are sufficient and that additional fines, penalties, or 
other sanctions are not necessary or appropriate. Consequently, 
commenters supported the Commission's proposal to add Instruction A.10 
to Form NRSRO. While the Commission is adopting Instruction A.10 to 
Form NRSRO, it is deferring establishing new fines or penalties in 
addition to those provided for in the Exchange Act. The Commission may 
choose to use the authority to establish new fines or penalties in the 
future.\584\
---------------------------------------------------------------------------

    \583\ See Nationally Recognized Statistical Rating 
Organizations, 76 FR at 33552.
    \584\ One commenter recommended the Commission re-propose the 
rules and, in doing so, invoke its authority under section 15E(p)(4) 
of the Exchange Act to seek fines and the disgorgement of profits 
when an NRSRO persistently ``issues non-standardized'' credit 
ratings. See CFA II Letter.
---------------------------------------------------------------------------

2. Economic Analysis
    The final amendments should not create any costs for NRSROs and may 
provide some benefits. It could benefit credit rating agencies applying 
for registration as NRSROs and NRSROs because it should notify them of 
the potential consequences of violating provisions of the Exchange Act 
and Commission rules.

E. Disclosure of Information About the Performance of Credit Ratings

    Section 932(a)(8) of the Dodd-Frank Act added subsection (q) to 
section 15E of the Exchange Act.\585\ Section 15E(q)(1) provides that 
the Commission shall, by rule, require NRSROs to publicly disclose 
information on the initial credit ratings determined by the NRSRO for 
each type of obligor, security, and money market instrument, and any 
subsequent changes to such credit ratings, for the purpose of allowing 
users of credit ratings to evaluate the accuracy of credit ratings and 
compare the performance of credit ratings by different NRSROs.\586\ 
Section 15E(q)(2) provides that the Commission's rules shall require, 
at a minimum, disclosures that:
---------------------------------------------------------------------------

    \585\ See Public Law 111-203, 932(a)(8); 15 U.S.C. 78o-7(q).
    \586\ See 15 U.S.C. 78o-7(q)(1).
---------------------------------------------------------------------------

     are comparable among NRSROs, to allow users of credit 
ratings to compare the performance of credit ratings across NRSROs; 
\587\
---------------------------------------------------------------------------

    \587\ See 15 U.S.C. 78o-7(q)(2)(A).
---------------------------------------------------------------------------

     are clear and informative for investors having a wide 
range of sophistication who use or might use credit ratings; \588\
---------------------------------------------------------------------------

    \588\ See 15 U.S.C. 78o-7(q)(2)(B).
---------------------------------------------------------------------------

     include performance information over a range of years and 
for a variety of types of credit ratings, including for credit ratings 
withdrawn by the NRSRO; \589\
---------------------------------------------------------------------------

    \589\ See 15 U.S.C. 78o-7(q)(2)(C).
---------------------------------------------------------------------------

     are published and made freely available by the NRSRO, on 
an easily accessible portion of its Web site, and in writing, when 
requested; \590\
---------------------------------------------------------------------------

    \590\ See 15 U.S.C. 78o-7(q)(2)(D).
---------------------------------------------------------------------------

     are appropriate to the business model of an NRSRO; \591\ 
and
---------------------------------------------------------------------------

    \591\ See 15 U.S.C. 78o-7(q)(2)(E).
---------------------------------------------------------------------------

     require an NRSRO to include an attestation with any credit 
rating it issues affirming that no part of the credit rating was 
influenced by any other business activities, that the credit rating was 
based solely on the merits of the instruments being rated, and that 
such credit rating was an independent evaluation of the risks and 
merits of the instrument.\592\
---------------------------------------------------------------------------

    \592\ See 15 U.S.C. 78o-7(q)(2)(F). As discussed in section 
II.G.4. of this release, the Commission is including this 
attestation requirement in the rule the Commission is adopting to 
implement section 15E(s) of the Exchange Act, which requires, among 
other things, that the Commission adopt rules requiring an NRSRO to 
generate a form to be included with the publication of a credit 
rating. See 15 U.S.C. 78o-7(s); paragraph (a)(1)(iii) of Rule 17g-7.
---------------------------------------------------------------------------

    The rules in existence before today's amendments require NRSROs to 
publish two types of information about the performance of their credit 
ratings: (1) Performance statistics \593\ and (2) rating 
histories.\594\ The Commission proposed to implement the rulemaking 
mandated in section 15E(q) of the Exchange Act, in substantial part, by 
significantly enhancing the requirements for generating and disclosing 
this information by amending the instructions to Form NRSRO as they 
relate to Exhibit 1 and the disclosure of transition and default 
statistics, and by amending Rule 17g-1, Rule 17g-2, and Rule 17g-7 with 
respect to the disclosure of rating histories.\595\ The Commission is 
adopting the amendments substantially as proposed, with modifications, 
in part, in response to comments received.
---------------------------------------------------------------------------

    \593\ See Nationally Recognized Statistical Rating 
Organizations, 76 FR at 33434. This type of disclosure shows the 
performance of an NRSRO's credit ratings in the aggregate through 
statistics. Specifically, it provides the percent of credit ratings 
assigned to obligors, securities, and money market instruments in 
each category of credit rating in a rating scale (for example, AAA, 
AA, A, BBB, BB, B, CCC, CC, and C) that over a given time period 
were downgraded or upgraded to another credit rating category 
(``transition rates'') or classified as a default (``default 
rates''). The goal is to provide a mechanism for users of credit 
ratings to compare the performance statistics of credit ratings in 
each category across NRSROs.
    \594\ See Nationally Recognized Statistical Rating 
Organizations, 76 FR at 33434. This type of disclosure shows the 
credit rating history of a given rated obligor, security, or money 
market instrument. Specifically, it shows the initial credit rating 
and all subsequent modifications to the credit rating (such as 
upgrades and downgrades) and the dates of such actions. The goal is 
to allow users of credit ratings to compare how different NRSROs 
rated an individual obligor, security, or money market instrument 
and how and when those ratings were changed over time. The 
disclosure of rating histories also is designed to provide ``raw 
data'' that can be used by third parties to generate independent 
performance statistics such as transition and default rates.
    \595\ See Nationally Recognized Statistical Rating 
Organizations, 76 FR at 33433-33452.

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[[Page 55128]]

1. Amendments to Instructions for Exhibit 1 to Form NRSRO
a. Proposal
    Exhibit 1 is part of the registration application a credit rating 
agency seeking to be registered as an NRSRO must submit to the 
Commission and that an NRSRO must file with the Commission, keep up-to-
date, and publicly disclose.\596\ Section 15E(a)(1)(B)(i) of the 
Exchange Act requires that an application f or registration as an NRSRO 
include performance measurement statistics over short-term, mid-term, 
and long-term periods (as applicable).\597\ The Commission implemented 
this requirement, in large part, through Exhibit 1 to Form NRSRO and 
the instructions for Exhibit 1.\598\ Section 15E(b)(1)(A) of the 
Exchange Act provides that the performance measurement statistics must 
be updated annually in the annual certification required by section 
15E(b)(2).\599\ Paragraph (i) of Rule 17g-1 provides, among other 
things, that the NRSRO must make the annual certification publicly 
available within ten business days of furnishing the annual 
certification to the Commission.\600\
---------------------------------------------------------------------------

    \596\ In particular, section 15E(a)(1)(A) of the Exchange Act 
requires an applicant to furnish an application for registration to 
the Commission, in such form as the Commission shall require, by 
rule or regulation. See 15 U.S.C. 78o-7(a)(1)(A). Section 
15E(a)(1)(B) of the Exchange Act identifies information that must be 
included in the application for registration. See 15 U.S.C. 78o-
7(a)(1)(B)(i) through (x). The Commission implemented sections 
15E(a)(1)(A) and (B) of the Exchange Act by adopting Form NRSRO. See 
Form NRSRO available at http://www.sec.gov/about/forms/formnrsro.pdf; see also Oversight of Credit Rating Agencies 
Registered as Nationally Recognized Statistical Rating 
Organizations, 72 FR at 33569-33582. Section 15E(a)(3) of the 
Exchange Act provides that the Commission, by rule, shall require an 
NRSRO, upon being granted registration, to make the information and 
documents in its completed application for registration, or in any 
amendment to its application, publicly available on its Web site, or 
through another comparable, readily accessible means, except for 
certain information that is submitted on a confidential basis. See 
15 U.S.C. 78o-7(a)(3). The Commission implemented this provision by 
adopting paragraph (i) of Rule 17g-1. See 17 CFR 240.17g-1(i); see 
also Oversight of Credit Rating Agencies Registered as Nationally 
Recognized Statistical Rating Organizations, 72 FR at 33569. Section 
15E(b)(1) requires an NRSRO to promptly amend its application for 
registration if any information or document provided therein becomes 
materially inaccurate; however, (as discussed below) certain 
information does not have to be updated and other information must 
be updated only on an annual basis. See 15 U.S.C. 78o-7(b)(1); 15 
U.S.C. 78o-7(b)(1); 15 U.S.C. 78o-7(a)(1)(B)(ix). The Commission 
implemented this provision by adopting Form NRSRO and paragraph (e) 
of Rule 17g-1. See Form NRSRO; 17 CFR 240.17g-1(e). See also 
Oversight of Credit Rating Agencies Registered as Nationally 
Recognized Statistical Rating Organizations, 72 FR at 33567, 33569-
33582.
    \597\ See 15 U.S.C. 78o-7(a)(1)(B)(i).
    \598\ See Oversight of Credit Rating Agencies Registered as 
Nationally Recognized Statistical Rating Organizations, 72 FR at 
33628, 33634.
    \599\ See 15 U.S.C. 78o-7(b)(1) and (2). In particular, section 
15E(b) of the Exchange Act provides that not later than ninety days 
after the end of each calendar year, an NRSRO shall file with the 
Commission an amendment to its registration application, in such 
form as the Commission, by rule, may prescribe: (1) Certifying that 
the information and documents in the application for registration 
continue to be accurate; (2) listing any material change that 
occurred to such information and documents during the previous 
calendar year; and (3) updating its credit ratings performance 
measurement statistics. See 15 U.S.C. 78o-7(b). The Commission 
implemented these provisions by adopting Form NRSRO and paragraph 
(f) of Rule 17g-1. See Instruction F to Form NRSRO; 17 CFR 240.17g-
1(f). See also Oversight of Credit Rating Agencies Registered as 
Nationally Recognized Statistical Rating Organizations, 72 FR at 
33567, 33569-33582.
    \600\ See 17 CFR.240.17g-1(i).
---------------------------------------------------------------------------

    Before today's amendments, the instructions for Exhibit 1 required 
the applicant or NRSRO to provide performance statistics for the credit 
ratings of the applicant or NRSRO, including performance statistics for 
each class of credit ratings for which the applicant is seeking 
registration or the NRSRO is registered.\601\ The classes of credit 
ratings for which an NRSRO can be registered are enumerated in the 
definition of nationally recognized statistical rating organization in 
section 3(a)(62) of the Exchange Act: (1) Financial institutions, 
brokers, or dealers; \602\ (2) insurance companies; \603\ (3) corporate 
issuers; \604\ (4) issuers of asset-backed securities (as that term is 
defined in section 1101(c) of part 229 of Title 17, Code of Federal 
Regulations, ``as in effect on the date of enactment of this 
paragraph''); \605\ and (5) issuers of government securities, municipal 
securities, or securities issued by a foreign government.\606\
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    \601\ As used throughout this release, the term category of a 
credit rating scale refers to a distinct level in a rating scale 
represented by a unique symbol, number, or score. For example, if a 
rating scale consists of symbols (for example, AAA, AA, A, BBB, BB, 
B, CCC, CC, and C), each unique symbol would represent a category in 
the rating scale. Similarly, if a rating scale consists of numbers 
(for example, 1, 2, 3, 4, 5, 6, 7, 8, and 9), each number would 
represent a category in the rating scale. Each category also 
represents a notch in the rating scale. In addition, some NRSRO 
rating scales attach additional symbols or numbers to the symbols 
representing categories in order to denote gradations within a 
category. For example, a rating scale may indicate gradations within 
a category by attaching a plus or a minus or a number to a rating 
symbol. For example, AA+, AA, and AA- or AA1, AA2, and AA3 would be 
three gradations within the AA category. If a rating scale has 
gradations within a category, each category and gradation within a 
category would constitute a notch in the rating scale. For example, 
the following symbols would each represent a notch in the rating 
scale in descending order: AAA, AA+, AA, AA-, A+, A, A-, BBB+, BBB, 
BBB-, BB+, BB, BB-, CCC+, CCC, CCC-, CC, C, and D. Furthermore, for 
the purposes of this release, changing a credit rating (for example, 
upgrading or downgrading the credit rating) means assigning a credit 
rating at a different notch in the rating scale (for example, 
downgrading an obligor assigned an AA rating to an AA- rating or an 
A+ rating).
    \602\ See 15 U.S.C. 78c(a)(62)(A)(i).
    \603\ See 15 U.S.C. 78c(a)(62)(A)(ii).
    \604\ See 15 U.S.C. 78c(a)(62)(A)(iii).
    \605\ See 15 U.S.C. 78c(a)(62)(A)(iv). The instructions for 
Exhibit 1 in existence before today's amendments broadened this 
class of credit rating to include a credit rating of any security or 
money market instrument issued by an asset pool or as part of any 
asset-backed or mortgage-backed securities transaction. The intent 
of the instruction was to include in the class (and, therefore, in 
the performance statistics for the class) credit ratings for 
structured finance products that are outside the scope of the 
definition referenced in section 3(a)(62)(A)(iv) of the Exchange 
Act. See 15 U.S.C. 78c(a)(62)(A)(iv); Amendments to Rules for 
Nationally Recognized Statistical Rating Organizations, 74 FR at 
6458. As discussed below, the final amendments to the instructions 
for Exhibit 1 continue to use this broadened definition.
    \606\ See 15 U.S.C. 78c(a)(62)(A)(v). With respect to this class 
of credit ratings, the instructions for Exhibit 1 in existence 
before today's amendments required the applicant or NRSRO to provide 
performance measurement statistics for the following three 
subclasses (as opposed to the class as a whole): Sovereigns, U.S. 
public finance, and international public finance. As discussed 
below, the final amendments to the instructions for Exhibit 1 
continue to require performance statistics for these subclasses.
---------------------------------------------------------------------------

    In addition, the instructions required that the performance 
statistics ``must at a minimum show the performance of credit ratings 
in each class over 1-year, 3-year, and 10-year periods (as applicable) 
through the most recent calendar year-end, including, as applicable: 
Historical ratings transition and default rates within each of the 
credit rating categories,\607\ notches, grades, or rankings used by the 
applicant or NRSRO as an indicator of the assessment of the 
creditworthiness of an obligor, security, or money market instrument in 
each class of credit rating.''
---------------------------------------------------------------------------

    \607\ The transition rate is the percent of credit ratings at a 
given rating notch that transition to another specified rating notch 
over a given time period. Only credit ratings that were outstanding 
at the beginning of the time period are used in the calculation of 
the transition rate. Transition rates are generally used to measure 
the stability of credit ratings. The default rate is the percent of 
credit ratings at a given rating notch that have defaulted over a 
given time period. Only the credit ratings that were outstanding at 
the beginning of the time period are used in the calculation.
---------------------------------------------------------------------------

    Before today's amendments, the instructions for Exhibit 1 did not 
prescribe the methodology an applicant or NRSRO must use to calculate 
the performance statistics or the format by which they must be 
disclosed; nor did the instructions limit the type of information that 
can be disclosed in Exhibit 1.\608\ Consequently, as stated in

[[Page 55129]]

a 2010 report of the GAO, NRSROs at that time used different techniques 
to produce performance statistics, which limited the ability of 
investors and other users of credit ratings to compare the performance 
of credit ratings across NRSROs.\609\ In addition, several NRSROs 
included substantial amounts of information in Exhibit 1 about 
performance statistics, in addition to transition and default rates.
---------------------------------------------------------------------------

    \608\ When adopting Form NRSRO, the Commission explained that 
the instructions would not prescribe how NRSROs must calculate 
transition rates and default rates, noting that commenters had 
opposed a standard approach because NRSROs use different 
methodologies to determine credit ratings. See Oversight of Credit 
Rating Agencies Registered as Nationally Recognized Statistical 
Rating Organizations, 72 FR at 33574. The Commission stated that it 
intended to continue to consider the issue ``to determine the 
feasibility, as well as the potential benefits and limitations, of 
devising measurements that would allow reliable comparisons of 
performance between NRSROs.'' Id. The Commission took an incremental 
step toward standardizing the disclosure requirements in Exhibit 1 
by amending the Form in 2009 to require an NRSRO to disclose 
transition and default rates for each class of credit rating for 
which it was registered and for 1-year, 3-year, and 10-year periods. 
See Amendments to Rules for Nationally Recognized Statistical Rating 
Organizations 74 FR at 6457-6459.
    \609\ See, e.g., GAO, Securities and Exchange Commission: Action 
Needed to Improve Rating Agency Registration Program and Performance 
Related Disclosures, Report 10-782 (Sept. 2010) (``GAO Report 10-
782''). Section 7 of the Rating Agency Act required the GAO to 
review the implementation of the Rating Agency Act of 2006. See 
Public Law 109-291, 7. Among other things, the report evaluated the 
performance-related NRSRO disclosures required by Commission rules 
under the Exchange Act. See GAO Report 10-782, pp. 24-46.
---------------------------------------------------------------------------

    As noted above, NRSROs have produced and presented performance 
statistics in various ways. For example, for the calendar year 2009 
performance statistics published by the NRSROs, some NRSROs used a 
``single cohort approach'' to determine transition rates for their 
credit ratings.\610\ Under this approach, an NRSRO would calculate 
transition rates for the most recent 1-year, 3-year, or 10-year period. 
For example, for its 2009 3-year transition rates for corporate issuers 
using the single cohort approach, an NRSRO would calculate transition 
rates for the class of corporate issuers for the period December 31, 
2006 through December 31, 2009. Other NRSROs used an ``average cohort 
approach.'' \611\ Under this approach, an NRSRO would calculate 
transition rates for multiple 1-year, 3-year, or 10-year periods and 
then average them. For example, for its 2009 3-year transition rates 
for corporate issuers using the average cohort approach, an NRSRO would 
calculate 3-year transition rates for the class of corporate issuers 
for multiple 3-year periods (for example, 3-year periods from 1981 to 
2009) and then average them. Two NRSROs also published ``Lorenz 
curves,'' which are ``visual tools for assessing the accuracy of the 
rank ordering of creditworthiness that a set of ratings provides.'' 
\612\ The GAO found that the variability in how NRSROs produce 
performance statistics limited the ability of investors and other users 
of credit ratings to compare the performance of credit ratings across 
NRSROs.\613\
---------------------------------------------------------------------------

    \610\ See GAO Report 10-782, p. 28.
    \611\ Id.
    \612\ Id. at 25, note 38 (``[Lorenz curves] are considered 
useful for comparing the relative accuracy of different rating 
systems or the relative accuracy of a single rating system measured 
at different points of time for different cohorts.'').
    \613\ Id. at 27-37.
---------------------------------------------------------------------------

    As described by the GAO, the single cohort approach uses 
information from the most recent time periods, while the average cohort 
approach uses information from multiple time periods. The GAO stated 
that the single cohort approach may be useful to predict the 
performance of credit ratings under similar circumstances, while the 
average cohort approach may be useful to predict future transition 
rates under different economic and other conditions.\614\ The GAO also 
found that ``[b]oth approaches are valid, depending on the needs of the 
user, but they do not yield comparable information.'' \615\
---------------------------------------------------------------------------

    \614\ Id. at 27.
    \615\ Id. at 27.
---------------------------------------------------------------------------

    As indicated above, before today's amendments, the instructions for 
Exhibit 1 permitted NRSROs to use differing methods to calculate 
performance statistics and to include additional information in Exhibit 
1. This created the potential that the presentation of information in 
the exhibits would be inconsistent across NRSROs. To address this issue 
and to implement section 15E(q) of the Exchange Act, the Commission 
proposed significant amendments to the instructions for Exhibit 1.\616\ 
The proposed amendments would standardize the calculation of the 
performance statistics by requiring the applicant or NRSRO to calculate 
1-year, 3-year, and 10-year transition and default rates for each 
applicable class and subclass of credit rating using a single cohort 
approach.\617\ Further, the results would need to be presented in 
tabular form using a standardized format (a ``Transition/Default 
Matrix'').\618\ Finally, the proposed amendments would specify that an 
applicant or NRSRO must not disclose information in the Exhibit that is 
not required to be disclosed.\619\
---------------------------------------------------------------------------

    \616\ See Nationally Recognized Statistical Rating 
Organizations, 76 FR at 33434-33444. See also 15 U.S.C. 78o-
7(q)(2)(A) (requiring that the Commission's rules require 
disclosures that are comparable among NRSROs, to allow users of 
credit ratings to compare the performance of credit ratings across 
NRSROs).
    \617\ See Nationally Recognized Statistical Rating 
Organizations, 76 FR at 33556-33558.
    \618\ See id. at 33557.
    \619\ See id. at 33556-33557.
---------------------------------------------------------------------------

    Under the proposal, the ``issuers of asset-backed securities'' 
class of credit ratings would be divided into the following subclasses: 
RMBS; CMBS; collateralized loan obligations (``CLOs''); CDOs; asset-
backed commercial paper (``ABCP''); other asset-backed securities 
(``other ABS''); and other structured finance products (``other 
SFPs'').\620\
---------------------------------------------------------------------------

    \620\ See id. at 33556.
---------------------------------------------------------------------------

    As stated above, under the proposal the applicant or NRSRO would be 
required to use the single cohort approach to calculate transition and 
default rates in order to determine the percent of credit ratings at 
each notch in the rating scale for a given class or subclass and for 
the applicable time period (one, three, or ten years) that were rated 
at the same notch or transitioned to another notch as of the end of the 
period, and the percent of credit ratings at each notch that were 
classified as a default or paid off, or had been withdrawn for reasons 
other than being classified as a default or paid off during the 
period.\621\ For example, a matrix containing 3-year transition and 
default rates for the class of corporate issuers would disclose the 
number of credit ratings of corporate issuers the applicant or NRSRO 
had outstanding as of the period start date that is three years prior 
to the most recent calendar year end at each notch in the rating scale 
used by the applicant or NRSRO, the percent of those credit ratings 
that were rated at the same notch and the percent that transitioned to 
each other notch in the rating scale as of the end of the 3-year 
period, and the percent that were classified as a default or paid off, 
or had been withdrawn at any time during the 3-year period.\622\
---------------------------------------------------------------------------

    \621\ See id. at 33556-33558.
    \622\ See id. at 33556-33558.
---------------------------------------------------------------------------

    The Commission proposed that an applicant or NRSRO must classify 
the credit rating assigned to an obligor, security, or money market 
instrument as a default if, during the applicable period, either: (1) 
The obligor failed to timely pay principal or interest due according to 
the terms of an obligation or the issuer of the security or money 
market instrument failed to timely pay principal or interest due 
according to the terms of the security or money market instrument; or 
(2) the applicant or NRSRO classified the obligor, security, or money 
market instrument as having gone into default using its own

[[Page 55130]]

definition of default.\623\ The applicant or NRSRO would need to 
classify an obligor, security, or money market instrument as having 
gone into default even if the applicant or NRSRO assigned a credit 
rating to the obligor, security, or money market instrument at a notch 
above default in its rating scale on or after the event of default or 
withdrew the credit rating on or after the event of default.\624\
---------------------------------------------------------------------------

    \623\ See id. at 33557-33558.
    \624\ See id. at 33441-33442, 33557-33558.
---------------------------------------------------------------------------

    As proposed, an applicant or NRSRO would classify a credit rating 
assigned to an obligor, security, or money market instrument as paid 
off if, during the applicable period: (1) An obligor extinguished the 
obligation by paying in full all outstanding principal and interest due 
on the obligation according to the terms of the obligation (for 
example, because the obligation matured, was called, or was prepaid) 
and the applicant or NRSRO withdrew the credit rating because the 
obligation was extinguished; or (2) the issuer of a security or money 
market instrument extinguished its obligation with respect to the 
security or money market instrument by paying in full all outstanding 
principal and interest due according to the terms of the security or 
money market instrument (for example, because the security or money 
market instrument matured, was called, or was prepaid) and the 
applicant or NRSRO withdrew the credit rating for the security or money 
market instrument because the obligation was extinguished.\625\
---------------------------------------------------------------------------

    \625\ See id. at 33557-33558.
---------------------------------------------------------------------------

    The proposal would require the applicant or NRSRO to determine and 
disclose the number of obligors, securities, and money market 
instruments assigned a credit rating as of the period start date for 
which the applicant or NRSRO withdrew a credit rating at any time 
during the applicable time period for a reason other than that the 
credit rating assigned to the obligor, security, or money market 
instrument was classified as a default or paid-off.\626\ The applicant 
or NRSRO would have to classify the credit rating assigned to the 
obligor, security, or money market instrument as withdrawn even if the 
applicant or NRSRO assigned a credit rating to the obligor, security, 
or money market instrument after withdrawing the credit rating.\627\
---------------------------------------------------------------------------

    \626\ See 15 U.S.C. 78o-7(q)(2)(C) (requiring that the 
disclosures include information for credit ratings withdrawn by the 
NRSRO).
    \627\ See Nationally Recognized Statistical Rating 
Organizations, 76 FR at 33557-33558.
---------------------------------------------------------------------------

    Finally, the performance statistics would need to be presented in a 
``Transition/Default Matrix'' in a format specified in the 
instructions, which included a sample matrix.\628\
---------------------------------------------------------------------------

    \628\ See id. at 33557.
---------------------------------------------------------------------------

b. Final Rule
    Paragraph (1) of the instructions for Exhibit 1. The Commission is 
adopting paragraph (1) of the instructions for Exhibit 1 with two 
technical modifications from the proposal.\629\ This paragraph requires 
the applicant or NRSRO to provide performance statistics for each class 
of credit ratings for which the applicant is seeking registration as an 
NRSRO or the NRSRO is registered and for the applicable subclasses of 
credit ratings listed in the paragraph.\630\ Specifically, it requires 
the applicant or NRSRO to provide transition and default rates for 1-
year, 3-year, and 10-year periods for each applicable class or subclass 
of credit rating.\631\ It further requires the applicant or NRSRO to 
produce and present three separate transition and default statistics 
for each applicable class or subclass of credit rating; namely, for 1-
year, 3-year, and 10-year time periods through the most recent calendar 
year end. In addition, the applicant or NRSRO must present the 
transition and default rates for each time period together in tabular 
form using a standard format (a ``Transition/Default Matrix'').\632\
---------------------------------------------------------------------------

    \629\ See paragraph (1) of the instructions for Exhibit 1. One 
commenter stated that the phrase ``up-to-date Exhibit 1'' as used in 
proposed paragraph (1) of the instructions for Exhibit 1 was 
ambiguous. See Moody's Letter. Specifically, as proposed, paragraph 
(1) of the instructions for Exhibit 1 would provide that the 
performance measurement statistics must be updated yearly in the 
NRSRO's annual certification in accordance with section 15E(b)(1)(A) 
of the Exchange Act and paragraph (f) of Rule 17g-1 (in particular, 
a Form NRSRO with updated performance measurement statistics--the 
annual certification--must be filed with the Commission no later 
than ninety days after the end of the calendar year). The proposed 
instructions also would remind an NRSRO that, pursuant to paragraph 
(i) of Rule 17g-1, the annual certification with the updated 
performance measurement statistics must be made publicly and freely 
available on an easily accessible portion of the NRSRO's corporate 
Internet Web site within ten business days after the filing and that 
the NRSRO must make its ``up-to-date'' Exhibit 1 freely available in 
writing to any individual who requests a copy of the Exhibit. The 
Commission agrees with the comment and is replacing the phrase ``up-
to-date Exhibit 1'' with the phrase ``most recently filed Exhibit 
1'' as suggested by the commenter. Further, as proposed, the 
instructions referenced the ``classes and subclasses'' for which an 
applicant is seeking registration or for which an NRSRO is 
registered. As discussed in section II.I.1. of this release, a 
commenter noted that applicants and NRSROs do not register in 
``subclasses'' of credit ratings. See DBRS Letter. Paragraph (1) of 
the instructions for Exhibit 1 has therefore been modified to make 
this clear. See paragraph (1) of the Instructions for Exhibit 1.
    \630\ See paragraph (1) of the instructions for Exhibit 1.
    \631\ See id.
    \632\ See id.
---------------------------------------------------------------------------

    Paragraph (1) of the instructions for Exhibit 1 specifies the 
classes and subclasses of credit ratings for which the applicant or 
NRSRO must produce Transition/Default Matrices, as applicable.\633\ The 
identified classes reference the classes of credit ratings for which an 
NRSRO can be registered as enumerated in the definition of nationally 
recognized statistical rating organization in section 3(a)(62)(A) of 
the Exchange Act.\634\ As was the case prior to today's amendments, the 
class of credit ratings enumerated in section 3(a)(62)(A)(iv) of the 
Exchange Act (issuers of certain asset-backed securities) is expanded 
to include a broader range of structured finance products than are 
within the scope of the definition in section 3(a)(62)(A)(iv).\635\ 
Moreover, this class has been divided into the following subclasses: 
RMBS; \636\ CMBS; \637\ CLOs; \638\ CDOs; \639\ ABCP; \640\ other

[[Page 55131]]

ABS; \641\ and other structured finance products.\642\
---------------------------------------------------------------------------

    \633\ See id.
    \634\ Compare 15 U.S.C. 78c(a)(62)(A)(i) through (v), with 
paragraphs (1)(A) through (E) of the instructions for Exhibit 1. As 
was the case prior to today's amendments, paragraph (1) of the 
instructions for Exhibit 1 divides the class of credit ratings 
enumerated in section 3(a)(62)(A)(v) of the Exchange Act (issuers of 
government securities, municipal securities, or securities issued by 
a foreign government) into three subclasses: Sovereign issuers; U.S. 
public finance; and international public finance. See paragraph (1) 
of the instructions for Exhibit 1.
    \635\ See paragraph (1) of the instructions for Exhibit 1; 15 
U.S.C. 78c(a)(62)(A)(iv). As was the case before today's amendments, 
the instructions for Exhibit 1 broaden this class of credit rating 
to include a credit rating of any security or money market 
instrument issued by an asset pool or as part of any asset-backed or 
mortgage-backed securities transaction.
    \636\ The instructions provide that RMBS means a securitization 
of primarily residential mortgages. See paragraph (1)(D)(i) of the 
instructions for Exhibit 1.
    \637\ The instructions provide that CMBS means a securitization 
of primarily commercial mortgages. See paragraph (1)(D)(ii) of the 
instructions for Exhibit 1.
    \638\ The instructions provide that CLO means a securitization 
of primarily commercial loans. See paragraph (1)(D)(iii) of the 
Instructions for Exhibit 1.
    \639\ The instructions provide that CDO means a securitization 
primarily of other debt instruments such as RMBS, CMBS, CLOs, CDOs, 
other ABS, and corporate bonds. See paragraph (1)(D)(iv) of the 
instructions for Exhibit 1.
    \640\ The instructions provide that ABCP means short term notes 
issued by a structure that securitizes a variety of financial assets 
(for example, trade receivables, credit card receivables), which 
secure the notes. See paragraph (1)(D)(v) of the instructions for 
Exhibit 1.
    \641\ The instructions provide that other ABS means a 
securitization primarily of auto loans, auto leases, floor plan 
financings, credit card receivables, student loans, consumer loans, 
equipment loans, or equipment leases. See paragraph (1)(D)(vi) of 
the instructions for Exhibit 1.
    \642\ The instructions provide that other structured finance 
product means a structured finance product that does not fit into 
any of the other subclasses of structured products. See paragraph 
(1)(D)(vii) of the instructions for Exhibit 1.
---------------------------------------------------------------------------

    Regarding the proposed seven subclasses of asset-backed securities, 
one commenter stated that the proposed degree of granularity ``would 
lead to the creation of sparse Transition/Default Matrices because many 
NRSROs do not have enough ratings for each proposed subclass to produce 
statistically significant results'' and that the class of ABS ratings 
should be divided into three classes: RMBS, CMBS, and ``Other ABS.'' 
\643\ Another NRSRO stated that dividing the class of credit ratings 
for structured finance products as proposed ``would tend to further 
increase market transparency'' and that the proposed subclasses are 
``suitable,'' but that ``greater stratification may in some cases 
produce subclasses that are too small to generate meaningful 
statistics.'' \644\
---------------------------------------------------------------------------

    \643\ See DBRS Letter.
    \644\ See S&P Letter.
---------------------------------------------------------------------------

    In response, the Commission notes that the reason for dividing the 
broad class of structured finance products into these subclasses is to 
provide investors and other users of credit ratings with more useful 
information about the performance of an NRSRO's structured finance 
credit ratings.\645\ Each subclass has characteristics that distinguish 
it from the other subclasses. Consequently, the separation of 
performance statistics into these subclasses will provide users of 
credit ratings with additional information and allow them to compare 
the performance of the credit ratings in each subclass among the 
NRSROs. Further, the NRSRO must disclose the number of credit ratings 
outstanding in each subclass at the beginning of the period, so users 
of credit ratings will be aware of the number of credit ratings the 
statistics are based upon.
---------------------------------------------------------------------------

    \645\ See, e.g., GAO Report 10-782, p. 36 (observing that the 
various structured finance sectors have risk characteristics that 
vary significantly and, therefore, presenting performance statistics 
for the class as a whole ``may not be useful.''). During the recent 
crisis, NRSROs assigned credit ratings to RMBS and CDOs that 
performed far differently than credit ratings of some other types of 
securitizations. See, e.g., S&P, A Global Cross-Asset Report Card of 
Ratings Performance in Times of Stress (June 8, 2010).
---------------------------------------------------------------------------

    Paragraph (2) of the instructions for Exhibit 1. The Commission is 
adopting paragraph (2) of the instructions for Exhibit 1 with 
modifications.\646\ This paragraph prescribes how the applicant or 
NRSRO must present the performance statistics and other required 
information in the Exhibit.\647\ Specifically, it requires that the 
Transition/Default Matrices for each applicable class and subclass of 
credit ratings be presented in the order that the classes and 
subclasses are identified in paragraphs (1)(A) through (E) of the 
instructions for Exhibit 1.\648\ In addition, the order of the 
Transition/Default Matrices for a given class or subclass must be: The 
1-year matrix, the 3-year matrix, and then the 10-year matrix.\649\ 
Further, if the applicant or NRSRO did not issue credit ratings in a 
particular class or subclass for the length of time necessary to 
produce a Transition/Default Matrix for a 1-year, 3-year, or 10-year 
period, it must explain that fact in the location where the Transition/
Default Matrix would have been presented in the Exhibit.\650\
---------------------------------------------------------------------------

    \646\ See paragraph (2) of the instructions for Exhibit 1.
    \647\ See id.
    \648\ See id.
    \649\ See id.
    \650\ See id. For example, if an NRSRO is registered in the 
corporate issuer class but has been issuing credit ratings for only 
seven years in that class, it could not produce a 10-year 
Transition/Default Matrix for the class. Instead, the NRSRO must 
provide an explanation in the location where a 10-year Transition/
Default Matrix would have been located (namely, after the 3-year 
matrix) that it had not been issuing credit ratings in that class 
for a sufficient amount of time to produce a 10-year Transition/
Default Matrix.
---------------------------------------------------------------------------

    The instructions require the applicant or NRSRO to clearly define 
in Exhibit 1, after the presentation of all applicable Transition/
Default Matrices, each symbol, number, or score in the rating scale 
used by the applicant or NRSRO to denote a credit rating category and 
notches within a category for each class and subclass of credit ratings 
in any Transition/Default Matrix presented in the Exhibit.\651\ The 
instructions also require the applicant or NRSRO to clearly explain the 
conditions under which it classifies obligors, securities, or money 
market instruments as being in default.\652\ Further, the instructions 
require that the applicant or NRSRO provide in Exhibit 1 the uniform 
resource locator (``URL'') of its corporate Internet Web site where the 
credit rating histories required to be disclosed pursuant to paragraph 
(b) of Rule 17g-7 would be located (in the case of an applicant) or are 
located (in the case of an NRSRO).\653\
---------------------------------------------------------------------------

    \651\ See paragraph (2) of the instructions for Exhibit 1. As 
discussed in section II.J.2. of this release, the Commission is 
implementing section 938(a)(2) of the Dodd-Frank Act through 
paragraph (b)(2) of Rule 17g-8, which requires an NRSRO to have 
policies and procedures reasonably designed to clearly define each 
symbol, number, or score in the rating scale used by the NRSRO to 
denote a credit rating category and notches within a category for 
each class of credit ratings for which the NRSRO is registered, 
including in Exhibit 1 to Form NRSRO. See Public Law 111-203, 
938(a)(2); paragraph (b)(2) of Rule 17g-8.
    \652\ See paragraph (2) of the instructions for Exhibit 1.
    \653\ See id. As discussed below in section II.E.3. of this 
release, the Commission is amending Rule 17g-2 and Rule 17g-7 to 
enhance the rating histories disclosure requirements currently 
codified in Rule 17g-2. Among other things, the amendments relocate 
the credit rating history disclosure requirements from Rule 17g-2 to 
Rule 17g-7.
---------------------------------------------------------------------------

    Finally, as proposed, the instructions provided that the Exhibit 
must contain no performance statistics or information other than as 
described in, and required by, the instructions for Exhibit 1; except 
that the applicant or NRSRO would be permitted to provide, after the 
presentation of all required Transition/Default Matrices and other 
required disclosures, Internet Web site URLs where other information 
relating to performance statistics of the applicant or NRSRO is 
located.\654\ This provision was intended to address the fact that some 
NRSROs included substantial amounts of information in Exhibit 1 about 
performance statistics, in addition to transition and default 
rates.\655\ As discussed in more detail below, some commenters stated 
that there are advantages and limitations to using the single cohort 
approach as compared to the average cohort approach to calculate the 
performance statistics.\656\ While the instructions for Exhibit 1 
mandate the use of the single cohort approach, the Commission believes 
that, if an NRSRO also calculates performance statistics using the 
average cohort approach, it would be appropriate to disclose that fact 
in Exhibit 1 and provide an Internet URL where the performance 
statistics are located. This will provide additional information to 
evaluate the performance of the NRSRO's credit ratings. For these 
reasons, paragraph (2) of the instructions for Exhibit 1 has been 
modified to provide that Exhibit 1 must contain no performance 
measurement statistics or information other than as described in, and 
required by, the Instructions for Exhibit 1; except that

[[Page 55132]]

the NRSRO may provide after the presentation of all required 
Transition/Default Matrices and other disclosures:
---------------------------------------------------------------------------

    \654\ See paragraph (2) of the instructions for Exhibit 1. To 
the extent that an NRSRO wishes to include other information that it 
believes is relevant for the purposes of drawing comparisons among 
credit ratings, the NRSRO could use an Internet Web site URL as a 
channel to provide the reader with additional information the NRSRO 
believes to be relevant.
    \655\ See Nationally Recognized Statistical Rating 
Organizations, 76 FR at 33437.
    \656\ The advantages and limitations of the single cohort 
approach as compared to the average cohort approach are also 
discussed in section II.E.4. of this release.
---------------------------------------------------------------------------

     A short statement describing the required method of 
calculating the performance measurement statistics in Exhibit 1 (the 
single cohort approach) and any advantages or limitations to the single 
cohort approach the NRSRO believes would be appropriate to disclose;
     A short statement that the NRSRO has calculated and 
published on an Internet Web site performance measurement statistics 
using the average cohort approach (if applicable), a description of the 
differences between the single cohort approach and the average cohort 
approach used to calculate the performance measurement statistics, and 
the Internet Web site URL where the performance measurements statistics 
calculated using the average cohort approach are located; and
     The Internet Web site URLs where any other information 
relating to performance measurement statistics of the NRSRO is 
located.\657\
---------------------------------------------------------------------------

    \657\ See paragraph (2) of the instructions for Exhibit 1.
---------------------------------------------------------------------------

    Paragraph (3) of the instructions for Exhibit 1. The Commission is 
adopting paragraph (3) of the instructions for Exhibit 1 with 
modifications to make the disclosures more understandable to users of 
credit ratings.\658\ This paragraph prescribes the format for a 
Transition/Default Matrix and includes a sample matrix.\659\ 
Specifically, the prescribed format is designed to allow the applicant 
or NRSRO to show in the matrix the number of outstanding credit ratings 
in the class or subclass at each notch in the applicable rating scale 
at the period start-date, and the percent of those credit ratings that 
were rated at the same notch at the end of the period, the percent of 
those credit ratings that were rated at each different notch in the 
rating scale at the end of the period, and the percent of those credit 
ratings that were classified as a default or paid off or were withdrawn 
at any time during the period.\660\ The prescribed format also is 
designed so that this information will be displayed in Exhibit 1 in a 
standard manner across the NRSROs to make it easier for users of NRSRO 
credit ratings and others to understand and compare the statistics.
---------------------------------------------------------------------------

    \658\ See paragraph (3) of the instructions for Exhibit 1.
    \659\ See id.
    \660\ See id.
---------------------------------------------------------------------------

    One commenter suggested adding the heading ``Status of those 
ratings at the end of the time period'' to the Transition/Default 
Matrix because ``less sophisticated investors'' may not understand the 
term ``transition,'' and also suggested that it may be useful to 
highlight the box on the chart that corresponds with the credit rating 
being at the same notch at the end of the period as it was at the 
beginning.\661\ The Commission agrees that these types of modifications 
could assist users to better understand the information disclosed in 
the Transition/Default Matrices. Consequently, the narrative 
instructions in paragraph (3) and the illustration of the sample 
Transition/Default Matrix have been modified to require highlighting of 
the cell in the matrix that corresponds with the credit rating being at 
the same notch at the end of the period as it was at the beginning and 
to require that the legends at the top of the matrix reflect that the 
first two columns represent the status of the credit ratings as of the 
period start date, the subsequent rating category columns represent the 
status of the credit ratings as of the period end date, and the 
Default, Paid Off, and Withdrawn (other) columns represent other 
outcomes that occurred during the period.\662\
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    \661\ See CFA/AFR Letter. One commenter also suggested that the 
Commission re-propose the rules and, in doing so, require NRSROs to 
present their performance statistics in a way that allows the public 
to compare and cross-reference different assets with the same credit 
rating. See CFA II Letter. The Commission believes the amendments 
being adopted today--by simplifying the presentation of the 
transition and default statistics and enhancing the rating history 
disclosures--will make it much easier for this kind of comparison to 
be made.
    \662\ See paragraph (3) of the instructions for Exhibit 1.
---------------------------------------------------------------------------

    As adopted, the sample Transition/Default Matrix in Figure 2 is the 
sample matrix provided in the instructions that the applicant or NRSRO 
must use as a model for its Transition/Default Matrices.
[GRAPHIC] [TIFF OMITTED] TR15SE14.001

    Paragraph (4) of the instructions for Exhibit 1. The Commission is 
adopting paragraph (4) of the instructions for Exhibit 1 with the 
modifications discussed below.\663\ This paragraph prescribes how the 
applicant or NRSRO must calculate the performance statistics and enter 
information into the Transition/Default Matrices.\664\
---------------------------------------------------------------------------

    \663\ See paragraph (4) of the instructions for Exhibit 1.
    \664\ See id.

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[[Page 55133]]

Determining Start Date Cohorts
    The final amendments (as was proposed) require the applicant or 
NRSRO to use the single cohort approach to calculate the transition and 
default rates.\665\ One NRSRO stated that the single cohort approach is 
a ``reasonable approach'' and ``is the best approach as it is, in our 
opinion, the clearest way to calculate a meaningful default rate.'' 
\666\ Another NRSRO requested that the Commission provide ``fuller 
background'' on decisions such as the determination to use the single 
cohort approach rather than an average cohort approach, with a 
description of potential benefits and limitations of those 
decisions.\667\ Some commenters suggested that the Commission use an 
average cohort approach in lieu of or in addition to the single cohort 
approach.\668\
---------------------------------------------------------------------------

    \665\ See id.
    \666\ See S&P Letter. This commenter also stated that a better 
way to measure the performance of rating systems ``that do not 
define their ratings in terms of target default and transition 
rates'' is ``a measure of rank-ordering power, such as the Gini 
coefficient.''
    \667\ See Kroll Letter.
    \668\ See DBRS Letter (advocating use of the average cohort 
approach); CFA/AFR Letter (advocating using both approaches).
---------------------------------------------------------------------------

    The Commission recognizes that different methods of measuring the 
performance of credit ratings may have unique advantages in terms of 
the information provided. As the GAO noted in comparing the single 
cohort approach and the average cohort approach, ``[b]oth approaches 
are valid, depending on the needs of the user, but they do not yield 
comparable information.'' \669\ For example, the average cohort 
approach may provide better information about how credit ratings 
perform on average across a wider variety of economic conditions when 
compared to the single cohort approach.\670\ However, the single cohort 
approach, because it does not average out performance over multiple 
cohorts, may more readily highlight how a given NRSRO's credit ratings 
have performed in more recent economic cycles.
---------------------------------------------------------------------------

    \669\ See, e.g., GAO Report 10-782, p. 28.
    \670\ See section II.E.4. of this release (discussing in more 
detail the relative advantages of the single and average cohort 
approaches).
---------------------------------------------------------------------------

    Moreover, the single cohort approach is a simpler approach than the 
other methods noted by the GAO and, therefore, it may be easier for 
less sophisticated investors and other users of credit ratings to 
understand how the performance statistics were produced. As stated 
above, section (q)(2)(B) of the Exchange Act provides that the 
Commission's rules shall require that the performance measurement 
disclosures be clear and informative for investors having a wide range 
of sophistication.\671\ The Commission notes that one commenter stated 
that the single cohort approach ``is the clearest way to calculate a 
meaningful default rate.'' \672\ In addition, it will be easier for 
NRSROs to produce performance statistics using this approach as it 
requires simpler calculations and, consequently, will be less 
burdensome than the other approaches.
---------------------------------------------------------------------------

    \671\ See 15 U.S.C. 78o-7(q)(2)(B).
    \672\ See S&P Letter.
---------------------------------------------------------------------------

    One commenter stated that the single cohort approach could lead to 
results that are ``significantly more volatile within the shorter time 
period, which will make interpreting those results more difficult.'' 
\673\ This commenter stated further that ``the volatility impact will 
be amplified for NRSROs with fewer ratings, which could lead to bias 
against smaller NRSROs.'' \674\ The Commission has balanced this 
concern with the need to prescribe an easy to understand method for 
calculating the performance statistics. As discussed below, the 
requirements in the instructions for Exhibit 1 provide for very 
transparent disclosures about the number of credit ratings in the start 
date cohort and in the cohort for each notch in the credit rating scale 
of a given class or subclass.\675\ This transparency will provide 
persons reviewing the performance statistics with information to assess 
how the small number of credit ratings in a given cohort may have 
impacted the results.\676\ Moreover, as discussed above, the Commission 
has modified paragraph (2) of the instructions for Exhibit 1 to permit 
an NRSRO to include a statement about any advantages or limitations to 
the single cohort approach the firm believes would be appropriate to 
disclose and, if applicable, a statement disclosing that the NRSRO has 
calculated performance statistics using the average cohort approach and 
identifying the Internet Web site URL where those statistics are 
located.
---------------------------------------------------------------------------

    \673\ See DBRS Letter.
    \674\ See id.
    \675\ See paragraph (4)(A) of the instructions for Exhibit 1 
(requiring the applicant or NRSRO to enter into the second column of 
the Transition/Default Matrix the number of credit ratings in the 
start-date cohort for each notch in the rating scale). This 
disclosure is illustrated in the first and second columns of the 
Sample Transition/Default Matrix in Figure 2 (above).
    \676\ For example, if the outcome for a notch with ten credit 
ratings is that five were classified as a default during the period, 
the default rate reflected on the Transition/Default Matrix for that 
notch would be 50%. Similarly, if the outcome of a notch with 5,000 
credit ratings is that 2,500 were classified as a default during the 
period, the default rate for that notch would be 50% as well. 
Investors and other users of credit ratings might conclude that 
2,500 credit ratings being classified as defaulting during the 
period reflects significantly worse performance than five credit 
ratings being classified as defaulting during the period.
---------------------------------------------------------------------------

    One commenter suggested that NRSROs should be required to calculate 
performance statistics using both the single cohort approach and the 
average cohort approach.\677\ One of the objectives of the amendments 
is to make the disclosures in Exhibit 1 to Form NRSRO shorter and 
easier to understand. Mandating two sets of 1-year, 3-year, and 10-year 
performance statistics (one based on the single cohort approach and one 
based on the average cohort approach) for each class or subclass of 
credit ratings would substantially increase the length and complexity 
of the disclosure in Exhibit 1. In addition, it would increase the 
compliance burden. However, as discussed above, NRSROs that also 
calculate performance statistics using the average cohort approach can 
disclose that fact in Exhibit 1.
---------------------------------------------------------------------------

    \677\ See CFA/AFR Letter.
---------------------------------------------------------------------------

    Finally, one commenter stated that NRSROs should be required to use 
the single cohort approach for credit ratings of corporate and 
sovereign debt and a ``static pool approach'' for credit ratings of 
structured finance products.\678\ The Commission believes that doing so 
would make the disclosure unnecessarily complex and undermine the 
objective of making the performance statistics clear and informative 
for investors having a wide range of sophistication.\679\
---------------------------------------------------------------------------

    \678\ See TradeMetrics Letter.
    \679\ See 15 U.S.C. 78o-7(q)(2)(B).
---------------------------------------------------------------------------

    For all the reasons discussed above, the final amendments require 
NRSROs to produce the performance statistics using the single cohort 
approach.\680\ However, in response to comments, the Commission is 
modifying the requirement with respect to identifying the credit 
ratings that must be included in a start-date cohort. Several 
commenters addressed the proposed requirement that a start-date cohort 
consist of the obligors, securities, and money market instruments in 
the applicable class or subclass of credit ratings that were assigned a 
credit rating as of the beginning of the period. One NRSRO stated that 
``mixing units of study,'' consisting of obligors, securities, and 
money-market instruments ``can create mismatched data and potentially 
double counting.'' \681\ Similarly, another NRSRO recommended that, 
except for the structured finance class of credit

[[Page 55134]]

ratings, the rule should require calculating a senior credit rating for 
a given issuer and using that rating in the construction of the cohort, 
as a single issuer can have many issuances, and including each one in 
the cohort may skew the performance statistics.\682\ A third NRSRO 
stated that for the structured finance category of credit ratings, 
``the obligations/issues should be included in the start-date cohorts'' 
because ``those transactions do not have obligors in a traditional 
sense . . .'' \683\ A fourth NRSRO agreed, stating that ``the start-
date cohorts should be comprised of obligors for corporate ratings and 
securities lines for the various subclasses of structured finance 
ratings.'' \684\
---------------------------------------------------------------------------

    \680\ See paragraph (4) of the instructions for Exhibit 1.
    \681\ See Kroll Letter.
    \682\ See Moody's Letter.
    \683\ See S&P Letter.
    \684\ See DBRS Letter.
---------------------------------------------------------------------------

    The Commission agrees with these comments and has modified the 
instructions. The final amendments provide that, to determine the 
number of credit ratings outstanding as of the period start date for 
all classes of credit ratings other than the class of issuers of asset-
backed securities, the applicant or NRSRO must: (1) Identify each 
obligor that the applicant or NRSRO assigned a credit rating to as an 
entity where the credit rating was outstanding as of the period start 
date; (2) identify each additional obligor that issued securities or 
money market instruments that the applicant or NRSRO assigned credit 
ratings to where the credit ratings were outstanding as of the period 
start date; and (3) include in the start-date cohort only credit 
ratings assigned to an obligor as an entity, or, if the obligor is not 
assigned a credit rating as an entity, the credit rating of the 
obligor's senior unsecured debt.\685\ All other credit ratings 
outstanding as of the period start date assigned to securities or money 
market instruments issued by the obligor must be excluded from the 
start-date cohort.\686\ For the class of issuers of asset-backed 
securities, the start-date cohort (as was proposed) must consist of 
credit ratings that the applicant or NRSRO assigned to all securities 
or money market instruments in the class where the credit ratings were 
outstanding as of the period start date, excluding expected or 
preliminary credit ratings.\687\
---------------------------------------------------------------------------

    \685\ See paragraph (4)(A) of the instructions for Exhibit 1.
    \686\ See id. For example, assume an obligor is assigned a 
credit rating of AA as an entity, and also has outstanding senior 
unsecured debt that is also rated AA and subordinated debt that is 
rated BBB, meaning there are a total of three credit ratings 
associated with the obligor. Under the final amendments, the 
obligor's credit rating as an entity must be included in the start-
date cohort, and the credit ratings of the obligor's senior 
unsecured debt and subordinated debt must be excluded. 
Alternatively, if the obligor in the above example is not assigned a 
credit rating as an entity, the credit rating of the obligor's 
senior unsecured debt must be included in the start-date cohort and 
the credit rating of the obligor's subordinated debt must be 
excluded.
    \687\ See paragraph (4)(A) of the instructions for Exhibit 1; 
Nationally Recognized Statistical Rating Organizations, 76 FR at 
33438. For example, assume a structured finance issuer has ten 
tranches of securities and the NRSRO has assigned credit ratings to 
six of the tranches. All six credit ratings must be included in the 
start-date cohort. As stated, ``expected'' or ``preliminary'' credit 
ratings must be excluded from the start-date cohort. These types of 
credit ratings most commonly are issued by an NRSRO with respect to 
a structured finance product at the time the issuer commences the 
offering and typically are included in pre-sale reports. Expected or 
preliminary credit ratings may include a range of credit ratings, or 
any other indications of a credit rating prior to the assignment of 
an initial credit rating for a new issuance. Consequently, they 
should be excluded from the start date cohort since the issuance of 
the initial credit rating is the first formal expression of the 
NRSRO's view of the relative creditworthiness of the obligor, 
security, or money market instrument.
---------------------------------------------------------------------------

    Finally, as proposed, the start date cohort for all classes of 
credit ratings must exclude credit ratings that the applicant or NRSRO 
classified as in default (using its own definition of default) as of 
the period start-date (and, as discussed above, expected or preliminary 
credit ratings).\688\ As explained in the proposing release, the 
Transition/Default Matrices should not include credit ratings of 
obligors, securities, and money market instruments the applicant or 
NRSRO has classified as in default because the firm is no longer 
assessing the relative likelihood that the obligor, security, or money 
market will continue to meet its obligations to make timely payments of 
principal and interest as they come due (that is, not default on its 
obligations).\689\ Consequently, as long as the obligor, security, or 
money market instrument continues to be classified as in default there 
is no credit rating performance to measure. However, if the credit 
rating is upgraded from the default category because, for example, the 
obligor emerges from a bankruptcy proceeding, the obligor's credit 
rating will need to be included in a Transition/Default Matrix that has 
a start date after the upgrade.\690\
---------------------------------------------------------------------------

    \688\ See paragraph (4)(A) of the instructions for Exhibit 1; 
Nationally Recognized Statistical Rating Organizations, 76 FR at 
33438-33439. The determination of whether the credit rating of the 
obligor, security, or money market instrument should be excluded 
from the start-date cohort would be based on the definition of 
default used by the applicant or NRSRO. As discussed below, in 
determining the outcome of a credit rating assigned to an obligor, 
security, and money market instrument during the applicable time 
period covered by a Transition/Default Matrix, the applicant or 
NRSRO will need to use the standard definition of default in 
paragraph (4)(B)(iii) of the instructions for Exhibit 1 (as opposed 
to its own definition). The use of a standard definition of default 
to determine the outcome of a credit rating during the applicable 
time period could result in a credit rating of an obligor, security, 
or money market instrument being included in the start-date cohort 
that, as of the start date, would be classified as in default under 
the standard definition of default in paragraph (4)(B)(iii). This is 
because the applicant or NRSRO may not have classified the obligor, 
security, or money market instrument as in default as of the start 
date if it uses a definition of default that is narrower than the 
standard definition in paragraph (4)(B)(iii). In this case, the 
credit rating of the obligor, security, or money market instrument 
should be included in the start-date cohort since the applicant or 
NRSRO, as of the start date, had assigned it a credit rating 
representing a relative assessment of the likelihood of default 
(rather than a classification of default) on the start date. Thus, 
the performance of the applicant or NRSRO in rating that obligor, 
security, or money market instrument should be incorporated into the 
default rate shown on the Transition/Default Matrix.
    \689\ See Nationally Recognized Statistical Rating 
Organizations, 76 FR at 33438-33439. This does not mean that the 
obligor, security, or money market instrument will never be 
reflected in default rates. For example, assume that as of the date 
ten years prior to the most recently ended calendar year-end an 
obligor in the corporate issuer class was assigned a credit rating 
of BBB. This credit rating will be included in the start-date cohort 
for the 10-year Transition/Default Matrix and grouped with the other 
BBB credit ratings. Further, assume that during the first seven 
years of the 10-year period, the credit rating of the obligor was 
downgraded from BBB to BB (in year two), from BB to B (in year five) 
and from B to CCC (in year seven). Having an outstanding credit 
rating of CCC in year seven, the obligor's credit rating will be 
included in the start-date cohort for the 3-year Transition/Default 
Matrix and grouped with the other CCC credit ratings. Finally assume 
the obligor defaults in year 8. For the purposes of the 10-year and 
3-year Transition/Default Matrices, the obligor's credit rating will 
need to be classified as having defaulted and be included in the 
default rates calculated for those matrices. However, because the 
obligor will be in default as of the period start date for the 1-
year Transition/Default Matrix, it will not be included in the 
start-date cohort for that matrix.
    \690\ See paragraph (4)(A) of the instructions for Exhibit 1. 
For example, assume an obligor was classified as in default by the 
NRSRO as of the start date for the 10-year Transition/Default 
Matrix. The obligor's credit rating would be excluded from the 
start-date cohort for the matrix. Assume further that two years 
later the obligor emerged from a bankruptcy proceeding after a 
restructuring. At that point in time, the NRSRO upgraded the obligor 
from the default category by assigning it a credit rating of BBB. 
Assume that three years later the NRSRO upgraded the obligor's 
credit rating from BBB to A- and that it retained that rating for 
the next five years. In this case, the obligor must be included in 
the start-date cohorts for the 1-year and 3-year Transition/Default 
Matrices.
---------------------------------------------------------------------------

    After determining the credit ratings in the start-date cohort, the 
applicant or NRSRO must determine the number of credit ratings in the 
start-date cohort for each notch in the rating scale used for the class 
or subclass as of the period start date.\691\ The final step is to 
enter

[[Page 55135]]

these amounts, as well as the total number of credit ratings in the 
start-date cohort, in the second column of the Transition/Default 
Matrix.\692\
---------------------------------------------------------------------------

    \691\ See paragraph (4)(A) of the instructions for Exhibit 1. 
For the class of credit ratings in the Sample Transition/Default 
Matrix in Figure 2, this would mean determining how many credit 
ratings in the start-date cohort were assigned a credit rating of 
AAA, AA, A, BBB, BB, B, CCC, CC, and C as of the start date. For 
example, the Sample Transition/Default Matrix in Figure 2 shows a 
total start-date cohort of 11,770 credit ratings. Within this cohort 
and as of the December 31, 2000 start date, ten were AAA credit 
ratings, 2000 were AA credit ratings, 4000 were A credit ratings, 
3600 were BBB credit ratings, 1000 were BB credit ratings, 500 were 
B credit ratings, 300 were CCC credit ratings, 200 were CC credit 
ratings, and 160 were C credit ratings.
    \692\ See paragraph (4)(A) of the instructions for Exhibit 1.
---------------------------------------------------------------------------

Calculating Transition and Default Statistics
    Paragraph (4)(B) of the instructions for Exhibit 1 prescribes how 
the applicant or NRSRO must calculate the performance statistics and 
enter the results into the Transition/Default Matrices.\693\ More 
specifically, the instructions provide that each row representing a 
credit rating notch in the Transition/Default Matrix must contain 
percentages indicating the credit rating outcomes as of the period end 
date for all the credit ratings in the start-date cohort at that notch 
as of the period start date.\694\ The instructions also provide that 
the percentages in a row must add up to 100%.\695\ The final amendments 
(as was proposed) identify five potential outcomes for a credit rating 
in the start-date cohort: (1) It is assigned the same credit rating as 
of the period end date; (2) it is assigned a different credit rating as 
of the period end date; (3) it was classified as a default at any time 
during the period; (4) it was classified as paid off at any time during 
the period; or (5) the applicant or NRSRO withdrew the credit rating at 
any time during the period for a reason other than that the credit 
rating assigned to the obligor, security, or money market instrument 
was classified as a default or paid off.\696\ Because the percentages 
in a row must add up to 100%, each credit rating in a start-date cohort 
must be assigned one and only one outcome.\697\
---------------------------------------------------------------------------

    \693\ See paragraph (4)(B) of the instructions for Exhibit 1.
    \694\ See id. For example, in the Sample Transition/Default 
Matrix in Figure 2, cumulative outcomes would need to be calculated 
for: The cohort of ten credit ratings at the AAA notch; the cohort 
of 2000 credit ratings at the AA notch; the cohort of 4000 credit 
ratings at the A notch; the cohort of 3600 credit ratings at the BBB 
notch; the cohort of 1000 credit ratings at the BB notch; the cohort 
of 300 credit ratings at the CCC notch; the cohort of 200 credit 
ratings at the CC notch; and the cohort of 160 credit ratings at the 
C notch.
    \695\ See paragraph (4)(B) of the instructions for Exhibit 1. 
For example, in the Sample Transition/Default Matrix in Figure 2, 
the outcomes for the ten credit ratings in the AAA category are: 50% 
remained at the AAA category, 10% transitioned to the AA category, 
and 40% were paid off during the period.
    \696\ See paragraphs (4)(B)(i) through (v) of the instructions 
for Exhibit 1; Nationally Recognized Statistical Rating 
Organizations, 76 FR at 33557-33558.
    \697\ See paragraph (4)(B) of the instructions for Exhibit 1.
---------------------------------------------------------------------------

    The final amendments (as was proposed) require the applicant or 
NRSRO to determine the number of credit ratings in a given notch as of 
the period start date that were assigned the same credit rating as of 
the period end date.\698\ The instructions require that: (1) This 
number must be expressed as a percent of the total number of credit 
ratings at that notch as of the period start date; (2) the percent must 
be entered in the column representing the same notch; and (3) the cell 
must be highlighted.\699\ An obligor, security, or money market 
instrument could have the same credit rating as of the period end date 
because the credit rating did not change between the start date and the 
end date or the credit rating transitioned to one or more other notches 
in the rating scale during the relevant period but transitioned back to 
the start-date notch where it remained as of the period end date. 
Consequently, the instructions provide that, to determine this number, 
the applicant or NRSRO must use the credit rating at the notch assigned 
to the obligor, security, or money market instrument as of the period 
end date and not a credit rating at any other notch assigned to the 
obligor, security, or money market instrument between the period start 
date and the period end date.\700\
---------------------------------------------------------------------------

    \698\ See paragraph (4)(B)(i) of the instructions for Exhibit 1.
    \699\ For example, in the Sample Transition/Default Matrix in 
Figure 2, there were ten credit ratings in the AAA cohort as of the 
December 31, 2000 start date. Of these ten, five (or 50%) were 
assigned a credit rating of AAA as of the December 31, 2010 end 
date. Accordingly, 50% is entered in the AAA column.
    \700\ See paragraph (4)(B)(i) of the instructions for Exhibit 1. 
For example, assume an obligor was assigned a credit rating of BBB 
as of the start date of a 10-year Transition/Default Matrix. Assume 
further that three years after the start date, the credit rating was 
upgraded to AA but then eight years after the start date the credit 
rating was downgraded to A, and nine years after the start date the 
credit rating was downgraded to BBB where it remained as of the 
period end date. For the purpose of the 10-year Transition/Default 
Matrix, the outcome assigned to this obligor would be that it had 
the same credit rating as of the period end date. However, the 
transitions that occurred in years eight and nine would be 
reflected, respectively, in the 3-year and 1-year Transition/Default 
Matrices for the class or subclass of credit ratings. In other 
words, the credit rating history for this obligor would reflect 
volatility over the short term but stability over the long term.
---------------------------------------------------------------------------

    The final amendments (as was proposed) require the applicant or 
NRSRO to determine the number of credit ratings in a given notch at the 
period start date that were assigned a credit rating at each other 
notch in the rating scale as of the period end date.\701\ The 
instructions require that: (1) These numbers must be expressed as 
percentages of the total number of credit ratings at that notch as of 
the period start date; and (2) the percentages must be entered in the 
columns representing each notch.\702\ The instructions in the paragraph 
clarify that, to determine these numbers, the applicant or NRSRO would 
need to use the credit rating at the notch assigned to the obligor, 
security, or money market instrument as of the period end date and not 
a credit rating at any other notch assigned to the obligor, security, 
or money market instrument between the period start date and the period 
end date.\703\
---------------------------------------------------------------------------

    \701\ See paragraph (4)(B)(ii) of the instructions for Exhibit 
1; Nationally Recognized Statistical Rating Organizations, 76 FR at 
33557-33558.
    \702\ See paragraph (4)(B)(ii) of the instructions for Exhibit 
1. For example, in the Sample Transition/Default Matrix in Figure 2, 
there were 2000 credit ratings in the AA cohort as of the December 
31, 2000 start date. Of these 2000 credit ratings, as of the period 
end date: Twenty (or 1%) transitioned to the AAA notch; 780 (or 39%) 
were at the AA notch as of the period end date; 240 (or 12%) 
transitioned to the A notch; 200 (or 10%) transitioned to the BBB 
notch; 160 (or 8%) transitioned to the BB notch; 100 (or 5%) 
transitioned to the B notch; and eighty (or 4%) transitioned to the 
CCC notch. Accordingly, 1% is entered into the AAA column, 39% is 
entered into the AA column, 12% is entered into the A column, 10% is 
entered into the BBB column, 8% is entered into the BB column, 5% is 
entered into the B column, and 4% is entered into the CCC column.
    \703\ See paragraph (4)(B)(ii) of the instructions for Exhibit 
1; Nationally Recognized Statistical Rating Organizations, 76 FR at 
33557-33558. As explained above, the applicant or NRSRO must reflect 
in the transition rate for a given notch the credit ratings at that 
notch as of the period end date (rather than any other credit 
ratings during the period). For example, in the Sample Transition/
Default Matrix in Figure 2, there were 2000 credit ratings at the AA 
notch as of December 31, 2000. As of December 31, 2010, 4% (or 80) 
of the credit ratings were at the CCC notch. The path by which these 
credit ratings arrived at the CCC notch as of the period end date 
could have been through a series of rating actions that occurred 
during the ten year period (e.g., being downgraded to A, then BBB, 
then BB, then B, and then CCC). The credit ratings during the 
period, other than the CCC rating as of the period end, must not be 
reflected in the transition rate for the AA notch.
---------------------------------------------------------------------------

    The final amendments (as was proposed) require the applicant or 
NRSRO to determine the total number of credit ratings in a given notch 
at the period start date that were classified as a default at any time 
during the applicable time period.\704\ The instructions require that: 
(1) This number must be expressed as a percent of the total number of 
credit ratings at that notch as of the period start date;

[[Page 55136]]

and (2) the percent must be entered in the Default column.\705\
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    \704\ See paragraph (4)(B)(iii) of the instructions for Exhibit 
1; Nationally Recognized Statistical Rating Organizations, 76 FR at 
33557-33558.
    \705\ See paragraph (4)(B)(iii) of the instructions for Exhibit 
1. For example, in the Sample Transition/Default Matrix in Figure 2, 
there were 500 credit ratings in the B cohort as of the December 31, 
2000 start date. Of these 500 credit ratings, seventy-five (or 15%) 
were classified as having gone into default during the period 
(December 31, 2000 through December 31, 2010). Accordingly, 15% is 
entered in the Default column.
---------------------------------------------------------------------------

    As indicated, the applicant or NRSRO must treat the credit rating 
as a default if the credit rating was classified as a default at any 
time during the applicable period.\706\ This is different from the 
calculations of the percent of credit ratings that stayed at the same 
notch or transitioned to a different notch in the rating scale that are 
based on the end-date status of the credit rating.\707\ This period-
long approach is designed to address concerns that an applicant or 
NRSRO might withdraw a credit rating that was classified as a default 
during the period in order to improve the default rates presented in 
the matrix.\708\
---------------------------------------------------------------------------

    \706\ See paragraph (4)(B)(iii) of the instructions for Exhibit 
1.
    \707\ See paragraphs (4)(B)(i) and (ii) of the instructions for 
Exhibit 1.
    \708\ See 15 U.S.C. 78o-7(q)(2)(C) (providing that the 
disclosures include performance information over a range of years 
and for a variety of types of credit ratings, including for credit 
ratings withdrawn by the NRSRO). The following provides an example 
of how withdrawals can be used to impact a default rate. In the 
Sample Transition/Default Matrix in Figure 2, the default rate over 
the 10-year period for the 3600 credit ratings at the BBB notch is 
4%. This means that 144 credit ratings in this cohort were 
classified as a default during the period (144/3600 = 4%). If the 
default rate was determined by the credit rating assigned to these 
144 obligors as of the period end date, the NRSRO could withdraw, 
for example, 100 of these credit ratings after default. 
Consequently, only forty-four of the credit ratings would be 
classified as a default as of the period end-date and, therefore, 
the default rate for the BBB notch would be approximately 1.2% 
instead of 4% (44/3600 = approximately 1.2%).
---------------------------------------------------------------------------

    The Commission proposed a standard definition of default to be used 
to classify credit ratings as defaults for the purposes of calculating 
the default rates.\709\ The Commission's goal in proposing a standard 
definition was to make the default rates calculated and disclosed by 
the NRSROs more readily comparable.\710\ The Commission was concerned 
that if applicants or NRSROs use their own definitions of default, 
differences in those definitions could result in applicants and NRSROs 
inconsistently classifying credit ratings as in default.\711\
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    \709\ See Nationally Recognized Statistical Rating 
Organizations, 76 FR at 33440-33442, 33557-33558.
    \710\ See Nationally Recognized Statistical Rating 
Organizations, 76 FR at 33441. See also 15 U.S.C. 78o-7(q)(2)(A) 
(providing that the Commission's rules shall require disclosures 
that are comparable among NRSROs, to allow users of credit ratings 
to compare the performance of credit ratings across NRSROs).
    \711\ See, e.g., GAO Report 10-782, p. 38 (``NRSROs can differ 
in how they define default. Therefore, some agencies may have higher 
default rates than others as a result of a broader set of criteria 
for determining that a default has occurred.'').
---------------------------------------------------------------------------

    A number of commenters addressed the proposed standardized 
definition of default. One NRSRO stated that it agreed ``in principle 
that there may be value in having'' a standard definition ``so long as 
allowance is made for ratings that use a term such as `default' in a 
non-standard way.'' \712\ Another NRSRO stated that the proposed 
definition of default would fail to classify as defaults non-payment 
events on all instruments that legally constitute equity, including all 
securitization instruments that use ``pass-through'' trusts.\713\ One 
NRSRO stated that requiring an NRSRO to classify a security as having 
gone into default when the NRSRO would not choose that classification 
under its definition ``comes dangerously close to the prohibition 
against regulating the substance of credit ratings.'' \714\ This NRSRO 
also suggested that the proposed language be modified to clarify that 
the ``terms of an obligation'' include any grace periods within which 
an obligor or issuer might cure the default. Another commenter objected 
to the proposed definition of default, because by incorporating the 
definition used by the NRSRO it ``defeats the aim of promoting 
uniformity in the performance data for credit ratings.'' \715\
---------------------------------------------------------------------------

    \712\ See Kroll Letter.
    \713\ See S&P Letter.
    \714\ See DBRS Letter.
    \715\ See Better Markets Letter.
---------------------------------------------------------------------------

    The Commission is adopting a standard definition of default with a 
modification from the proposal to broaden the definition to capture 
certain events identified by one commenter. As adopted, the final 
amendments provide that the applicant or NRSRO must classify a credit 
rating as a default if any of the following conditions are met:
     The obligor failed to timely pay principal or interest due 
according to the terms of an obligation during the applicable period or 
the issuer of the security or money market instrument failed to timely 
pay principal or interest due according to the terms of the security or 
money market instrument during the applicable period;
     The security or money market instrument was subject to a 
write-down, applied loss, or other realized deficiency of the 
outstanding principal amount during the applicable period; or
     The applicant or NRSRO classified the obligor, security, 
or money market instrument as having gone into default using its own 
definition of default during the applicable period.\716\
---------------------------------------------------------------------------

    \716\ See paragraphs (4)(B)(iii)(a) through (c) of the 
instructions for Exhibit 1.
---------------------------------------------------------------------------

    The first and second prongs of the definition comprise the standard 
definition of default that must be used by the applicant or NRSRO.\717\ 
The second prong was added to the definition in response to a comment 
that the standard definition of default did not incorporate certain 
events generally viewed as defaults but that do not involve failure to 
timely pay principal or interest, such as events relating to 
securitization instruments that use pass-through trusts.\718\ The legal 
terms of securitizations using pass-through trusts generally do not 
entitle the certificate holders to receive a greater amount than is 
collected by the trust. Therefore, failure to make payments to 
certificate holders in excess of the amounts collected would not 
constitute a payment default as contemplated under the first prong of 
the definition.
---------------------------------------------------------------------------

    \717\ See paragraphs (4)(B)(iii)(a) and (b) of the instructions 
for Exhibit 1.
    \718\ See S&P Letter. See also Nationally Recognized Statistical 
Rating Organizations, 76 FR at 33444 (soliciting comment on whether 
the proposed standard definition of default was sufficiently broad 
to apply to most, if not all, events commonly understood as 
constituting a default).
---------------------------------------------------------------------------

    The second prong is meant to capture events--such as principal 
write-downs--that are generally viewed to be defaults on this type of 
security even though such events do not involve failure to timely pay 
principal or interest. For example, a securitization that uses a pass 
through trust may experience a write-down of its principal due to 
losses on underlying collateral backing the security, if those losses 
cause the security to become under-collateralized (i.e., the principal 
balance of the collateral is less than the principal balance owed to 
the holders of the security). Such a write-down results in an immediate 
loss to the certificate holders since the principal balance against 
which interest is calculated has been reduced. This is usually 
considered a situation of default for this type of security. The second 
prong would also capture distressed exchanges of preferred stock and 
other hybrid instruments where the principal amount due to preferred 
security holders is reduced, resulting in a loss to the security 
holders.
    In response to the comment questioning whether the Commission 
should prescribe a standard definition of default,\719\ the Commission 
notes that one objective of a standard definition is

[[Page 55137]]

to avoid a situation in which NRSROs use differing definitions of 
default, which, as stated above, could result in some NRSROs using 
materially narrower definitions in order to produce more favorable 
default rates. Moreover, consistent with paragraph (q)(2)(A) of section 
15E of the Exchange Act, the Commission sought to establish a rule that 
requires disclosures that are comparable among NRSROs and allows users 
of credit ratings to compare the performance of credit ratings across 
NRSROs.\720\ Further, the final amendments do not require that NRSROs 
use the standard definition of default in determining and monitoring 
credit ratings. The amendments only require that the standard 
definition be used in calculating credit rating default statistics. 
Consequently, the amendments do not regulate the substance of credit 
ratings or the procedures or methodologies an NRSRO uses to determine 
credit ratings.\721\
---------------------------------------------------------------------------

    \719\ See DBRS Letter.
    \720\ See 15 U.S.C. 78o-7(q)(2)(A).
    \721\ See 15 U.S.C. 78o-7(c)(2); DBRS Letter.
---------------------------------------------------------------------------

    The third prong of the definition applies if the applicant or NRSRO 
classified the obligor, security, or money market instrument as having 
gone into default using its own definition of default.\722\ In response 
to the comment questioning whether the rule should incorporate the 
applicant's or NRSRO's internal definition,\723\ the objective is to 
supplement the standard definition to address a situation in which the 
applicant's or NRSRO's definition of default is broader than the 
standard definition. In this case, the NRSRO potentially could classify 
a rated obligor, security, or money market instrument as having gone 
into default during the time period even though, under the standard 
definition, the applicant or NRSRO would not need to make a default 
classification. As stated above, each credit rating in the start date 
cohort must be assigned one of five potential outcomes: (1) It is 
assigned the same credit rating as of the period end date; (2) it is 
assigned a different credit rating as of the period end date; (3) it 
was classified as a default at any time during the period; (4) it was 
classified as paid off at any time during the period; or (5) the 
applicant or NRSRO withdrew the credit rating at any time during the 
period for a reason other than the credit rating assigned to the 
obligor, security, or money market instrument was classified as a 
default or paid off. If the NRSRO has classified the credit rating as a 
default, there is no other outcome other than default that would be 
appropriate. It would make the Transition/Default Matrices 
unnecessarily complex to specify a sixth outcome: That the NRSRO has 
classified the credit rating as a default but the standard definition 
did not. The standard definition is broad (particularly with the 
modification discussed above) and should apply to most cases commonly 
understood as a default. Consequently, it should rarely happen that an 
applicant or NRSRO classifies a credit rating as a default and the 
standard definition does not.\724\ For these reasons, the definition 
incorporates the applicant's or NRSRO's definition of default.
---------------------------------------------------------------------------

    \722\ See paragraph (4)(B)(iii)(c) of the instructions for 
Exhibit 1.
    \723\ See Better Markets Letter.
    \724\ The Commission recognizes that supplementing the standard 
definition of default with the definition used by the applicant or 
NRSRO creates the potential for inconsistent classifications. 
However, any such impact will increase the number of defaults for 
purposes of calculating the performance statistics (that is, the 
definition used by the applicant or NRSRO cannot narrow the standard 
definition). The Commission believes that the incremental increase 
in the number of credit ratings classified as default using the 
internal definition would be minimal given the broad scope of the 
standard definition and, therefore, would not have a material impact 
on the overall default rates.
---------------------------------------------------------------------------

    The Commission agrees with the comment suggesting that the ``terms 
of an obligation'' as used in the standard definition of default would 
include any grace period provided in those terms within which an 
obligor or issuer may cure the default.\725\ Consequently, an applicant 
or NRSRO need not classify a credit rating as a default under the 
standard definition if the obligor is within a grace period 
specifically provided for under the terms and conditions of the 
obligation and subsequently ``cures the default.''
---------------------------------------------------------------------------

    \725\ See DBRS Letter.
---------------------------------------------------------------------------

    Finally, as proposed, the final amendments provide that a credit 
rating must be classified as a default even if the applicant or NRSRO 
assigned a credit rating to the obligor, security, or money market 
instrument at a notch above default in its rating scale on or after the 
event of default or withdrew the credit rating on or after the event of 
default.\726\ This is designed to make clear that the requirement that 
a credit rating classified as a default at any time during the period 
covered by the Transition/Default Matrix must be included in the 
default rate irrespective of any post-default rating actions taken by 
the NRSRO.
---------------------------------------------------------------------------

    \726\ See paragraph (4)(B)(iv) of the instructions for Exhibit 
1.
---------------------------------------------------------------------------

    As discussed above, the Transition/Default Matrix must provide 
statistics on the number of credit ratings in the start-date cohort at 
a given rating notch that were classified as paid off at any time 
during the relevant period.\727\ The instructions require that: (1) 
This amount be expressed as a percent of the total number of a credit 
ratings in the start date cohort as of the period start date; and (2) 
the percent be entered in the Paid Off column.\728\ This classification 
must be made if the credit rating is classified as paid off at any time 
during the period.\729\
---------------------------------------------------------------------------

    \727\ See paragraph (4)(B)(iv) of the instructions for Exhibit 
1.
    \728\ Id. For example, in the Sample Transition/Default Matrix 
in Figure 2, there were 200 credit ratings in the CC cohort as of 
the December 31, 2000 start date. Of these 200 credit ratings, four 
(or 2%) were classified as paid off during the period (December 31, 
2000 through December 31, 2010). Accordingly, 2% is entered in the 
Paid Off column.
    \729\ See paragraph (4)(B)(iv) of the instructions for Exhibit 
1.
---------------------------------------------------------------------------

    The proposed rule prescribed a standard definition of paid off with 
two prongs: (1) One applicable to obligors; and (2) one applicable to 
securities and money market instruments.\730\ One commenter stated that 
the paid off classification as applied to obligors ``is not 
practicable'' because some obligors do not have rated debt outstanding 
and it would be difficult to track whether all obligations of an 
obligor are paid off.\731\ Further, as discussed above, the 
determination of the start-date cohorts for classes of credit ratings 
other than the issuer of asset-backed securities class will require--
under the modifications to the proposal--that the applicant or NRSRO 
use the credit ratings of obligors as entities and exclude the credit 
ratings of securities issued by the obligor unless the obligor does not 
have an entity credit rating (in which case only the credit rating of 
the obligor's senior unsecured debt must be included). A credit rating 
of an obligor as an entity does not relate to a single obligation with 
a maturity date but rather to the obligor's overall ability to meet any 
obligations as they come due. Therefore, an obligor credit rating 
normally cannot be classified as paid off since it does not reference a 
specific obligation that will mature.
---------------------------------------------------------------------------

    \730\ See Nationally Recognized Statistical Rating 
Organizations, 76 FR at 33442, 33557-33558.
    \731\ See S&P Letter.
---------------------------------------------------------------------------

    For these reasons, the Commission has modified the standard 
definition of paid off to eliminate the prong that applied to entity 
ratings of obligors. The final amendments provide that the applicant or 
NRSRO must classify the credit rating as paid off only if the issuer of 
the security or money market instrument extinguished its obligation 
with respect to the security or money market instrument during the 
applicable time period by paying in full all outstanding principal and 
interest due

[[Page 55138]]

according to the terms of the security or money market instrument (for 
example, because the security or money market instrument matured, was 
called, or was prepaid); and the applicant or NRSRO withdrew the credit 
rating for the security or money market instrument because the 
obligation was extinguished.\732\
---------------------------------------------------------------------------

    \732\ See paragraph (4)(B)(iv)(b) of the instructions for 
Exhibit 1.
---------------------------------------------------------------------------

    As discussed above, the Transition/Default Matrix must provide 
statistics on the number of credit ratings in the start-date cohort at 
a given rating notch that were withdrawn for a reason other than they 
were classified as a default or paid-off.\733\ The instructions require 
that: (1) This amount be expressed as a percent of the total number of 
credit ratings at a given notch in the rating scale as of the period 
start date; and (2) the percent be entered in the Withdrawn (other) 
column.\734\ The instructions provide that the applicant or NRSRO must 
classify the credit rating as withdrawn even if the applicant or NRSRO 
assigned a credit rating to the obligor, security, or money market 
instrument after withdrawing the credit rating.\735\
---------------------------------------------------------------------------

    \733\ See paragraph (4)(B)(v) of the instructions for Exhibit 1.
    \734\ Id. For example, in the Sample Transition/Default Matrix 
in Figure 2, there were 4000 credit ratings in the A cohort as of 
the December 31, 2000 start date. Of these 4000 credit ratings, 
eighty (or 2%) were classified as withdrawn for other reasons during 
the period (December 31, 2000 through December 31, 2010). 
Accordingly, 2% is entered in the Withdrawn (other) column.
    \735\ See paragraph (4)(B)(v) of the instructions for Exhibit 1.
---------------------------------------------------------------------------

    There are legitimate reasons to withdraw a credit rating assigned 
to an obligor, security, or money market instrument. For example, an 
NRSRO might withdraw a credit rating because the rated obligor or 
issuer of the rated security or money market instrument stopped paying 
for the surveillance of the credit rating or because the NRSRO issued 
and was monitoring the credit rating on an unsolicited basis and no 
longer wanted to devote resources to monitoring it. However, an 
applicant or NRSRO could withdraw a credit rating to make its 
transition or default rates appear more favorable.\736\ The Commission 
believes that the instructions with respect to withdrawn credit ratings 
permit NRSROs the flexibility to withdraw credit ratings for legitimate 
reasons, including those stated above, while helping to prevent 
manipulation that would make their transition or default rates appear 
more favorable.
---------------------------------------------------------------------------

    \736\ For example, in the Sample Transition/Default Matrix in 
Figure 2, there were 3600 credit ratings in the BBB cohort as of the 
start date. The transition rates from a BBB rating to a lower rating 
are: 15% (BB), 10% (B), 6% (CCC), 5% (CC), and 1% (C). Taken 
together, this means that 37% (or 1332) of the credit ratings 
transitioned to a credit rating as of the end-date that was below 
BBB (that is, to categories commonly referred to as non-investment 
grade or speculative). An NRSRO could make its performance 
statistics appear better by decreasing the number of ``investment 
grade'' credit ratings that transition to ``non-investment grade'' 
credit ratings. For example, the credit ratings for 400 obligors, 
securities, or money market instruments assigned a BBB credit rating 
as of the start date could be withdrawn. This would reduce the 
transition rate of BBB credit ratings to credit ratings below BBB 
from 37% (1332/3600) to approximately 26% (932/3600).
---------------------------------------------------------------------------

    The Commission did not propose that NRSROs be required to track 
obligors, securities, or money market instruments after they had 
withdrawn credit ratings assigned to them, but the Commission did seek 
comment on whether this should be required.\737\ Two NRSROs stated that 
NRSROs should not be required to track withdrawn ratings after 
withdrawal.\738\ The amendments, as adopted, do not require NRSROs to 
track the outcomes of obligors, securities, or money market instruments 
after the credit ratings assigned to them are withdrawn.
---------------------------------------------------------------------------

    \737\ See Nationally Recognized Statistical Rating 
Organizations, 76 FR 33444-33445.
    \738\ See Moody's Letter; S&P Letter.
---------------------------------------------------------------------------

2. Amendments to Rule 17g-1
    As discussed above, section 932(a)(8) of the Dodd-Frank Act added 
subsection (q) to section 15E of the Exchange Act.\739\ Section 
15E(q)(2)(D) of the Exchange Act provides that the Commission's rules 
must require an NRSRO to publish the information about the performance 
of its credit ratings and make it freely available on an easily 
accessible portion of its Internet Web site, and in writing when 
requested.\740\ The Commission proposed to implement section 
15E(q)(2)(D) by amending paragraph (i) of Rule 17g-1.\741\
---------------------------------------------------------------------------

    \739\ See 15 U.S.C. 78o-7(q).
    \740\ See 15 U.S.C. 78o-7(q)(2)(D).
    \741\ See Nationally Recognized Statistical Rating 
Organizations, 76 FR at 33445-33446.
---------------------------------------------------------------------------

    Before today's amendments, paragraph (i) of Rule 17g-1 required an 
NRSRO to make its current Form NRSRO and information and documents 
submitted in Exhibits 1 through 9 publicly available on its Internet 
Web site or through another comparable, readily accessible means within 
ten business days of being granted an initial registration or a 
registration in an additional class of credit ratings, and within ten 
business days of furnishing a Form NRSRO to update information on the 
Form, to provide the annual certification, and to withdraw a 
registration.\742\ These requirements implemented section 15E(a)(3) of 
the Exchange Act, which provides, among other things, that the 
Commission shall, by rule, require an NRSRO, upon the granting of a 
registration, to make the information and documents submitted to the 
Commission in its completed application for registration, or in any 
amendment, publicly available on its Internet Web site, or through 
another comparable, readily accessible means.\743\
---------------------------------------------------------------------------

    \742\ See Oversight of Credit Rating Agencies Registered as 
Nationally Recognized Statistical Rating Organizations, 72 FR at 
33620.
    \743\ See 15 U.S.C. 78o-7(a)(3); Oversight of Credit Rating 
Agencies Registered as Nationally Recognized Statistical Rating 
Organizations, 72 FR at 33569.
---------------------------------------------------------------------------

    Although section 15E(q)(2)(D) addresses the disclosure of 
information about the performance of credit ratings (which NRSROs 
disclose in Exhibit 1 to Form NRSRO), the Commission proposed amending 
paragraph (i) of Rule 17g-1 to require an NRSRO to ``make its current 
Form NRSRO and Exhibits 1 through 9 to Form NRSRO publicly and freely 
available on an easily accessible portion of its corporate Internet Web 
site'' to avoid having separate requirements for the Exhibit 1 
performance statistics and the rest of Form NRSRO and the other public 
exhibits.\744\ In this regard, the Commission stated that it believed 
that a Form NRSRO would be on an ``easily accessible'' portion of an 
Internet Web site if it could be accessed through a clearly and 
prominently labeled hyperlink to the form on the homepage of the 
NRSRO's corporate Internet Web site.\745\
---------------------------------------------------------------------------

    \744\ See Nationally Recognized Statistical Rating 
Organizations, 76 FR at 33538.
    \745\ See id. at 33445.
---------------------------------------------------------------------------

    In addition, to implement section 15E(q)(2)(D) of the Exchange Act, 
the Commission proposed to amend paragraph (i) to provide that an NRSRO 
``must make its up-to-date Exhibit 1 to Form NRSRO freely available in 
writing to any individual who requests a copy of the Exhibit.''\746\
---------------------------------------------------------------------------

    \746\ See id. at 33538.
---------------------------------------------------------------------------

    Because there were references in Form NRSRO and the Instructions 
for Form NRSRO to make Form NRSRO and information and documents 
submitted in Exhibits 1 through 9 ``publicly available on [the NRSRO's] 
Web site or through another comparable, readily accessible means,'' the 
Commission proposed amending these references to mirror the text of the 
proposed amendment to paragraph (i).\747\
---------------------------------------------------------------------------

    \747\ See Nationally Recognized Statistical Rating 
Organizations, 76 FR at 33445.

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

[[Page 55139]]

    Several comment letters addressed the proposal.\748\ One NRSRO 
supported the proposal as long as it does not require the disclosure of 
confidential information.\749\ Three NRSROs stated that, as NRSROs are 
required to make public disclosures in addition to Form NRSRO, a link 
on the homepage of their corporate Internet Web site labeled 
``Regulatory Disclosures'' (or similar language) to a section of the 
site that included Form NRSRO would be appropriate and would still 
provide easy access to Form NRSRO and Exhibits 1 through 9.\750\ Two 
NRSROs stated that there would be costs but no benefits in requiring 
that Exhibit 1 be made freely available in writing to any individual 
who requests a copy of the Exhibit, and these NRSROs suggested that 
NRSROs be able to charge reasonable postage and handling fees.\751\
---------------------------------------------------------------------------

    \748\ See DBRS Letter; Moody's Letter; Morningstar Letter; S&P 
Letter.
    \749\ See S&P Letter.
    \750\ See DBRS Letter; Moody's Letter; Morningstar Letter.
    \751\ See DBRS Letter; S&P Letter.
---------------------------------------------------------------------------

    The Commission is adopting the proposed amendments to paragraph (i) 
of Rule 17g-1 substantially as proposed. In conformity with the 
modification (in response to comment) to the proposed instructions for 
Exhibit 1 to Form NRSRO,\752\ the Commission is modifying the proposal 
to replace the phrase ``up-to-date Exhibit 1'' with the phrase ``most 
recently filed Exhibit 1.'' The Commission also is replacing the phrase 
``Web site'' with the word ``Web site,'' consistent with the usage in 
other NRSRO rules.
---------------------------------------------------------------------------

    \752\ See Moody's Letter.
---------------------------------------------------------------------------

    The Commission agrees with the comments suggesting that NRSROs may 
charge reasonable postage and handling fees for sending a written copy 
of Exhibit 1 to individuals who request it in written form.\753\ This 
should reduce the costs of the requirement and incentivize individuals 
to access the information using the NRSRO's Internet Web site, which is 
a more efficient method of obtaining the information.
---------------------------------------------------------------------------

    \753\ See DBRS Letter; S&P Letter.
---------------------------------------------------------------------------

    The Commission also is making conforming amendments to Form NRSRO 
and the Instructions to Form NRSRO (as was proposed).\754\ Finally, the 
Commission agrees with commenters\755\ that a Form NRSRO and Exhibits 1 
through 9 to Form NRSRO would be on an ``easily accessible'' portion of 
an NRSRO's corporate Internet Web site if it could be accessed through 
a clearly and prominently labeled hyperlink labeled ``Regulatory 
Disclosures'' on the homepage of the Web site.
---------------------------------------------------------------------------

    \754\ See Item 5, the Note to Item 6.C, Item 8, and Item 9 of 
Form NRSRO; Instruction A.3 and Instruction H to Form NRSRO.
    \755\ See DBRS Letter; Moody's Letter; Morningstar Letter.
---------------------------------------------------------------------------

3. Amendments to Rule 17g-2 and Rule 17g-7
a. Proposal
    Paragraph (a)(8) of Rule 17g-2 requires an NRSRO to make and retain 
a record that, ``for each outstanding credit rating, shows all rating 
actions and the date of such actions from the initial credit rating to 
the current credit rating identified by the name of the rated security 
or obligor and, if applicable, the CUSIP of the rated security or the 
Central Index Key (``CIK'') number of the rated obligor.''\756\ An 
NRSRO is required to retain this record for three years under paragraph 
(c) of Rule 17g-2.\757\
---------------------------------------------------------------------------

    \756\ 17 CFR 240.17-2(a)(8). A CIK number has ten digits and is 
assigned to uniquely identify a filer using the Commission's EDGAR 
system. CUSIP is an acronym for the Committee on Uniform Securities 
and Identification. A CUSIP number consists of nine characters that 
uniquely identify a company or issuer and the type of security.
    \757\ See 17 CFR 240.17g-2(c).
---------------------------------------------------------------------------

    Before today's amendments, paragraph (d)(2) of Rule 17g-2 (the 
``10% Rule'') required an NRSRO to ``make and keep publicly available 
on its corporate Internet Web site in an eXtensible Business Reporting 
Language (``XBRL'') format'' the information required to be documented 
pursuant to paragraph (a)(8) of Rule 17g-2 for 10% of the outstanding 
credit ratings, selected on a random basis, in each class of credit 
rating for which the NRSRO is registered if the credit rating was paid 
for by the obligor being rated or by the issuer, underwriter, or 
sponsor of the security being rated (``issuer-paid'' credit ratings) 
and the NRSRO has 500 or more such issuer-paid credit ratings 
outstanding in that class.\758\ Paragraph (d)(2) further provided that 
any ratings action required to be disclosed need not be made public 
less than six months from the date the action is taken; that if a 
credit rating made public pursuant to the rule is withdrawn or the 
rated instrument matures, the NRSRO must randomly select a new 
outstanding credit rating from that class of credit ratings in order to 
maintain the 10% disclosure threshold; and that in making the 
information available on its corporate Internet Web site, the NRSRO 
must use the List of XBRL Tags for NRSROs as specified on the 
Commission's Internet Web site.
---------------------------------------------------------------------------

    \758\ See Amendments to Rules for Nationally Recognized 
Statistical Rating Organizations, 74 FR at 63864.
---------------------------------------------------------------------------

    Before today's amendments, paragraph (d)(3) of Rule 17g-2 (the 
``100% Rule'') required an NRSRO to make publicly available on its 
corporate Internet Web site information required to be documented 
pursuant to paragraph (a)(8) of the rule for any credit rating 
initially determined by the NRSRO on or after June 26, 2007, the 
effective date of the Rating Agency Act of 2006.\759\ The 100% Rule 
applied to all types of credit ratings (as opposed to the 10% Rule, 
which was limited to issuer-paid credit ratings). However, the 100% 
Rule prescribed different grace periods for when an NRSRO must disclose 
a rating action depending on whether or not it involved an issuer-paid 
credit rating. For issuer-paid credit ratings, the grace period was 
twelve months after the date the rating action was taken, and for non-
issuer paid credit ratings, the grace period was twenty-four months 
after the date the rating action was taken. The NRSRO was required to 
disclose the rating history information on its corporate Internet Web 
site in an XBRL format using the List of XBRL Tags for NRSROs as 
published by the Commission on its Internet Web site.\760\
---------------------------------------------------------------------------

    \759\ Id.
    \760\ Information about the List of XBRL Tags is located at the 
following page on the Commission's Web site: http://www.sec.gov/spotlight/xbrl/nrsro-implementation-guide.shtml. The XBRL Tags 
identified by the Commission include mandatory tags with respect to 
the information identified in paragraph (a)(8) of Rule 17g-2. The 
XBRL Tags also identify additional information that could be tagged 
by the NRSRO.
---------------------------------------------------------------------------

    The Commission proposed repealing the 10% Rule, significantly 
amending the 100% Rule, and codifying the revised 100% Rule in 
paragraph (b) of Rule 17g-7.\761\ As discussed below in section 
II.E.3.b. of this release, these proposals took into account findings 
by the GAO.\762\ As proposed to be amended, the 100% Rule would 
incorporate requirements in place before the proposed amendments and, 
in addition, would require that an NRSRO disclose rating history 
information on an ``easily accessible'' portion of its Internet Web 
site, add more rating histories to its disclosures, provide more 
information about each rating action, and not remove a rating history 
from the

[[Page 55140]]

disclosure until twenty years after the NRSRO withdraws the credit 
rating.\763\
---------------------------------------------------------------------------

    \761\ See Nationally Recognized Statistical Rating 
Organizations, 76 FR at 33446-33452.
    \762\ See id. (discussing the GAO findings); GAO Report 10-782, 
pp. 40-46 (discussing, among other things, the limitations of the 
data fields specified in the original rule). See also section 
II.E.3.b. of this release.
    \763\ See Nationally Recognized Statistical Rating 
Organizations, 76 FR at 33446-33452.
---------------------------------------------------------------------------

    To add more rating histories to the disclosures, the 100% Rule, as 
proposed, would no longer be limited to the disclosure of histories for 
credit ratings that were initially determined on or after June 26, 
2007.\764\ Instead, as proposed, the rule would apply to any credit 
rating that was outstanding as of June 26, 2007, but the rating 
histories disclosed for these credit ratings would not need to include 
information about actions taken before June 26, 2007. Moreover, in 
order to immediately include these credit ratings in the disclosure, 
the proposals would require the NRSRO to disclose the credit rating 
assigned to the obligor, security, or money market instrument and 
associated information as of June 26, 2007. The proposals provided that 
the rating actions that would need to be included in the history are 
the initial credit rating or the credit rating as of June 26, 2007 (if 
the initial credit rating was prior to that date) and any subsequent 
upgrades or downgrades of the credit rating (including a downgrade to, 
or assignment of, default), any placements of the credit rating on 
credit watch or review, any affirmation of the credit rating, and a 
withdrawal of the credit rating.
---------------------------------------------------------------------------

    \764\ See paragraph (b)(1) of Rule 17g-7, as proposed (emphasis 
added); Nationally Recognized Statistical Rating Organizations, 76 
FR at 33541-33542.
---------------------------------------------------------------------------

    To provide more information about each rating action in a rating 
history, the proposals would increase the number and scope of the 
required data fields.\765\ Specifically, the 100% Rule, as proposed, 
would identify seven categories of data that would need to be disclosed 
when a credit rating action is published. The categories of information 
were:
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    \765\ See paragraph (b)(2) of Rule 17g-7, as proposed; 
Nationally Recognized Statistical Rating Organizations, 76 FR at 
33541-33542.
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     The identity of the NRSRO disclosing the rating action;
     The date of the rating action;
     If the rating action is taken with respect to a credit 
rating of an obligor as an entity, the following identifying 
information about the obligor, as applicable: (1) The CIK number of the 
rated obligor; and (2) the legal name of the obligor;
     If the rating action is taken with respect to a credit 
rating of a security or money market instrument, as applicable: (1) CIK 
number of the issuer of the security or money market instrument; (2) 
the legal name of the issuer of the security or money market 
instrument; and (3) the CUSIP of the security or money market 
instrument;
     A classification of the rating action as either: (1) A 
disclosure of a credit rating that was outstanding as of June 26, 2007 
for purposes of the rule; (2) an initial credit rating; (3) an upgrade 
of an existing credit rating; (4) a downgrade of an existing credit 
rating, which would include classifying the obligor, security, or money 
market instrument as in default, if applicable; (5) a placement of an 
existing credit rating on credit watch or review; (6) an affirmation of 
an existing credit rating; or (7) a withdrawal of an existing credit 
rating and, if the classification is withdrawal, the reason for the 
withdrawal as either a default, the obligation was paid off, or the 
withdrawal was for other reasons;
     The classification of the class or subclass that applies 
to the credit rating as either: (1) Financial institutions, brokers, or 
dealers; (2) insurance companies; (3) corporate issuers; (4) RMBS, 
CMBS, CLO, CDO, ABCP, other ABS, or another structured finance product 
(in the issuers of structured finance products class); or (5) sovereign 
issuer, U.S. public finance, or international public finance (in the 
issuers of government securities, municipal securities, or securities 
issued by a foreign government class); and
     The credit rating symbol, number, or score the NRSRO 
assigned to the obligor, security, or money market instrument as a 
result of the rating action or, if the credit rating remained unchanged 
as a result of the rating action, the credit rating symbol, number, or 
score the NRSRO assigned to the obligor, security, or money market 
instrument as of the date of the rating action.\766\
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    \766\ See paragraphs (b)(2)(i) through (vii) of Rule 17g-7, as 
proposed; Nationally Recognized Statistical Rating Organizations, 76 
FR at 33541-33542.
---------------------------------------------------------------------------

    The proposed amendments specified when a rating action and its 
related data would need to be disclosed by establishing two distinct 
grace periods: Twelve months and twenty-four months.\767\ In 
particular, a rating action would need to be disclosed: (1) Within 
twelve months from the date the action is taken, if the credit rating 
subject to the action was issuer-paid; \768\ or (2) within twenty-four 
months from the date the action is taken, if the credit rating subject 
to the action was not issuer-paid.\769\ These proposed separate grace 
periods for issuer-paid and non-issuer-paid credit ratings were 
consistent with the requirements of the 100% Rule prior to today's 
amendments.\770\
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    \767\ See paragraph (b)(4) of Rule 17g-7, as proposed; 
Nationally Recognized Statistical Rating Organizations, 76 FR at 
33542.
    \768\ See paragraph (b)(4)(i) of Rule 17g-7, as proposed; 
Nationally Recognized Statistical Rating Organizations, 76 FR at 
33542.
    \769\ See paragraph (b)(4)(ii) of Rule 17g-7; as proposed; 
Nationally Recognized Statistical Rating Organizations, 76 FR at 
33542.
    \770\ See Amendments to Rules for Nationally Recognized 
Statistical Rating Organizations, 74 FR at 63837-63842 (discussing 
the 100% Rule and the reasons the Commission adopted distinct twelve 
and twenty-four month grace periods).
---------------------------------------------------------------------------

    Finally, the proposed amendments provided that an NRSRO may cease 
disclosing a rating history of an obligor, security, or money market 
instrument no earlier than twenty years after the date a rating action 
with respect to the obligor, security, or money market instrument is 
classified as a withdrawal.\771\
---------------------------------------------------------------------------

    \771\ See paragraph (b)(5) of Rule 17g-7, as proposed; 
Nationally Recognized Statistical Rating Organizations, 76 FR at 
33542.
---------------------------------------------------------------------------

b. Final Rule
    As proposed, the Commission is eliminating the 10% Rule.\772\ The 
10% Rule did not permit comparability across NRSROs because it captured 
only issuer-paid credit ratings in a class of credit ratings where 
there are 500 or more such ratings and only if two or more NRSROs 
randomly select the same rated obligor, issuer, or money instrument to 
be included in the sample.\773\ Moreover, the 10% Rule did not produce 
sufficient ``raw data'' to allow third parties to generate independent 
performance statistics.\774\ The goal of the rule was to provide some 
information about how an NRSRO's credit ratings performed, particularly 
ratings assigned to obligors, securities and money market instruments 
that had been rated for ten or twenty years. In light of the 
enhancements to the instructions for Exhibit 1 to Form NRSRO (discussed 
above in section II.E.1. of this release) and the 100% Rule, retaining 
the 10% Rule would provide little, if any, incremental benefit to 
investors and other users of credit ratings in terms of providing 
information about the performance of a given NRSRO's credit ratings. 
Several commenters addressed the proposal to eliminate the 10% 
Rule.\775\ All of these commenters supported its elimination.
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    \772\ See paragraph (d) of Rule 17g-2.
    \773\ See, e.g., GAO Report 10-782, pp. 40-47.
    \774\ See id.
    \775\ See CFA/AFR Letter; DBRS Letter; S&P Letter.
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    The Commission is adopting the amendments to the 100% Rule 
(including moving its provisions from Rule 17g-2 to Rule 17g-7) with

[[Page 55141]]

modifications, in part, in response to comments.\776\ Two commenters 
generally supported the proposed amendments to the 100% Rule.\777\ On 
the other hand, one NRSRO objected to the Commission's proposal to 
expand the 100% Rule ``until a more thorough cost-benefit analysis'' 
has been conducted.\778\ This NRSRO stated that on average only one 
person per month is accessing its rating history disclosures, but that 
it incurs substantial costs to make the information available. Further, 
it stated that constantly updating the database for the 100% Rule 
``would impose an unwarranted burden on NRSROs'' and that the 
Commission has ``substantially underestimated the costs'' of the 
proposal. Another NRSRO also did not support the proposal, stating that 
it would impose significant costs on NRSROs, that lost subscription 
revenue due to the requirement to provide historical data for free will 
limit NRSROs' ability to innovate, and that industry competition will 
be undermined, particularly for smaller NRSROs who may be more 
dependent on subscription fees.\779\ Among other benefits, the 
modification to the proposal--as discussed below--should address some 
of the practical and burden concerns raised by NRSROs.
---------------------------------------------------------------------------

    \776\ See paragraph (b) of Rule 17g-7.
    \777\ See CFA/AFR Letter; Levin Letter.
    \778\ See DBRS Letter.
    \779\ See Fitch Letter.
---------------------------------------------------------------------------

    The final amendments (as was proposed) require that the NRSRO 
publicly disclose the rating histories for free on an easily accessible 
portion of its corporate Internet Web site.\780\ It also broadens the 
scope of credit ratings that will be subject to the disclosure 
requirements (as was proposed).\781\ The objective is to require the 
disclosure of information about all outstanding credit ratings in each 
class and subclass of credit ratings for which the NRSRO is registered 
but within certain prescribed timeframes.
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    \780\ See paragraph (b)(1) of Rule 17g-7. As discussed above, 
section 15E(q)(2)(D) of the Exchange Act provides that the 
Commission's rules shall require the information about the 
performance of credit ratings be published and made freely available 
by the NRSRO on an easily accessible portion of its Web site and in 
writing when requested. See 15 U.S.C. 78o-7(q)(2)(D). The Commission 
did not propose that the ``in writing'' requirement apply to the 
disclosures of rating histories because such a requirement would not 
be feasible. See Nationally Recognized Statistical Rating 
Organizations, 76 FR 33447, n.264. Consistent with the proposal, the 
final amendments do not apply the ``in writing'' requirement to the 
disclosures of rating histories. First, the data file containing the 
disclosures would need to be updated by the NRSRO as new rating 
actions are added. Thus, it would not remain static like the Exhibit 
1 performance measurement statistics, which are updated annually. 
Consequently, by the time a party received a written copy of the 
disclosure, it may not be up to date. Second, the amount of 
information in the data file would be substantial (particularly for 
NRSROs that have issued hundreds of thousands of credit ratings) and 
would increase over time. For these reasons, converting the 
information in the electronic disclosure to written form and mailing 
it to the party making the request would be impractical. In terms of 
utility, as discussed below, the electronic disclosure of the data 
must be made using an XBRL format. This is a much more efficient and 
practical medium for accessing and analyzing the information rather 
than obtaining it in paper form.
    \781\ See paragraphs (b)(1)(i) and (ii) of Rule 17g-7.
---------------------------------------------------------------------------

    In addition to general burden concerns noted above, commenters 
raised significant concerns about the proposal to include all credit 
ratings that were outstanding as of June 26, 2007 and information about 
credit ratings that is more than three years old (that is, outside the 
record retention requirements of Rule 17g-2).\782\ For example, one 
NRSRO stated that it may not have, or may find it difficult to obtain, 
the additional information required by the amendments.\783\ A second 
NRSRO that generally supported the amendments also stated that NRSROs 
may not be able to provide XBRL information as of June 26, 2007, since 
those rating actions are beyond the scope of the 3-year record 
retention requirement.\784\ A third NRSRO stated that--because it does 
not consider affirmations, confirmations, placement of credit ratings 
on watch or review, and assignment of default status to be credit 
rating actions and does not subdivide withdrawn ratings into the 
subcategories of withdrawn due to default, withdrawn because the 
obligation was paid in full, and withdrawn for ``other'' reasons--it 
does not capture that information in a format that is readily 
retrievable.\785\ Consequently, the commenter recommended that the 
amendment exempt an NRSRO from providing historical data to the extent 
it does not already capture the data in a readily retrievable format.
---------------------------------------------------------------------------

    \782\ See DBRS Letter; Fitch Letter; Moody's Letter; Morningstar 
Letter.
    \783\ See S&P Letter.
    \784\ See Morningstar Letter.
    \785\ See Moody's Letter (also stating that collecting data for 
past rating actions would require ``tens of thousands of hours of 
analysis'').
---------------------------------------------------------------------------

    The Commission is persuaded that the proposal raises legitimate 
practical concerns (for example, the additional information may not be 
available) and would impose a substantial burden. Accordingly, the 
final amendments have been modified from the proposal so that an NRSRO 
need only retrieve information that is no more than three years 
old.\786\ In particular, under the final amendments, for a class of 
credit rating in which the NRSRO is registered with the Commission as 
of the effective date of the rule, the disclosure requirement applies 
to a credit rating in the class that was outstanding as of, or 
initially determined on or after, the date three years prior to the 
effective date of the rule.\787\ Further, for a class of credit rating 
in which the NRSRO is registered with the Commission after the 
effective date of the rule, the disclosure requirement applies to a 
credit rating in the class that was outstanding as of, or initially 
determined on or after, the date three years prior to the date the 
NRSRO is registered in the class.\788\ Consequently, an NRSRO that is 
registered in a particular class of credit ratings as of the rule's 
effective date will need to begin complying with the rule by disclosing 
information about all credit ratings in that class that were 
outstanding as of the date three years prior to the effective date or 
that were initially determined on or after that date, subject to the 
grace periods discussed below. After the effective date of the rule, a 
credit rating agency that becomes registered with the Commission as an 
NRSRO or an NRSRO that adds a class of credit ratings to its NRSRO 
registration will need to begin complying with the rule by disclosing 
information about all credit ratings in the classes for which it is 
registered that were outstanding as of the date three years prior to 
the registration date or that were initially determined on or after 
that date, subject to the grace periods. This aligns the retrieval 
requirement for all NRSROs regardless of when they are registered in a 
class of credit ratings.\789\ It also substantially reduces the burden 
of adding past rating actions to the rating histories because the NRSRO 
will need to provide only

[[Page 55142]]

three years of historical information initially, which should mitigate, 
to some degree, concerns about having to retrieve information that was 
not retained by the NRSRO.\790\
---------------------------------------------------------------------------

    \786\ See paragraphs (b)(1)(i) and (ii) of Rule 17g-7.
    \787\ See paragraph (b)(1)(i) of Rule 17g-7. Rule 17g-2 requires 
certain rating history information to be retained for a period of 
three years. See, e.g., 17 CFR 240.17g-2(a)(8).
    \788\ See paragraph (b)(1)(ii) of Rule 17g-7.
    \789\ For example, under the proposal, NRSROs registered with 
the Commission in a class of credit ratings when the rule went 
effective would need to have retrieved information about the credit 
ratings in that class covering a period from June 26, 2007 to the 
effective date of the rule. The span of time between June 26, 2007 
and the effective date of the rule would be fixed at that point and 
all NRSROs registered in one or more classes of securities on the 
effective date would need to retrieve information spanning the same 
period of time. However, any NRSRO registered after the effective 
date, or an NRSRO adding a class of credit ratings to its 
registration after the effective date, would to need retrieve 
information spanning a longer period of time and, as time 
progressed, the retrieval period would increase as would the burden 
of retrieval.
    \790\ As indicated above, one commenter recommended that the 
rule exempt an NRSRO from providing historical data to the extent it 
does not already capture the data in a readily retrievable format. 
See Moody's Letter. While the Commission believes the modifications 
discussed above will address the commenter's concerns to a large 
degree, an NRSRO can seek exemptive relief from the Commission under 
section 36 of the Exchange Act. See 17 U.S.C. 78mm.
---------------------------------------------------------------------------

    Under the proposal, if a credit rating was added to the rating 
histories disclosure either because it was outstanding as of June 26, 
2007 or was initially determined on or after that date, the rating 
history for the credit rating needed to include every subsequent 
upgrade or downgrade of the credit rating (including a downgrade to, or 
assignment of, default), any placements of the credit rating on credit 
watch or review, any affirmation of the credit rating, and a withdrawal 
of the credit rating.\791\ Several commenters raised concerns about the 
proposed types of rating actions that would trigger the disclosure 
requirements, including rating affirmations.\792\ One NRSRO suggested 
that the disclosure rules apply only to initial ratings because 
subscription-based NRSROs will likely have significantly more rating 
actions, and the proposed rule may encourage these NRSROs to provide 
less frequent surveillance.\793\ Another commenter stated that a rating 
affirmation should not be included in rating actions as the required 
disclosures may make NRSROs less likely to provide confirmations of 
credit ratings, which may make it impossible to amend transaction 
documents.\794\ An NRSRO stated that including affirmations in rating 
actions would significantly increase the burden on NRSROs.\795\ The 
commenter recommended that if affirmations were included, the 
Commission should state that the term affirmation refers only to a 
published announcement, or written communication in the case of a 
private or confidential credit rating, by an NRSRO that it is 
maintaining the credit rating at its current level, and that the term 
should not include any purely internal discussions by an NRSRO about a 
credit rating.
---------------------------------------------------------------------------

    \791\ See paragraph (b)(1) of Rule 17g-7, as proposed; 
Nationally Recognized Statistical Rating Organizations, 76 FR at 
33542.
    \792\ See ABA Letter; Deloitte Letter; Moody's Letter; 
Morningstar Letter; TradeMetrics Letter.
    \793\ See Morningstar Letter.
    \794\ See ABA Letter.
    \795\ See S&P Letter.
---------------------------------------------------------------------------

    The Commission is persuaded by the comments that the types of 
rating actions triggering the disclosure requirement can be reduced and 
the 100% Rule can still meet the objective of allowing users of credit 
ratings and others to compare the performance of credit ratings among 
NRSROs and generate their own performance statistics. Consequently, to 
focus the disclosure on the rating actions that are most relevant to 
evaluating performance, the final amendments provide that the history 
of a credit rating must include, in addition to the initial credit 
rating or the initial entry of the credit rating into the history, any 
subsequent upgrade or downgrade of the credit rating (including a 
downgrade to, or assignment of, default) and a withdrawal of the credit 
rating.\796\ These are the rating actions necessary to calculate 
transition and default rates. With this modification, the final 
amendments eliminate the requirement to include placements on watch and 
affirmations (and the required data associated with those actions) in 
the rating histories. In addition to reducing the burden of the rule, 
this may alleviate concerns that requiring NRSROs to disclose rating 
histories (even with the grace periods) may cause subscribers to stop 
paying for access to credit ratings or for downloads of credit rating 
actions and instead to use the disclosures of rating histories as a 
substitute for these types of subscriptions. For example, information 
about placements of credit ratings on watch and credit rating 
affirmations may be information that subscribers value as part of their 
subscriptions.
---------------------------------------------------------------------------

    \796\ See paragraphs (b)(1)(i) and (ii) of Rule 17g-7.
---------------------------------------------------------------------------

    The final amendments (as was proposed) increase the information 
that must be disclosed about a rating action.\797\ Specifically, 
paragraph (b)(2) of Rule 17g-7 specifies seven categories of data that 
must be disclosed with a rating action.\798\ The objective of these 
enhancements is to make the disclosures more useful in terms of the 
amount of information provided, the ability to search and sort the 
information, and the ability to compare historical rating information 
across NRSROs.\799\ As discussed below, the Commission has made some 
modifications to the required data categories in response to 
suggestions by commenters and to correspond to the modifications 
discussed above that change the scope of the credit ratings and rating 
actions covered by the disclosure requirement.
---------------------------------------------------------------------------

    \797\ See paragraph (b)(2) of Rule 17g-7.
    \798\ The Commission will update the List of XBRL Tags to 
include some of the new data fields. Other fields are covered by 
existing Tags, including by some of the voluntary Tags.
    \799\ See, e.g., GAO Report 10-782, p. 41 (``First, SEC [sic] 
did not specify the data fields the NRSROs were to disclose in the 
rule, and the data fields provided by the NRSROs were not always 
sufficient to identify a complete rating history for ratings in each 
of the seven samples. If users cannot identify the rating history 
for each rating in the sample, they cannot develop performance 
measures that track how an issuer's credit rating evolves.'').
---------------------------------------------------------------------------

    Paragraphs (b)(2)(i) and (ii) of Rule 17g-7 are being adopted as 
proposed.\800\ Paragraph (b)(2)(i) identifies the first category of 
data that must be disclosed with each rating action: The identity of 
the NRSRO disclosing the rating action.\801\ Because the NRSRO must 
assign an XBRL Tag to each item of information, including and tagging 
the identity of the NRSRO will assist users who download and combine 
data files of multiple NRSROs to sort credit ratings by a given NRSRO. 
Paragraph (b)(2)(ii) identifies the second category of data: The date 
of the rating action.\802\ This will allow a person reviewing the 
credit rating histories of the NRSROs to reach conclusions about their 
relative capabilities in making appropriate and timely adjustments to 
their credit ratings.\803\
---------------------------------------------------------------------------

    \800\ See paragraphs (b)(2)(i) and (ii) of Rule 17g-7.
    \801\ See paragraph (b)(2)(i) of Rule 17g-7.
    \802\ See paragraph (b)(2)(ii) of Rule 17g-7.
    \803\ See Nationally Recognized Statistical Rating 
Organizations, 76 FR at 33448-33449.
---------------------------------------------------------------------------

    Paragraph (b)(2)(iii) of Rule 17g-7, as proposed, would identify 
the third category of data that must be disclosed: (1) The CIK number 
of the rated obligor; and (2) the name of the obligor.\804\ Under the 
proposal, the information in this category would need to be disclosed 
only if the rating action is taken with respect to a credit rating of 
an obligor as an entity (as opposed to a credit rating of a security or 
money market instrument).\805\
---------------------------------------------------------------------------

    \804\ See paragraph (b)(2)(iii) of Rule 17g-2, as proposed; 
Nationally Recognized Statistical Rating Organizations, 76 FR at 
33542.
    \805\ See Nationally Recognized Statistical Rating 
Organizations, 76 FR at 33449.
---------------------------------------------------------------------------

    Commenters raised concerns about requiring disclosure of the CIK 
number.\806\ One NRSRO questioned the cost-effectiveness of the 
requirement and recommended that the requirement to provide CIK numbers 
be eliminated.\807\ Another NRSRO stated that it was ``unnecessarily 
burdensome'' to require the use of identifiers that may become 
obsolete, that require NRSROs to pay a fee, or that may not be used 
outside the United States, as long as NRSROs ``use some kind of 
identifier

[[Page 55143]]

system sufficient to identify the rated obligor and obligation,'' for 
example, ``an internationally recognized LEI [Legal Entity Identifier] 
system.'' \808\
---------------------------------------------------------------------------

    \806\ See DBRS Letter; Moody's Letter (suggesting use of the 
LEI).
    \807\ See DBRS Letter.
    \808\ See Moody's Letter. The LEI is a reference code to 
uniquely identify a legally distinct entity that engages in a 
financial transaction. Further information about LEI is available at 
http://www.treasury.gov/initiatives/wsr/ofr/Documents/LEI_FAQs_August2012_FINAL.pdf.
---------------------------------------------------------------------------

    The Commission believes that the use of an LEI can promote accuracy 
and standardization of NRSRO data, and therefore can further the 
purpose of allowing users of credit ratings to compare the performance 
of credit ratings by different NRSROs.\809\ The effort to standardize a 
universal LEI has progressed significantly over the last few years, and 
an international standard was published by the International 
Organization for Standardization (``ISO'') in June 2012, which set out 
the elements of a working system.\810\
---------------------------------------------------------------------------

    \809\ The Commission has prescribed the use of an LEI for the 
purposes of reporting information on Form PF. See Reporting by 
Investment Advisers to Private Funds and Certain Commodity Pool 
Operators and Commodity Trading Advisors on Form PF, Investment 
Adviser Act of 1940 Release No. 3308 (Oct. 31, 2011), 76 FR 71128 
(Nov. 16, 2011). Form PF is available at http://www.sec.gov/rules/final/2011/ia-3308-formpf.pdf. The glossary of terms for the form 
provides the following definition of LEI: ``With respect to any 
company, the `legal entity identifier' assigned by or on behalf of 
an internationally recognized standards setting body and required 
for reporting purposes by the U.S. Department of the Treasury's 
Office of Financial Research or a financial regulator. In the case 
of a financial institution, if a `legal entity identifier' has not 
been assigned, then provide the RSSD ID assigned by the National 
Information Center of the Board of Governors of the Federal Reserve 
System, if any.''
    \810\ See ISO 17442:2012, Financial services--Legal Entity 
Identifier (LEI). A copy of the standard can be purchased at http://www.iso.org/iso/home/store/catalogue_tc/catalogue_detail.htm?csnumber=59771. See also CFTC, Amended 
Order Designating The Provider Of Legal Entity Identifiers To Be 
Used In Recordkeeping And Swap Data Reporting Pursuant To The 
Commission's Regulations, available at http://www.cftc.gov/ucm/groups/public/@newsroom/documents/file/leiamendedorder.pdf (order 
expanding, through mutual acceptance by international regulators, 
the list of identifiers that can be used by registered entities and 
swap counterparties in complying with the CFTC's swap data reporting 
regulations).
---------------------------------------------------------------------------

    The Commission is modifying the proposal to require, with respect 
to a rating action involving a credit rating of an obligor as an 
entity, the disclosure of the obligor's LEI issued by a utility 
endorsed or otherwise governed by the Global LEI Regulatory Oversight 
Committee \811\ or the Global LEI Foundation, if available, or, if the 
LEI is not available, the disclosure of the obligor's CIK, if 
available.\812\ The Commission believes that having some method of 
identifying the obligor--in addition to its name--is appropriate as it 
will make the data searchable and comparable across NRSROs. Coded 
identifiers like the LEI and CIK will add a level of standardization to 
the credit rating history data, making for easier electronic querying 
and processing.
---------------------------------------------------------------------------

    \811\ See www.leiroc.org.
    \812\ See paragraph (b)(2)(iii)(A) of Rule 17g-7. The proposal 
is modified by separating the LEI and CIK disclosure requirements in 
paragraph (b)(2)(iii)(A) and the legal name disclosure requirement 
in paragraph (b)(2)(iii)(B). See paragraphs (b)(2)(iii)(A) and (B) 
of Rule 17g-7. While the description of the LEI in Rule 17g-7 is 
different than the description in the glossary of terms for Form PF, 
it is intended to have the same meaning. The description in Rule 
17g-7 is designed to be more generic and, therefore, address future 
changes in the organizations administering LEIs.
---------------------------------------------------------------------------

    An NRSRO recommended not requiring inclusion of the legal name of 
the issuer because inconsistent use of abbreviations has made this 
problematic.\813\ The Commission believes that the name of the obligor 
provides a more intuitive means of searching for a specific credit 
rating history in comparison to the LEI or CIK number. The Commission 
does not, however, view the LEI or CIK as a replacement for a name. For 
example, the user of the data can search for the name if the user does 
not know the LEI or CIK number. The Commission agrees with the 
commenter that requiring the specific legal name can be problematic. 
Consequently, the proposal has been modified to require the NRSRO to 
provide the obligor's ``name'' rather than ``legal name.'' \814\ An 
NRSRO must disclose a name that clearly identifies the obligor and use 
that name consistently.\815\ For these reasons, the final amendments 
require the disclosure of the obligor's name.\816\
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    \813\ See S&P Letter.
    \814\ See paragraph (b)(2)(iii)(B) of Rule 17g-7.
    \815\ As discussed below in section II.G.3. of this release, the 
Commission is taking a similar approach to the identification of the 
obligor's name in the form to accompany a credit rating.
    \816\ See paragraph (b)(2)(iii)(B) of Rule 17g-7.
---------------------------------------------------------------------------

    Paragraph (b)(2)(iv) of Rule 17g-7, as proposed, would identify the 
fourth category of data to be disclosed with a rating action: (1) The 
CIK number of the issuer of the security or money market instrument; 
(2) the name of the issuer of the security or money market instrument; 
and (3) the CUSIP of the security or money market instrument.\817\ The 
information in this category would need to be disclosed when the rating 
action is taken with respect to a security or money market instrument. 
The Commission is adopting paragraph (b)(2)(iv) of Rule 17g-7 with 
modifications from the proposal.
---------------------------------------------------------------------------

    \817\ See paragraph (b)(2)(iii) of Rule 17g-2, as proposed; 
Nationally Recognized Statistical Rating Organizations, 76 FR at 
33542.
---------------------------------------------------------------------------

    First, the paragraph requires an NRSRO to disclose the LEI of the 
issuer, if available, or, if an LEI is not available, the CIK number of 
the issuer, if available.\818\ This will make paragraph (b)(2)(iv) 
consistent with paragraph (b)(2)(iii), which, as discussed above, 
requires the disclosure of the LEI of the obligor, if available, or, if 
an LEI is not available, the CIK number of the issuer, if available. 
Second, as adopted, the paragraph requires the NRSRO to disclose the 
``name'' of the issuer, rather than the ``legal name'' as was 
proposed.\819\ This also will make paragraph (b)(2)(iv) consistent with 
paragraph (b)(2)(iii).
---------------------------------------------------------------------------

    \818\ See paragraph (b)(2)(iv)(A) of Rule 17g-7.
    \819\ See paragraph (b)(2)(iv)(B) of Rule 17g-7.
---------------------------------------------------------------------------

    The Commission is adopting the requirement to disclose the CUSIP of 
the security or money market instrument as was proposed.\820\ One NRSRO 
stated that the cost of adding CUSIP data should be included in the 
Commission's cost-benefit analysis.\821\ In response, the Commission 
notes that the requirement to disclose the CUSIP of the security or 
money market instrument was required by the 100% Rule before today's 
amendments.\822\ When adopting the 10% Rule and the 100% Rule, the 
Commission considered the costs associated with the CUSIP 
requirement.\823\ The Commission recognizes that the continued 
requirement to disclose the CUSIP number of the security or money 
market instrument subject to the rating action imposes licensing costs. 
However, without the CUSIP requirement, the disclosures could be of 
little utility as there would be no standard identifier with which to 
search for a specific security or money market instrument. This would 
make it difficult for users of the rating history disclosures to locate 
and compare the rating history for a given security or money market 
instrument. The Commission has balanced the cost of the requirement 
with the benefit of making the disclosures readily searchable and, 
therefore, enhancing their utility. For these reasons, the final 
amendments retain the CUSIP disclosure requirements.\824\
---------------------------------------------------------------------------

    \820\ See paragraph (b)(2)(iv)(C) of Rule 17g-7.
    \821\ See DBRS Letter.
    \822\ See 17 CFR 240.17g-2(a)(8) and (d)(3).
    \823\ See Amendments to Rules for Nationally Recognized 
Statistical Rating Organizations, 74 FR at 6477 (adopting the 10% 
Rule); Amendments to Rules for Nationally Recognized Statistical 
Rating Organizations, 74 FR at 63859 (adopting the 100% Rule).
    \824\ If securities or money market instruments are assigned 
LEIs, the Commission would consider replacing the CUSIP requirement 
with an LEI requirement.
---------------------------------------------------------------------------

    Paragraph (b)(2)(v) of Rule 17g-7, as proposed, would identify the 
fifth

[[Page 55144]]

category of data to be disclosed with a rating action: A classification 
of the type of rating action.\825\ Under the proposal, the NRSRO would 
be required to select one of seven classifications to identify the type 
of rating action.\826\ In particular, the seven possible 
classifications were:
---------------------------------------------------------------------------

    \825\ See paragraph (b)(2)(v) of Rule 17g-7, as proposed; 
Nationally Recognized Statistical Rating Organizations.
    \826\ The required disclosure would need to be the type of 
rating action and not the credit rating resulting from the rating 
action. For example, if the rating action was a downgrade, the NRSRO 
would need to classify it as a ``downgrade'' and not, for example, a 
change of the current credit rating from the AA notch to the AA- 
notch or from the C notch to default. This would allow users of the 
disclosures to sort the information by, for example, initial credit 
ratings, upgrades, and downgrades.
---------------------------------------------------------------------------

     A disclosure of a credit rating that was outstanding as of 
June 26, 2007; \827\
---------------------------------------------------------------------------

    \827\ See paragraph (b)(2)(v)(A) of Rule 17g-7, as proposed; 
Nationally Recognized Statistical Rating Organizations, 76 FR at 
33542. As discussed above, under the proposal, all credit ratings 
outstanding as of June 26, 2007 and associated information as of 
that date would need to be disclosed to establish the first data 
point in the rating history of a credit rating that was outstanding 
as of that date. This would have meant that thousands, if not 
hundreds of thousands, of rating histories each beginning on June 
26, 2007 would be disclosed. The proposed classification was 
designed to alert users of the disclosures that the proposed rule 
caused the June 26, 2007 entry in the rating history of the obligor, 
security, or money market instrument and not because, for example, a 
credit rating was initially determined for the obligor, security, or 
money market instrument on that date.
---------------------------------------------------------------------------

     An initial credit rating; \828\
---------------------------------------------------------------------------

    \828\ See paragraph (b)(2)(v)(B) of Rule 17g-7, as proposed; 
Nationally Recognized Statistical Rating Organizations, 76 FR at 
33542. An NRSRO would select this classification if the rating 
action was the first credit rating determined by the NRSRO with 
respect to the obligor, security, or money market instrument.
---------------------------------------------------------------------------

     An upgrade of an existing credit rating; \829\
---------------------------------------------------------------------------

    \829\ See paragraph (b)(2)(v)(C) of Rule 17g-7, as proposed; 
Nationally Recognized Statistical Rating Organizations, 76 FR at 
33542.
---------------------------------------------------------------------------

     A downgrade of an existing credit rating, which would 
include classifying the obligor, security, or money market instrument 
as in default, if applicable; \830\
---------------------------------------------------------------------------

    \830\ See paragraph (b)(2)(v)(D) of Rule 17g-7, as proposed; 
Nationally Recognized Statistical Rating Organizations, 76 FR at 
33542.
---------------------------------------------------------------------------

     A placement of an existing credit rating on credit watch 
or review; \831\
---------------------------------------------------------------------------

    \831\ See paragraph (b)(2)(v)(E) of Rule 17g-7, as proposed; 
Nationally Recognized Statistical Rating Organizations, 76 FR at 
33542.
---------------------------------------------------------------------------

     An affirmation of an existing credit rating; \832\ or
---------------------------------------------------------------------------

    \832\ See paragraph (b)(2)(v)(F) of Rule 17g-7, as proposed; 
Nationally Recognized Statistical Rating Organizations, 76 FR at 
33542.
---------------------------------------------------------------------------

     A withdrawal of an existing credit rating and, if the 
classification is withdrawal, the reason for the withdrawal as: (1) The 
obligor defaulted, or the security or money market instrument went into 
default; (2) the obligation subject to the credit rating was 
extinguished by payment in full of all outstanding principal and 
interest due on the obligation according to the terms of the 
obligation; or (3) the credit rating was withdrawn for reasons other 
than those set forth in items (1) or (2) above.\833\
---------------------------------------------------------------------------

    \833\ See paragraph (b)(2)(v)(G) of Rule 17g-7, as proposed; 
Nationally Recognized Statistical Rating Organizations, 76 FR at 
33542.
---------------------------------------------------------------------------

    The Commission is adopting paragraph (b)(2)(v) of Rule 17g-7 with 
modifications. First, the final amendments eliminate the rating action 
classifications with respect to placing a credit rating on watch or 
review and with respect to affirming a credit rating.\834\ As discussed 
above, the amendments do not require the rating histories disclosure to 
include these types of rating actions.
---------------------------------------------------------------------------

    \834\ See paragraph (b)(2)(v) of Rule 17g-7. As a result of 
these modifications, paragraph (b)(2)(v)(G) of Rule 17g-7, as 
proposed, is re-designated paragraph (b)(2)(v)(E) of Rule 17g-7.
---------------------------------------------------------------------------

    Second, paragraph (b)(2)(v)(A) of Rule 17g-7 has been 
modified.\835\ As discussed above, this provision was designed to alert 
a user of the rating histories disclosure that the credit rating and 
related information about the credit rating was added to the history 
because of the requirement in the proposal to add all credit ratings 
outstanding as of June 26, 2007. The final amendments--as discussed 
above--modify this requirement from the proposal so that an NRSRO must 
include with each credit rating disclosed under paragraph (b)(1) of 
Rule 17g-7 a classification of the rating action, if applicable, as an 
addition to the rating history disclosure: (1) Because the credit 
rating was outstanding as of the date three years prior to the 
effective date of the requirements in paragraph (b) of Rule 17g-7; or 
(2) because the credit rating was outstanding as of the date three 
years prior to the date the NRSRO became registered in the class of 
credit ratings.\836\ Consequently, paragraph (b)(2)(v)(A) of Rule 17a-
7, as adopted, is modified to conform to this change.\837\
---------------------------------------------------------------------------

    \835\ See paragraph (b)(2)(v)(A) of Rule 17g-7.
    \836\ See paragraph (b)(1) of Rule 17g-7.
    \837\ See paragraph (b)(2)(v)(A) of Rule 17g-7. The final 
amendments identify the classification as an addition to the rating 
history disclosure because the credit rating was outstanding as of 
the date three years prior to the effective date of the requirements 
in the amendments or because the credit rating was outstanding as of 
the date three years prior to the NRSRO becoming registered in the 
class of credit ratings. Id.
---------------------------------------------------------------------------

    Paragraph (b)(2)(v)(E) of Rule 17g-7, as adopted, requires the 
NRSRO, in the case of a withdrawal, to classify the reason for the 
withdrawal as either: (1) The obligor defaulted, or the security or 
money market instrument went into default; (2) the obligation subject 
to the credit rating was extinguished by payment in full of all 
outstanding principal and interest due on the obligation according to 
the terms of the obligation; or (3) the credit rating was withdrawn for 
reasons other than those set forth in (1) and (2) above.\838\ These 
sub-classifications parallel, in many respects, the outcomes identified 
in paragraphs (4)(B)(iii), (iv), and (v) of the instructions for 
Exhibit 1 to Form NRSRO discussed above in section II.E.1.b. of this 
release. However, unlike the instructions for Exhibit 1, the final 
amendments do not prescribe standard definitions of default and paid-
off for the purposes of making these classifications in the rating 
histories disclosure. The rating histories disclosure requirement is 
designed to allow investors and other users of credit ratings to 
compare how each NRSRO treats a commonly rated obligor, security, or 
money market instrument. In other words, unlike the production of 
performance statistics where standard definitions are necessary to 
promote comparability of aggregate statistics, the historical rating 
information should indicate on a granular level the differences among 
the NRSROs with respect to the rating actions they take for a commonly 
rated obligor, security, or money market instrument, including their 
differing definitions of default. This will allow investors and other 
users of credit ratings to review, for example, when one NRSRO 
downgraded an obligor to the default category as compared to another 
NRSRO or group of NRSROs. Among other things, investors and other users 
of credit ratings could review the data to identify NRSROs that are 
either quick or slow to downgrade obligors, securities, or money market 
instruments to default. In addition, an NRSRO with a very narrow 
definition of default might continue to maintain a security at a notch 
in its rating scale above the default category when other NRSROs, using 
broader definitions, had classified the security as having gone into 
default. Creating a mechanism to identify these types of variances is a 
goal of the enhancements to the 100% Rule.
---------------------------------------------------------------------------

    \838\ See paragraph (b)(2)(v)(G) of Rule 17g-7.
---------------------------------------------------------------------------

    The Commission believes a default and the extinguishment of an 
obligation because it was paid in full are the most frequently 
occurring reasons for an NRSRO to withdraw a credit rating. As 
discussed above in section II.E.1. of this release, there are other 
reasons an NRSRO might withdraw a credit rating, including that the 
rated obligor or issuer

[[Page 55145]]

of the rated security or money market instrument stopped paying for the 
surveillance of the credit rating or the NRSRO decided not to devote 
resources to continue to perform surveillance on the credit rating on 
an unsolicited basis. However, the withdrawal of credit ratings could 
be used to make performance statistics appear more favorable. 
Consequently, as with the Transition/Default Matrices in Exhibit 1 to 
Form NRSRO, an NRSRO would be required to identify when a credit rating 
was withdrawn for reasons other than default or the extinguishment of 
the obligation upon which the credit rating is based. Similar to the 
Transition/Default Matrices, persons using the rating history 
information could analyze how often an NRSRO withdraws a credit rating 
for other reasons in a class or subclass of credit ratings.
    One NRSRO stated that it does not subdivide withdrawn ratings into 
the subcategories of: (1) Withdrawn due to default; (2) Withdrawn 
because the obligation paid in full; and (3) withdrawn for ``other'' 
reasons.\839\ This NRSRO also stated that since it does not monitor 
withdrawn ratings, it could not certify with confidence that its 
performance statistics include all defaults with respect to withdrawn 
ratings, and requiring such monitoring might constitute regulation of 
the substance of an NRSRO's rating procedures. However, section 
15E(q)(2)(C) of the Exchange Act requires that the Commission's rules 
require the disclosure of performance information for a variety of 
credit ratings, including for credit ratings withdrawn by an 
NRSRO.\840\ As discussed above, the reason an NRSRO withdraws a credit 
rating is important information in terms of assessing the performance 
of an NRSRO's credit ratings. For these reasons, the final amendments 
retain the requirement to classify the reason for the withdrawal. In 
response to comment,\841\ as stated above with respect to the 
amendments to the instructions for Exhibit 1 to Form NRSRO, the 
Commission is clarifying that the amendments as adopted do not require 
NRSROs to monitor withdrawn credit ratings for a period of time after 
withdrawal. A withdrawn credit rating is categorized at the time of 
withdrawal. There is no requirement to update the rating history 
thereafter.
---------------------------------------------------------------------------

    \839\ See Moody's Letter.
    \840\ See 15 U.S.C. 78o-7(q)(2)(C).
    \841\ See Moody's Letter; S&P Letter.
---------------------------------------------------------------------------

    Paragraph (b)(2)(vi) of Rule 17g-7, as proposed, would identify the 
sixth category of data that must be disclosed with a rating action: A 
classification of the class or subclass of the credit rating.\842\ The 
Commission is adopting this paragraph as proposed.\843\ The 
classifications for the classes of credit ratings are based on the 
definition of nationally recognized statistical rating organization in 
section 3(a)(62) of the Exchange Act.\844\ Consequently, the first 
classification is financial institutions, brokers, or dealers.\845\ The 
second classification is insurance companies.\846\ The third 
classification is corporate issuers.\847\
---------------------------------------------------------------------------

    \842\ See paragraph (b)(2)(vi) of Rule 17g-7, as proposed; 
Nationally Recognized Statistical Rating Organizations, 76 FR at 
33542.
    \843\ See paragraph (b)(2)(vi) of Rule 17g-7.
    \844\ See 15 U.S.C. 78o-7(a)(62). This is consistent with how 
the classes of credit ratings are identified for the purposes of the 
performance statistics that must be disclosed in Exhibit 1 to Form 
NRSRO. Compare paragraphs (b)(2)(vi)(A) through (E) of Rule 17g-7, 
with paragraphs (1)(A) through (E) of the instructions for Form 
NRSRO.
    \845\ See paragraph (b)(2)(vi)(A) of Rule 17g-7; 15 U.S.C. 78o-
7(a)(62)(B)(i).
    \846\ See paragraph (b)(2)(vi)(B) of Rule 17g-7; 15 U.S.C. 78o-
7(a)(62)(B)(ii).
    \847\ See paragraph (b)(2)(vi)(C) of Rule 17g-7; 15 U.S.C. 78o-
7(a)(62)(B)(iii).
---------------------------------------------------------------------------

    The fourth classification is issuers of structured finance 
products.\848\ If the credit rating falls into this class, the NRSRO 
must disclose which of the following sub-classifications it falls into: 
RMBS; \849\ CMBS; \850\ CLOs; \851\ CDOs; \852\ ABCP; \853\ other 
asset-backed securities; \854\ or other structured finance 
products.\855\ The sub-classifications are the same subclasses for 
structured finance credit ratings an applicant and NRSRO must use for 
the purposes of the Transition/Default Matrices to be disclosed in 
Exhibit 1 to Form NRSRO.\856\
---------------------------------------------------------------------------

    \848\ See paragraph (b)(2)(vi)(D) of Rule 17g-7; 15 U.S.C. 78o-
7(a)(62)(B)(iv). Consistent with the instructions for Exhibit 1 to 
Form NRSRO, this class of credit rating is broader than the class 
identified in section 15E(a)(62)(B)(iv) of the Exchange Act.
    \849\ See paragraph (b)(2)(vi)(D)(1) of Rule 17g-7. Consistent 
with Exhibit 1 to Form NRSRO, the term RMBS for the purposes of the 
rule means a securitization primarily of residential mortgages.
    \850\ See paragraph (b)(2)(vi)(D)(2) of Rule 17g-7. Consistent 
with Exhibit 1 to Form NRSRO, the term CMBS for the purposes of the 
rule means a securitization primarily of commercial mortgages.
    \851\ See paragraph (b)(2)(vi)(D)(3) of Rule 17g-7. Consistent 
with Exhibit 1 to Form NRSRO, the term CLO for the purposes of the 
rule means a securitization primarily of commercial loans.
    \852\ See paragraph (b)(2)(vi)(D)(4) of Rule 17g-7. Consistent 
with Exhibit 1 to Form NRSRO, the term CDO for the purposes of the 
rule means a securitization primarily of other debt instruments such 
as RMBS, CMBS, CLOs, CDOs, other asset backed securities, and 
corporate bonds.
    \853\ See paragraph (b)(2)(vi)(D)(5) of Rule 17g-7. Consistent 
with Exhibit 1 to Form NRSRO, the term ABCP for the purposes of the 
rule means short term notes issued by a structure that securitizes a 
variety of financial assets (for example, trade receivables or 
credit card receivables), which secure the notes.
    \854\ See proposed paragraph (b)(2)(vi)(D)(6) of Rule 17g-7. 
Consistent with Exhibit 1 to Form NRSRO, the term other asset backed 
security for the purposes of the rule means a securitization 
primarily of auto loans, auto leases, floor plan financings, credit 
card receivables, student loans, consumer loans, equipment loans, or 
equipment leases.
    \855\ See proposed paragraph (b)(2)(vi)(D)(7) of Rule 17g-7. 
Consistent with Exhibit 1 to Form NRSRO, the term other structured 
finance product for the purposes of the rule means a structured 
finance product not identified in the other sub-classifications of 
structured finance products.
    \856\ See paragraphs (b)(2)(vi)(D)(1) through (7) of Rule 17g-7; 
paragraphs (1)(D)(i) through (vii) of the instructions for Exhibit 1 
to Form NRSRO.
---------------------------------------------------------------------------

    The fifth classification is issuers of government securities, 
municipal securities, or securities issued by a foreign 
government.\857\ If the credit rating falls into this class, the final 
amendments require the NRSRO to identify a sub-classification as 
well.\858\ The sub-classifications are the same as the sub-
classifications for this class in the instructions for Exhibit 1 to 
Form NRSRO: (1) Sovereign issuers; (2) U.S. public finance; or (3) 
international public finance.\859\
---------------------------------------------------------------------------

    \857\ See paragraph (b)(2)(vi)(E) of Rule 17g-7; 15 U.S.C. 78o-
7(a)(62)(B)(v).
    \858\ See paragraphs (b)(2)(vi)(E)(1) through (3) of Rule 17g-7.
    \859\ See paragraphs (b)(2)(vi)(E)(1) through (3) of Rule 17g-7; 
paragraphs (1)(E)(i) through (iii) of the instructions for Exhibit 
1.
---------------------------------------------------------------------------

    Paragraph (b)(2)(vii) of Rule 17g-7, as proposed, would identify 
the seventh category of data that must be disclosed with a rating 
action: The credit rating symbol, number, or score in the applicable 
rating scale of the NRSRO assigned to the obligor, security, or money 
market instrument as a result of the rating action or, if the credit 
rating remained unchanged as a result of the action, the credit rating 
symbol, number, or score in the applicable rating scale of the NRSRO 
assigned to the obligor, security, or money market instrument as of the 
date of the rating action.\860\ The NRSRO also would have to indicate 
whether the credit rating is in a default category. The Commission is 
adopting this paragraph as proposed.\861\ The rating symbol, number, or 
score is a key component of the data that must be disclosed as it 
reflects the NRSRO's view of the relative creditworthiness of the 
obligor, security, or money market instrument subject to the rating as 
of the date the action is taken.
---------------------------------------------------------------------------

    \860\ See paragraph (b)(2)(vii) of Rule 17g-7, as proposed; 
Nationally Recognized Statistical Rating Organizations, 76 FR at 
33542.
    \861\ See paragraph (b)(2)(vii) of Rule 17g-7. Because the final 
amendments eliminate rating affirmations from the rating histories, 
this requirement will be triggered only when an NRSRO withdraws a 
credit rating that had not changed.
---------------------------------------------------------------------------

    Paragraph (b)(3) of Rule 17g-7, as proposed, would provide that the 
information identified in paragraph

[[Page 55146]]

(b)(2) of Rule 17g-7 must be disclosed in an interactive data file that 
uses an XBRL format and the List of XBRL Tags for NRSROs as published 
on the Internet Web site of the Commission.\862\ One commenter stated 
that constantly updating the database for the 100% Rule ``would impose 
an unwarranted burden on NRSROs'' and requested that the Commission 
confirm that it may update the database monthly.\863\ The Commission 
agrees that the rule should prescribe a standard timeframe within which 
the XBRL data file must be updated and that the standard should take 
into account the burden of updating the file. Consequently, the final 
amendments provide that the XBRL data file must be updated no less 
frequently than monthly consistent with the commenter's proposal.\864\
---------------------------------------------------------------------------

    \862\ See paragraph (b)(3) of Rule 17g-7, as proposed; 
Nationally Recognized Statistical Rating Organizations, 76 FR at 
33542.
    \863\ See DBRS Letter.
    \864\ See paragraph (b)(3) of Rule 17g-7.
---------------------------------------------------------------------------

    Paragraph (b)(4) of Rule 17g-7, as proposed, would specify when a 
rating action would need to be disclosed by establishing two distinct 
grace periods: Twelve months and twenty-four months.\865\ In 
particular, a rating action would need to be disclosed: (1) Within 
twelve months from the date the action is taken, if the credit rating 
subject to the action was paid for by the obligor being rated or by the 
issuer, underwriter, depositor, or sponsor of the security being rated; 
\866\ or (2) within twenty-four months from the date the action is 
taken, if the credit rating subject to the action is not a rating 
described above.\867\ These separate grace periods are consistent with 
the requirements of the 100% Rule before today's amendments.\868\ 
Commenters expressed opposing views on the appropriate length of the 
grace periods and whether there should be one grace period for all 
NRSROs.\869\ One NRSRO stated that the grace periods are 
``appropriate.'' \870\ Another NRSRO stated that the Commission should 
consider a three-year grace period for rating histories of subscriber-
paid credit ratings.\871\ Two NRSROs were opposed to having two grace 
periods,\872\ and one of these NRSROs stated that there should be an 
eighteen month grace period for all NRSROs ``if the goal is to foster 
comparability among NRSROs.'' \873\ Another commenter was 
``disappointed'' that the Commission was retaining the twelve and 
twenty-four month grace periods, because ``such delay is excessive and 
severely diminishes the usefulness of the information.'' \874\
---------------------------------------------------------------------------

    \865\ See paragraph (b)(4) of Rule 17g-7, as proposed; 
Nationally Recognized Statistical Rating Organizations, 76 FR at 
33542.
    \866\ See paragraph (b)(4)(i) of Rule 17g-7, as proposed.
    \867\ See paragraph (b)(4)(ii) of Rule 17g-7, as proposed.
    \868\ See Amendments to Rules for Nationally Recognized 
Statistical Rating Organizations, 74 FR at 63837-63842 (discussing 
the 100% Rule and the reasons the Commission adopted distinct twelve 
and twenty-four month grace periods).
    \869\ See DBRS Letter; ICI Letter; Kroll Letter; Morningstar 
Letter; S&P Letter.
    \870\ See Morningstar Letter.
    \871\ See Kroll Letter.
    \872\ See DBRS Letter; S&P Letter.
    \873\ See DBRS Letter.
    \874\ See ICI Letter.
---------------------------------------------------------------------------

    The Commission believes that the twelve and twenty-four month grace 
periods strike an appropriate balance between the interests of users of 
credit ratings and the interests of NRSROs with various business 
models.\875\ In particular, the longer grace period for NRSROs 
operating under the subscriber-paid business model is premised on the 
fact that the revenues earned by these NRSROs for their credit rating 
activities are derived largely from subscriptions to access their 
credit ratings and related analyses. NRSROs operating under the issuer-
pay business model earn revenues largely from the fees paid by obligors 
and issuers to determine credit ratings for the obligor as an entity or 
for the issuer's securities or money market instruments. These issuer-
paid credit ratings typically are publicly disclosed. For these 
reasons, subscriber-paid NRSROs would be disproportionately impacted if 
the rating histories disclosure requirement resulted in subscribers 
canceling subscriptions. Consequently, the Commission continues to 
believe the longer twenty-four month grace period is appropriate to 
limit the disproportionate impact on subscriber-paid NRSROs.
---------------------------------------------------------------------------

    \875\ Section 15E(q)(2)(E) of the Exchange Act provides that the 
Commission's rules must require that the credit rating performance 
disclosures are appropriate for various business models of NRSROs. 
See 15 U.S.C. 78o-7(q)(2)(E).
---------------------------------------------------------------------------

    Finally, paragraph (b)(5) of Rule 17g-7, as proposed, would provide 
that an NRSRO may cease disclosing a rating history of an obligor, 
security, or money market instrument no earlier than twenty years after 
the date a rating action with respect to the obligor, security, or 
money market instrument is classified as a withdrawal of the credit 
rating, provided no subsequent credit ratings are assigned to the 
obligor, security, or money market instrument after the withdrawal 
classification.\876\ This proposed requirement was designed to ensure 
that information about credit ratings that are withdrawn for any reason 
would remain a part of the disclosure for a significant period of time. 
Two NRSROs commented on this aspect of the proposal.\877\ One NRSRO 
stated that ten years is sufficient, consistent with the Transition/
Default Matrices in Exhibit 1 to Form NRSRO, and that the Commission 
should perform a cost/benefit analysis of the requirement periodically 
to confirm that the benefits outweigh the costs.\878\ The other NRSRO 
stated that the information would become less useful to investors as 
the volume of information on withdrawn ratings increases.\879\ The 
Commission agrees at this time that a shorter retention period is 
appropriate considering the costs and benefits of retaining rating 
histories with respect to withdrawn ratings. Consequently, the final 
amendments provide that the NRSRO may cease disclosing a rating history 
of an obligor, security, or money market instrument if at least fifteen 
years has elapsed since a rating action classified as a withdrawal of a 
credit rating pursuant to paragraph (b)(2)(v)(E) of Rule 17g-7 was 
disclosed in the rating history of the obligor, security, or money 
market instrument.\880\
---------------------------------------------------------------------------

    \876\ See paragraph (b)(5) of Rule 17g-7, as proposed; 
Nationally Recognized Statistical Rating Organizations, 76 FR at 
33542.
    \877\ See DBRS Letter; S&P Letter.
    \878\ See DBRS Letter.
    \879\ See S&P Letter.
    \880\ See paragraph (b)(5) of Rule 17g-7.
---------------------------------------------------------------------------

4. Economic Analysis
    This section builds on the economic analysis in section I.B. of 
this release by presenting a focused analysis of the potential economic 
effects that may derive from the specific amendments relating to the 
disclosure of information about the performance of credit ratings.\881\ 
The baseline that existed before today's amendments was one in which 
NRSROs were required to make publicly available two types of 
information about the performance of their credit ratings: (1) 
Transition and default statistics; and (2) rating histories for certain 
subsets of the obligors, securities, and money-market instruments that 
they have rated.\882\
---------------------------------------------------------------------------

    \881\ The economic analysis in section I.B. of this release 
discusses the primary economic impacts that may derive from the 
amendments and new rules being adopted today.
    \882\ See Amendments to Rules for Nationally Recognized 
Statistical Rating Organizations, 74 FR at 6483; Amendments to Rules 
for Nationally Recognized Statistical Rating Organizations, 74 FR at 
63864.
---------------------------------------------------------------------------

    Before today's amendments, the instructions for Exhibit 1 required 
the applicant or NRSRO to provide performance statistics for the credit 
ratings of the applicant or NRSRO,

[[Page 55147]]

including performance statistics for each class of credit ratings for 
which the applicant is seeking registration or the NRSRO is registered. 
In addition, the instructions required that the performance statistics 
must, at a minimum, show the performance of credit ratings in each 
class over one-year, three-year, and ten-year periods (as applicable) 
through the most recent calendar year-end, including transition and 
default rates within each of the credit rating categories, notches, 
grades, or rankings used by the applicant or NRSRO. Before today's 
amendments, the instructions for Exhibit 1 did not prescribe the 
methodology to be used to calculate the performance statistics or the 
format in which they must be disclosed; nor did the instructions limit 
the type of information that can be disclosed in the Exhibit. The 
instructions did, however, require an applicant or NRSRO to define the 
credit rating categories, notches, grades, or rankings it used and to 
explain the performance measurement statistics, including the inputs, 
time horizons, and metrics used to determine the statistics. 
Disclosures provided in Exhibit 2, which require a ``general 
description of the procedures and methodologies used'' by the NRSRO in 
determining credit ratings, may have provided additional context for 
comparing the performance statistics of different NRSROs. NRSROs made 
their most recent Forms NRSRO and Exhibits 1 through 9 to the forms 
available on their corporate Internet Web sites, though they were also 
permitted to make the disclosures publicly available through another 
comparable, readily accessible means. They were not required to provide 
Exhibit 1 in writing when requested.
    NRSROs also voluntarily provided additional performance statistics 
in Exhibit 1 or elsewhere on their public Internet Web sites, such as 
transition and default statistics for particular asset sub-classes, 
geographies, or industries, or alternative analyses such as Lorenz 
curves. The voluntary disclosures of such statistics have varied, and 
some NRSROs, particularly larger ones, may have been able to provide 
more supplementary statistics at a granular level because they had more 
credit ratings, over a longer historical period, to analyze.\883\
---------------------------------------------------------------------------

    \883\ See GAO Report 10-782, p. 25.
---------------------------------------------------------------------------

    In characterizing the baseline, it is useful to consider the 
performance statistics disclosed in NRSROs' annual certifications for 
the 2009 calendar year, as reviewed by the GAO in its 2010 report. 
While the disclosures from that year may not be representative of 
current NRSRO practices, they provide insight into NRSRO practices in 
2009 under the rules governing the disclosure of performance statistics 
before today's amendments. Reviewing the 2009 disclosures of the ten 
NRSROs then registered, the GAO found significant differences across 
NRSROs in the computation of performance statistics, which limited 
their comparability.\884\ These differences included, among other 
things: (1) Whether a single cohort approach or an average cohort 
approach was used; (2) whether or not statistics were adjusted to 
exclude withdrawn credit ratings; (3) whether default rates were 
indicated relative to initial credit ratings or credit ratings as of 
the beginning of a given period, and (4) whether default statistics 
were adjusted based on the time to default.\885\ The GAO found that 
five NRSROs did not provide the number of credit ratings in each rating 
category, which made it impossible either to re-calculate more 
comparable statistics or to judge the reliability of the performance 
statistics.\886\ The GAO also found that the asset-backed security 
class of credit ratings may have been too broad for performance 
statistics for this class as a whole to be meaningful.\887\ The GAO 
concluded that ``the disclosure of these statistics has not had the 
intended effect of increasing transparency for users.'' \888\
---------------------------------------------------------------------------

    \884\ See id. at 24.
    \885\ See id. at 27-37. See also id. at 22-23 (``For the 
transition rates, they differed by whether they (1) were for a 
single cohort or averaged over many cohorts, (2) constructed cohorts 
on an annual basis or monthly basis, (3) were adjusted for entities 
that have had their ratings withdrawn or unadjusted, and (4) allowed 
entities to transition to default or not.''); Id. at 30-31 (``NRSROs 
also used different methodologies for calculating default rates. In 
general, default rates differed by whether they were (1) relative to 
ratings at the beginning of a given time period or relative to 
initial ratings, (2) adjusted for entities that had their ratings 
withdrawn or unadjusted, (3) adjusted for how long entities survived 
without defaulting or unadjusted, (4) calculated using annual or 
monthly cohorts, and (5) calculated for a single cohort or averaged 
over many cohorts.'').
    \886\ See GAO Report 10-782, pp. 28, 36.
    \887\ Id. at 36.
    \888\ Id. at 94.
---------------------------------------------------------------------------

    Before today's amendments, the requirements for NRSROs to make 
certain rating histories publicly available (the 10% Rule and the 100% 
Rule) were contained in paragraphs (d)(2) and (d)(3) of Rule 17g-2, 
respectively. The 10% Rule applied only to NRSROs operating under the 
issuer-pays model, and required the disclosure of rating actions for a 
random 10% sample of outstanding credit ratings in each class in which 
an NRSRO was registered and for which the NRSRO had more than 500 
issuer-paid credit ratings outstanding. The 100% Rule applied to all 
NRSROs, and required the disclosure of rating actions for any credit 
ratings initially determined by the NRSRO on or after June 26, 2007. 
Under both rules, the rating action information required to be 
disclosed was consistent with the information required to be retained 
pursuant to paragraph (a)(8) of Rule 17g-2. The rating actions that 
were required to be included in the histories were initial ratings, 
upgrades, downgrades, placements on credit watch, and withdrawals, and 
the information required to be disclosed for each such rating action 
was the rating action, date of the action, the name of the security or 
obligor, and, if applicable, the CUSIP of the security or CIK number of 
the obligor. The 10% Rule included a six-month grace period after 
ratings actions were taken before disclosure was required, while the 
100% Rule included a twelve-month grace period for issuer-paid credit 
ratings and a twenty-four-month grace period for all other credit 
ratings. NRSROs made the required rating histories publicly available 
on their corporate Internet Web sites.
    In characterizing the baseline, it is useful to consider, as in the 
case of performance statistics, the conclusions of the GAO in its 2010 
report with respect to the disclosure of rating histories by NRSROs. 
While the disclosures from that period may not be representative of 
current NRSRO practices, the GAO study provides insight into NRSRO 
practices at the time of the report and into the limitations of the 10% 
Rule and 100% Rule before today's amendments. The GAO stated its view 
that the rating histories provided at that time could not be used to 
generate reliable performance statistics because, among other things: 
(1) The 10% samples were being generated in ways that did not make them 
representative of the total population of credit ratings produced by 
the NRSROs; (2) the 100% samples were also unrepresentative, because, 
for example, they were missing the issuer credit ratings of many major 
American corporations because these credit ratings were initiated 
before 2007; (3) the data fields provided were insufficient; and (4) 
not all NRSROs disclosed defaults in these histories.\889\ The GAO also 
stated,

[[Page 55148]]

in explaining why the 10% and 100% samples were unrepresentative of the 
universe of credit ratings, that these samples were not required to 
include credit ratings that had been withdrawn in prior periods, 
leading to a sample in which cases of defaults would be 
underrepresented.\890\ The GAO concluded that it was unlikely that the 
required rating histories could be used to generate performance 
measures and studies to evaluate and compare NRSRO performance.\891\
---------------------------------------------------------------------------

    \889\ See GAO Report 10-782, p. 40-46 (stating, for example, 
with respect to the 10% samples, that the GAO ``could not use these 
samples to generate reliable performance statistics for the NRSROs, 
as the rule intended, for the following reasons: (1) The data fields 
the NRSROs included in their disclosures were not always sufficient 
to identify complete ratings histories for the rated entities 
comprising each sample, (2) the data fields did not always give us 
enough information to identify specific types of ratings for making 
comparisons, (3) the data fields did not always give us enough 
information to identify the beginning of the ratings histories in 
all of the samples, (4) SEC rules do not require the NRSROs to 
publish a codebook or any explanation of the variables used in the 
samples, (5) not all NRSROs are disclosing defaults in the ratings 
histories provided as part of their 10 percent samples, and (6) SEC 
guidance to the NRSROs for generating the random samples does not 
ensure that the methods used will create a sample that is 
representative of the population of credit ratings produced by each 
NRSRO.'').
    \890\ See GAO Report 10-782, p. 46.
    \891\ See id. at 95.
---------------------------------------------------------------------------

    Relative to the baseline, the amendments to the instructions for 
Exhibit 1 to Form NRSRO, Rule 17g-1, Rule 17g-2, and Rule 17g-7 with 
respect to the disclosure of performance statistics and rating 
histories should result in benefits for users of credit ratings. The 
amendments, which implement the provisions of section 15E(q) of the 
Exchange Act and, as discussed in sections II.E.1. and II.E.3. of this 
release, took into account findings by the GAO, should result in 
performance statistics that are more directly comparable across NRSROs 
and ratings histories that are more useful for performance analyses 
than those provided under the baseline requirements.\892\ To the extent 
that the new disclosures therefore facilitate the evaluation of the 
performance of an NRSRO's credit ratings and comparisons of rating 
performance across NRSROs--including direct comparisons of different 
NRSROs' treatment of the same obligor or instrument--the amendments may 
benefit users of credit ratings by allowing them to better assess the 
reliability and information content of credit ratings from different 
NRSROs and, in the case of subscriber-paid credit ratings, make more 
informed decisions regarding whether to subscribe to the credit ratings 
of particular NRSROs.
---------------------------------------------------------------------------

    \892\ While the amendments are designed to facilitate 
comparisons across NRSROs, differences in the meanings of the credit 
ratings of different NRSROs and in the procedures and methodologies 
they use to determine credit ratings will likely influence the 
ability to make perfect comparisons. For example, there is 
variability across NRSROs with respect to the information that is 
reflected in a credit rating. See, e.g., S&P Letter; GAO Report 10-
782, p. 37-39. Some credit ratings, for example, reflect relative 
assessments of the likelihood an obligor or issuer will default on 
the ``first dollar'' owed, whereas other credit ratings also reflect 
the expected loss in the case of default. In interpreting the 
performance statistics and rating histories, users of credit ratings 
may thus need to account for additional contextual information, such 
as the general description of the procedures and methodologies used 
by the NRSRO to determine credit ratings required to be disclosed in 
Exhibit 2, in order to understand the limits to the comparability of 
the disclosures.
---------------------------------------------------------------------------

    Specifically, the amendments to the instructions for Exhibit 1 
requiring a standardized calculation of performance statistics--using 
specified definitions and the single cohort approach--to be presented 
in a standardized format and specifying that an applicant or NRSRO must 
not disclose information in the Exhibit that is not required to be 
disclosed are expected to result in simpler, more standardized 
disclosures relative to the disclosures produced under the baseline 
requirements. Moreover, the single cohort approach involves simpler 
computations than other approaches, so it may be easier for users of 
credit ratings to understand how the statistics were produced. Also, 
requiring all NRSROs to use the single cohort approach ensures that the 
cohorts being analyzed will be aligned across NRSROs, increasing the 
comparability of the statistics versus other computation methods (such 
as the average cohort approach). The amendments therefore may allow 
users of credit ratings, including users with a wide range of 
sophistication, to more readily compare the performance of credit 
ratings of different NRSROs than they could previously. The new 
requirement to divide the class of issuers of asset-backed securities 
into subclasses and the requirement to separately disclose the number 
of credit ratings that are withdrawn because the obligation has been 
paid in full, because the obligor defaulted, and for other reasons, as 
well as to report the total number of credit ratings in the start-date 
cohort in each category, should provide users of credit ratings with 
additional information that may help them better interpret the 
transition and default rates for the purpose of evaluating and 
comparing performance.\893\
---------------------------------------------------------------------------

    \893\ While the standard definition of default is intended to 
facilitate comparisons across NRSROs, there may continue to be 
differences across NRSROs in the identification of defaults in the 
performance statistics which may reduce somewhat the comparability 
of these statistics. When an event occurs that does not meet the 
standardized definition of default in Exhibit 1, it may still be 
categorized as a default by an NRSRO under its own definition of 
default, which is incorporated into the Exhibit 1 definition. In 
interpreting the performance statistics, users of credit ratings may 
thus need to account for additional contextual information such as 
the new requirement to ``clearly explain'' the usage of the term 
default directly after the performance statistics.
---------------------------------------------------------------------------

    In addition, the new requirements that expand the scope of credit 
ratings that must be included in the rating histories should, over 
time, generate databases that will include a comprehensive sample of 
rating actions (in contrast to the data disclosed under the baseline 
requirements). The databases also will include information about 
cohorts of credit ratings beyond those reflected in the performance 
statistics disclosed in Exhibit 1. Thus, the enhanced rating histories 
can be used to generate alternative statistics for evaluating and 
comparing NRSRO performance, including certain transition and default 
statistics using average cohort approaches (though, as discussed below, 
these statistics will likely be based on fewer cohorts than were used 
by NRSROs that disclosed performance statistics in Exhibit 1 using the 
average cohort approach before today's amendments). Because the data 
will be more comprehensive than that disclosed in the baseline, it 
should also be more likely, relative to the baseline, that rating 
histories of different NRSROs with respect to the same obligor or 
instrument will be available. Therefore, users of credit ratings should 
have more opportunities to directly compare and analyze different 
NRSROs' treatment of the same obligor or instrument over time. The 
requirements regarding the enhanced data fields to be included with a 
rating action should make any analyses using the rating histories more 
practicable than was the case with the more limited data fields 
produced under the baseline requirements.\894\
---------------------------------------------------------------------------

    \894\ There may be differences across NRSROs in the 
identification of defaults and paid off obligations in the rating 
histories which reduce somewhat the comparability of this data 
across NRSROs, since the amendments do not prescribe definitions of 
these terms for the purpose of the rating histories. In interpreting 
the rating histories, users of credit ratings may thus need to 
account for additional contextual information such as the new 
requirement to ``clearly explain'' the conditions under which an 
NRSRO classifies obligors, securities, or money market instruments 
as being in default after the performance statistics presented in 
Exhibit 1.
---------------------------------------------------------------------------

    However, the benefits of the amendments in facilitating the 
evaluation and comparisons of NRSROs may be constrained by limits on 
the information required by the final rules, which, as discussed in 
this section, are intended to reduce the burdens on NRSROs resulting 
from the amendments and, with respect to the performance statistics, 
make them easier for users of credit ratings to understand how the 
statistics were produced. For example,

[[Page 55149]]

while mandating that only single cohort statistics be presented fosters 
comparability, the resulting disclosures will present the performance 
of only three particular cohorts of credit ratings (beginning one, 
three, and ten years prior to the end of the fiscal year). These 
statistics therefore may be subject to substantial volatility, 
particularly for NRSROs with fewer credit ratings.\895\ The fact that 
the credit ratings of particular NRSROs may be more heavily weighted 
towards particular industries, geographies, or other sectors that might 
experience more defaults or other changes in creditworthiness over a 
particular measurement period also may exacerbate volatility in their 
performance statistics and make it difficult to separate differences in 
NRSRO performance from the effects of recent conditions.\896\ NRSROs 
are only required to provide their current Form NRSRO on their Web 
sites, so users of credit ratings may not have access to previous Forms 
NRSRO in order to consider the cohorts analyzed in these other 
years.\897\
---------------------------------------------------------------------------

    \895\ Averages over a smaller sample size are more susceptible 
to being skewed by individual extreme data points. See also DBRS 
Letter (stating that ``results will be significantly more volatile 
within the shorter time period, which will make interpreting those 
results more difficult'' and that ``the volatility impact will be 
amplified for NRSROs with fewer ratings'').
    \896\ A particular industry, geography, or other sector of the 
market may experience a period of poor performance common to all 
issuers and securities in that group, resulting in high default 
rates in that period. Economy-wide default rates are likely to be 
less volatile than the default rates for these individual groups 
since they reflect an average across many such groups, which may 
face downturns at different times. Thus, when considering 
performance over a short period, as in the case of the single cohort 
approach, the performance of NRSROs that focus on fewer industries, 
geographies, or other sectors may be skewed by any recent extremes 
in performance experienced by these sectors, leading to more 
volatile performance statistics. When such NRSROs are compared to 
other NRSROs, it may be difficult to interpret whether differences 
in their single cohort performance statistics may be due to the 
recent performance of the sectors they focus on or whether they 
reflect differences in the ability of the NRSROs to produce accurate 
ratings.
    \897\ In the future, users of credit ratings will have access to 
certain previous Forms NRSRO, including Exhibits 1 through 9 to 
these Forms. As discussed below in section II.L. of this release, 
the amendments to Rule 101 of Regulation S-T will require an NRSRO 
to submit Form NRSRO and Exhibits 1 through 9 to the Form 
electronically through the EDGAR system. Submission through the 
EDGAR system will maintain the public availability of a Form NRSRO 
even after updated versions are submitted.
---------------------------------------------------------------------------

    The rating histories may be helpful to users of credit ratings in 
addressing the limitations of the performance statistics both in that 
information about many additional cohorts may be available and also 
through the ability to directly compare NRSRO performance with respect 
to the same obligor or instrument. Such direct comparisons should not 
be skewed by the industry or sector focus of a given NRSRO. However, 
the final rules require only one or two years of history to be 
disclosed initially, depending on the applicable grace periods, so the 
benefits of these histories will be delayed until the histories grow to 
a length suitable for analysis. Also, as discussed below, even as data 
for additional years becomes available, the ability of NRSROs to remove 
a rating history from the data file fifteen years after the credit 
rating is withdrawn will limit the amount of historical information in 
the data file and, therefore, limit analyses by users of credit ratings 
that require a representative sample of credit ratings over an extended 
period of time. On the other hand, users of credit ratings that are 
interested in comparing NRSRO performance over time with respect to the 
same obligor or instrument should not face the same limitation and, 
therefore, should be able to take advantage of the full length of 
histories provided under the amendments.
    A potential consequence of selecting one approach to be used for 
purposes of the Exhibit 1 disclosures is that it may impact the 
disclosures NRSROs make using other approaches. For example, even 
though the amendments require NRSROs to use the single cohort approach, 
NRSROs may continue on a voluntary basis to provide, not directly in 
Exhibit 1 but by reference to an Internet Web site address in this 
exhibit, disclosures of additional performance statistics such as 
statistics using the average cohort approach. These supplementary 
statistics may address some of the aforementioned limitations of 
statistics using the single cohort approach in that they may provide 
users of credit ratings with information about many more cohorts of 
credit ratings. However, NRSROs that previously disclosed average 
cohort statistics to fulfill their Exhibit 1 requirements might not 
continue to report these statistics voluntarily or might report them in 
an even less standardized fashion than previously (for example, for 
performance periods different from the one-year, three-year, and ten-
year periods required in Exhibit 1). Importantly, NRSROs might be less 
likely to voluntarily disclose such additional statistics when they do 
not compare favorably to the performance of competitors.
    The amendments may result in other benefits to users of credit 
ratings and NRSROs by enhancing accountability, competition, and 
efficiency. As has been widely documented, the most common NRSRO 
business model--the issuer-pay revenue model--creates an inherent 
conflict of interest.\898\ Given this conflict, and because the demand 
for an NRSRO's credit ratings depends on its reputation for producing 
credit ratings of high quality, reputation is thought to play a 
particularly important disciplinary role in this industry.\899\ To the 
extent that the amendments facilitate the external monitoring and 
comparative analysis of NRSROs, they may allow users of credit ratings 
to develop more refined views of NRSRO performance and thereby 
indirectly increase accountability and encourage integrity in the 
production of credit ratings, since NRSROs should have the incentive to 
maintain reputations for producing credit ratings of high quality in 
order to remain competitive. More comparable performance data also may 
help smaller NRSROs and new and recent entrants into the industry, 
including subscriber-paid NRSROs, to attract attention to their track 
records of issuing and monitoring credit ratings. If they produce track 
records comparable or superior to those of other NRSROs, this could 
enhance their ability to develop a reputation for producing high 
quality credit ratings. Such a reputation may allow them to better 
compete with more established competitors. The enhanced ability of 
users of credit ratings to evaluate the performance of NRSROs also may 
increase their ability to accurately interpret the information conveyed 
by credit ratings, potentially resulting in more efficient investment 
decisions. Market efficiency could also improve if this information is 
reflected in asset prices.\900\
---------------------------------------------------------------------------

    \898\ See, e.g., Lawrence White, Markets: The Credit Rating 
Agencies, J. of Economic Perspectives (Spring 2010), Volume 24, 
Number 2, p. 211-226.
    \899\ See, e.g., Jerome Mathis, James McAndrews, and Jean-
Charles Rochet, Rating the Raters: Are Reputation Concerns Powerful 
Enough to Discipline Rating Agencies?, J. of Monetary Economics 
(July 2009), p. 657-674; Lawrence White, Markets: The Credit Rating 
Agencies, J. of Economic Perspectives (Spring 2010), Volume 24, 
Number 2, p. 211-226; Daniel M. Covitz and Paul Harrison, Testing 
Conflicts of Interest at Bond Rating Agencies with Market 
Anticipation: Evidence that Reputation Incentives Dominate, Federal 
Reserve Board (Dec. 2003), available at http://www.federalreserve.gov/pubs/feds/2003/200368/200368pap.pdf.
    \900\ See section I.B.3. of this release (providing a broader 
discussion of the potential impacts of the amendments and new rules 
on efficiency, competition, and capital formation).
---------------------------------------------------------------------------

    The amendments to Rule 17g-1 and Rule 17g-7 requiring that these 
disclosures be published on an ``easily accessible'' portion of the 
NRSRO's Internet Web site could result in incremental benefits relative 
to the baseline. As mentioned above, the Commission agrees with 
commenters

[[Page 55150]]

that the disclosures would be on an ``easily accessible'' portion of an 
NRSRO's Internet Web site if they could be accessed through a clearly 
and prominently labeled hyperlink labeled ``Regulatory Disclosures'' on 
the homepage of the Web site. Some NRSROs may already provide Form 
NRSRO, Exhibits 1 through 9 to the form, and rating histories in such a 
location. However, to the extent that these amendments result in NRSROs 
moving the disclosures to a more prominent location on their Internet 
Web sites to fulfill the requirement that they be ``easily 
accessible,'' they may incrementally assist users of credit ratings in 
locating these disclosures. Requiring that Exhibit 1 be made available 
in writing when requested may benefit any users of credit ratings who 
do not have access to the Internet.
    Relative to the baseline, the amendments with respect to the 
disclosure of performance statistics and rating histories will impose 
costs on applicants and NRSROs. In particular, while all NRSROs 
currently disclose transition and default rates, the content and 
presentation of these performance statistics differ, to varying 
degrees, from the information required and the format prescribed by the 
rules. The revised requirements therefore will require the initial 
collection and analysis of certain additional historical data (for 
example, whether issuers or instruments defaulted under the standard 
definition) as well as changes in systems and procedures to collect and 
present this information according to the amendments going forward. The 
Commission's estimates of these costs--which are based on analyses for 
purposes of the PRA--are provided below.
    Two NRSROs have commented that, in some cases, collecting certain 
historical information would require substantial cost or could be 
impossible.\901\ The historical information required for the transition 
and default statistics which NRSROs may not have stored (or stored in a 
readily retrievable format) consists of, over a ten year history, the 
more detailed categorization of any withdrawn credit ratings and the 
assignment of credit ratings in the asset-backed securities class into 
sub-classes. As discussed above, the Commission has modified the 
amendments to reduce the amount of historical information that may need 
to be retrieved with respect to withdrawn credit ratings. In 
particular, the amendments provide that, except in the case of the 
asset-backed securities class of credit ratings, the transition and 
default statistics must include only credit ratings assigned to an 
obligor as an entity or, if there is no such credit rating, the credit 
rating of the obligor's senior unsecured debt, instead of all credit 
ratings of securities or money-market instruments in the respective 
class or subclass. The Commission has also revised the standard 
definition of paid off to eliminate the prong that applied to credit 
ratings of obligors as entities. Because the Commission has narrowed 
the scope of the credit ratings that must be included in the 
performance statistics for four of the five classes of credit ratings, 
and has revised the standard definition of paid off so that it does not 
apply to entity credit ratings, the cost of categorizing historical 
withdrawals based on the standard definitions of default and paid off 
and withdrawals for other reasons should be substantially reduced. The 
modifications from the proposal should therefore mitigate concerns to 
some degree about having to obtain information that was not 
traditionally retained by the NRSRO because it will significantly 
narrow the scope of such information that will need to be collected in 
order to calculate the performance statistics. While the Commission 
believes that these modifications may substantially reduce the amount 
of historical data to be collected, an NRSRO can seek exemptive relief 
from the Commission under section 36 of the Exchange Act.
---------------------------------------------------------------------------

    \901\ See, e.g., Moody's Letter (stating that collecting certain 
data for past rating actions would have to be done manually); S&P 
Letter (stating that ``it may not be possible to track'' the 
distinction between ratings withdrawn for different reasons 
``retroactively'').
---------------------------------------------------------------------------

    The costs of the compliance efforts described above should vary 
across NRSROs due to: (1) Differences in the quantity of credit ratings 
they issue and the number of classes of credit ratings for which they 
issue credit ratings; (2) differences in terms of how their disclosures 
under the baseline requirements compare to the disclosures required 
under the amendments; (3) differences with respect to the historical 
information they currently store in a readily-retrievable format; (4) 
differences in the number of past years and number of historical credit 
ratings for which additional historical information will need to be 
collected; and (5) differences in the design and flexibility of their 
information systems. However, based on analysis for purposes of the 
PRA, the Commission estimates that the amendments to Exhibit 1 to Form 
NRSRO will result in total industry-wide one-time costs to NRSROs of 
approximately $737,000 and total industry-wide annual costs to NRSROs 
of approximately $295,000.\902\
---------------------------------------------------------------------------

    \902\ See section V.E. of this release (discussing 
implementation and annual compliance considerations). The one-time 
and annual costs are determined by monetizing internal hour burdens 
and adding external costs identified in the PRA analysis in section 
IV.D.2. of this release.
---------------------------------------------------------------------------

    Under the amendments to paragraph (i) of Rule 17g-1, NRSROs are 
required to make Form NRSRO and Exhibits 1 through 9 freely available 
on an easily accessible portion of their corporate Internet Web site 
and to provide a paper copy of Exhibit 1 to individuals who request a 
paper copy. NRSROs may need to re-configure their corporate Internet 
Web sites to comply with the amendments and will need to establish 
procedures and protocols for processing requests for a paper copy. 
Based on analysis for purposes of the PRA, the Commission estimates 
that the amendments to paragraph (i) of Rule 17g-1 will result in total 
industry-wide one-time costs to NRSROs of approximately $150,000 and 
total industry-wide annual costs to NRSROs of approximately 
$121,000.\903\
---------------------------------------------------------------------------

    \903\ See section V.E. of this release (discussing 
implementation and annual compliance considerations). The one-time 
and annual costs are determined by monetizing internal hour burdens 
and adding external costs identified in the PRA analysis in section 
IV.D.1. of this release.
---------------------------------------------------------------------------

    The amendments to the instructions for Exhibit 1 also may result in 
other costs to NRSROs. For some NRSROs, it is possible that using only 
the single cohort approach to produce the performance statistics in 
Exhibit 1 may lead users of credit ratings to misinterpret their 
performance, negatively impacting competition in the industry. 
Specifically, as discussed above, the single cohort approach will 
produce statistics about three particular cohorts of credit ratings and 
may thus be subject to volatility. Further, the statistics may be 
particularly volatile for certain NRSROs, such as those that have a 
small number of credit ratings in a given start date cohort or those 
that focus on particular industries, geographies, or other sectors 
within a class of credit ratings. The requirements of the final 
amendments (that is, showing the number of credit ratings in the start 
date cohort) are designed to provide persons reviewing the statistics 
with sufficient information to readily assess the impact that a small 
number of credit ratings can have on the statistics. Also, the 
disclosure of ratings histories should permit more refined comparisons 
of performance in cases where differences in performance statistics may 
reflect differences in the universe of obligors or instruments rated

[[Page 55151]]

by NRSROs. However, some persons reviewing the transition and default 
rates could inappropriately view the volatility resulting from such 
factors unfavorably, potentially disadvantaging these NRSROs relative 
to the baseline to the extent that their reputation for producing 
quality credit ratings is negatively affected. The competitive position 
of small NRSROs may be further disadvantaged by the burden associated 
with establishing systems to produce the statistics, since this cost 
may not depend on the number of credit ratings in the start-date 
cohorts and thus may result in a higher relative burden for small 
NRSROs.\904\
---------------------------------------------------------------------------

    \904\ See section I.B.3. of this release (providing a broader 
discussion of the potential impacts of the amendments and new rules 
on efficiency, competition, and capital formation).
---------------------------------------------------------------------------

    Under the baseline requirements, NRSROs publicly disclosed certain 
rating histories data to fulfill the requirements of the 10% Rule and 
the 100% Rule, but the sample of credit ratings subject to the 
disclosure, the rating actions disclosed, the extent of the histories, 
and the included data fields differ, to varying degrees, from those 
required by the amendments. The amendments may thus require NRSROs to 
add more rating histories to their disclosures because in contrast to 
the baseline requirements the amendments: (1) Apply to all credit 
ratings outstanding as of the specified date or initiated thereafter 
rather than a random sample of credit ratings; (2) do not exclude 
credit ratings that were outstanding as of the specified date but 
initiated before June 26, 2007; and (3) require the rating histories of 
withdrawn ratings to be retained in the file for fifteen years. Also, 
the amendments will require NRSROs to revise which rating actions are 
included and to provide more information about each rating action in 
the rating histories. NRSROs initially will have to collect additional 
historical data and edit the history files to meet these requirements. 
Some of the required information which might not have been collected 
previously--such as the categorization of credit ratings in the asset-
backed securities class into sub-classes--will be retrieved in the 
process of complying with the amended instructions for Exhibit 1 to 
Form NRSRO discussed above. NRSROs also will have to reprogram existing 
systems and make changes in procedures to collect and upload the 
information according to the amendments going forward. NRSROs may have 
to make changes to their corporate Internet Web sites to disclose the 
information on an ``easily accessible'' portion of their Web sites, 
though the incremental changes required beyond the Web site changes to 
disclose Form NRSRO discussed above may be minimal. On an ongoing 
basis, the cost of the procedures required to update the rating 
histories files at least monthly may exceed the annual burden 
previously imposed by the 10% Rule (which is being repealed) and the 
100% Rule before today's amendments, given the comprehensive nature of 
the data required. The Commission's estimates of these costs--which are 
based on analyses for purposes of the PRA--are provided below.
    One commenter stated that the Commission ``substantially 
underestimated the costs'' of the proposed amendments to the 100% Rule 
in the proposing release.\905\ Two other commenters raised concerns 
that retrieving the required historical data would require substantial 
cost or could be impossible.\906\ The Commission acknowledges that the 
amendments will impose significant costs on NRSROs, and has modified 
the proposal in a number of ways to mitigate costs. First, the final 
amendments eliminate the requirement to include information for all 
credit ratings outstanding on June 26, 2007, and replace it with a 
standard three-year backward-looking requirement that applies 
irrespective of when the NRSRO is registered in a class of credit 
ratings. This should significantly reduce the costs of retrieving and 
analyzing historical information for the purposes of making the rating 
histories disclosures. Further, the final amendments eliminate two 
types of rating actions that would trigger a requirement to add 
information to a credit rating's history: Placements of the credit 
rating on watch or review and affirmations of the credit rating. This 
may further reduce the cost of retrieving the historical information 
that must be disclosed in the rating histories, since a record of an 
affirmation of the credit rating may not previously have been stored 
(or stored in a readily retrievable format) by NRSROs. Consequently, 
because of these modifications, NRSROs should not need to perform 
analyses to identify historical affirmations and reconstruct the 
information that would need to have been disclosed under the proposal 
in connection with each affirmation of the credit rating (for example, 
the date of the action). The remaining information that is required to 
be disclosed, but may not have been systematically stored by NRSROs 
previously (such as the required categorization of the reason for a 
withdrawal), generally will need to be collected only once for each 
rating history rather than for multiple rating actions within a 
history, as each rating history should, for example, have only one 
withdrawal (whereas a history could have multiple affirmations of the 
credit rating). The narrowing of the scope of the types of rating 
actions that are required to be included in the rating histories also 
should reduce the burden of updating the XBRL data file with new 
information in the future. While the Commission believes the 
modifications discussed above may substantially reduce the costs of 
retrieving historical data, an NRSRO can seek exemptive relief from the 
Commission under section 36 of the Exchange Act. The amendments also 
specify a standard for updating the file--no less frequently than 
monthly. This should mitigate concerns that the file would need to be 
updated more frequently. Finally, the final amendments modify the 
proposal to reduce the time period a credit rating history must be 
retained after the credit rating is withdrawn from twenty years to 
fifteen years. This should reduce the data retention and maintenance 
costs associated with the amendments compared to the proposal.
---------------------------------------------------------------------------

    \905\ See DBRS Letter.
    \906\ See, e.g., Moody's Letter (stating that collecting certain 
data for past rating actions would have to be done manually and 
``would require tens of thousands of hours of analysis''); S&P 
Letter (stating that ``it may not be possible to track'' the 
distinction between ratings withdrawn for different reasons 
``retroactively'').
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    The costs of the compliance efforts described above with respect to 
the amended requirements for disclosing rating histories should vary 
across NRSROs due to: (1) Differences in the quantity of credit ratings 
they issue and have issued in the historical years subject to 
disclosure; (2) differences in the data fields that they currently 
include in their rating histories; (3) differences with respect to the 
historical information they currently store in a readily-retrievable 
format; and (4) differences in the design and flexibility of their 
information systems. However, based on analysis for purposes of the 
PRA, the Commission estimates that the amendments to Rule 17g-2 and 
paragraph (b) of Rule 17g-7 will result in total industry-wide one-time 
costs to NRSROs of approximately $393,000, and total industry-wide 
annual costs to NRSROs of approximately $131,000.\907\
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    \907\ See section V.F. of this release (discussing 
implementation and annual compliance considerations). The one-time 
and annual costs are determined by monetizing internal hour burdens 
and adding external costs identified in the PRA analysis in section 
IV.D.6. of this release.
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    One commenter stated that the proposed amendments ``may force 
NRSROs to incur increased licensing

[[Page 55152]]

costs to add new CUSIP data.'' \908\ The CUSIP Global Services' license 
fees may vary based on the level of usage (that is, the number of 
CUSIPs databased and the licensees' business lines and regions of 
operation where the data will be used) and the form of usage (such as 
the internal databasing of CUSIP data or the distribution of CUSIP 
data).\909\ The Commission believes that most NRSROs already have 
licensing agreements in place for their current usage of CUSIP data, 
but it is possible that these baseline licensing agreements may need to 
be expanded given the additional CUSIP data that may have to be stored 
and disclosed to comply with the amendments. The comment letter that 
highlighted these potential costs did not provide an estimate of these 
costs and did not provide data or analysis that would allow the 
Commission to estimate how NRSROs' CUSIP licenses would need to be 
changed to account for the new requirements.\910\ Without information 
about the scope of the NRSROs' current licenses and the cost of 
obtaining updated licenses, it is not feasible for the Commission to 
develop an estimate of any such costs.\911\
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    \908\ See DBRS Letter (``Expanding the ratings history universe, 
may also force NRSROs to incur increased licensing costs to add new 
CUSIP data. Any such costs should be factored into the Commission's 
cost-benefit analysis of this proposal.'').
    \909\ Information about CUSIP licenses is available at http://www.cusip.com/cusip/cgs-license-fees.htm.
    \910\ See DBRS Letter.
    \911\ CUSIP Global Services does provide some information about 
potential license fees on its public Web site, but explicitly states 
that the disclosed fee schedule does not apply to ``information 
providers, whose fees for their own usage and redistribution of CGS 
data are calculated using a different pricing model.'' The Web site 
also states that the ``[f]inal determination of fees is at the 
judgment of CGS and consideration will be given to aspects of a 
customer's profile.'' See http://www.cusip.com/cusip/cgs-license-fees.htm.
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    Another potential cost to NRSROs is the potential loss of revenue 
from the sale of access to historical ratings data, as more of this 
data becomes publicly available. The Commission understands that 
revenue from this source may be significant for certain NRSROs, though 
commenters did not provide data or analysis that would allow the 
Commission to estimate the amount of revenue that could be lost.\912\ 
The Commission is unable to estimate the revenue attributable to the 
sale of access to historical ratings data from other sources because 
the information about NRSRO revenues available to the Commission is not 
broken down at this level of granularity and, in practice, access to 
such historical data may be bundled with access to analytical tools and 
other services. This potential loss of revenue may be mitigated by the 
grace periods before disclosure, the fact that historical information 
before the three-year look-back period is not required to be disclosed, 
the exclusion of placements on credit watch and affirmations from the 
rating actions that must be disclosed in the public rating 
histories,\913\ and the ability to remove a rating history from the 
public data file fifteen years after the credit rating is withdrawn. 
However, it is difficult to predict how subscribers will react to the 
change in the extent of publicly available data.
---------------------------------------------------------------------------

    \912\ See, e.g., Fitch Letter.
    \913\ For example, as discussed below, academic research 
suggests that placements on credit watch are significant information 
events, so some users of credit ratings may value information about 
historical NRSRO usage and timing of placements on credit watch.
---------------------------------------------------------------------------

    Because any such losses in revenue likely would disproportionately 
affect NRSROs that are more dependent on revenue from selling access to 
historical ratings data, and particularly NRSROs that operate on the 
subscriber-pay model, the disclosure requirement may disadvantage these 
NRSROs to the detriment of competition in the industry. Additional 
impacts on competition may result from the disproportionate burden on 
small NRSROs, given that some of the compliance costs are not likely to 
vary with size, and on NRSROs that have systems and data collection 
procedures that vary the most from the requirements of the amendments.
    In addition to these effects, the amendments may affect capital 
formation. Some academic research indicates that credit rating agencies 
should not focus exclusively on ratings accuracy, but also should 
consider the feedback effects of their credit ratings on the 
probability of survival of an issuer.\914\ Specifically, these theories 
suggest that if credit ratings can directly affect the default 
probability of an issuer, such as when a ratings downgrade itself makes 
it harder or more costly for a company to raise funds, then it may be 
optimal for credit rating agencies to delay credit rating downgrades in 
order to lessen the impact of such feedback on the company's prospects. 
If the adopted rules drive increased transparency with respect to 
performance, and this leads to pressures on NRSROs to assign more 
accurate credit ratings by making earlier downgrades, the amplified 
feedback effects could increase the default frequencies of issuers and 
other obligors.\915\
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    \914\ See, e.g., Gustavo Manso, Feedback Effects of Credit 
Ratings, J. of Financial Economics (2013), Volume 109, p. 535-548.
    \915\ See section I.B.3. of this release (providing a broader 
discussion of the potential impacts of the amendments and new rules 
on efficiency, competition, and capital formation).
---------------------------------------------------------------------------

    The Commission has considered the costs and benefits of reasonable 
alternatives relative to today's amendments, including certain 
alternatives that have been raised by commenters and discussed above. 
One NRSRO requested that the Commission provide ``fuller background'' 
on decisions such as the determination to require the single cohort 
approach rather than an average cohort approach for performance 
statistics, with a description of potential benefits and limitations of 
those decisions.\916\ As an alternative to the single cohort approach, 
the Commission could have required NRSROs to use the average cohort 
approach, or to present two sets of statistics using the average and 
single cohort approaches respectively, as suggested by commenters.\917\ 
Statistics generated using the average cohort approach would provide 
information to users of credit ratings that is not available from 
statistics generated using the single cohort approach, specifically 
with regard to how credit ratings perform on average across a wider 
variety of economic conditions. Such information may be of use to users 
of credit ratings in evaluating and comparing the performance of 
NRSROs. However, variation in the length of histories available at the 
different NRSROs makes it difficult to produce a standardized 
methodology for computing average cohort statistics that would be 
comparable across NRSROs. Also, because the single cohort approach 
requires simpler calculations, it may be less burdensome for NRSROs to 
produce such statistics and easier for less sophisticated investors to 
understand how such performance measurement statistics were produced. 
As discussed above, NRSROs will continue to be permitted to present 
alternative statistics on a voluntary basis on their public Web sites, 
and by reference to a URL in Exhibit 1.
---------------------------------------------------------------------------

    \916\ See Kroll Letter.
    \917\ See CFA/AFR Letter; DBRS Letter.
---------------------------------------------------------------------------

    A second alternative with respect to the performance statistics 
would be to require the disclosure of withdrawn credit ratings, without 
requiring that this category be separated into credit ratings that were 
withdrawn because the related obligation was paid off, because the 
obligor defaulted, or for other reasons. This alternative would be less 
burdensome than the approach in the amendments, because, as discussed 
by

[[Page 55153]]

two commenters,\918\ NRSROs that have not tracked this information 
historically likely would incur costs to collect the required 
information retroactively and change their systems to collect and 
report this information going forward. However, given that an applicant 
or NRSRO could withdraw a credit rating to make its transition or 
default rates appear more favorable, information about the reasons for 
withdrawal is likely to be useful to users of credit ratings in 
interpreting the performance statistics.
---------------------------------------------------------------------------

    \918\ See Moody's Letter (stating that it does not 
``systematically capture data that sub-divides withdrawn credit 
ratings into the three sub-categories'' and that collecting this 
data for past rating actions ``would have to be done manually''); 
S&P Letter (``NRSROs may not currently distinguish between ratings 
on instruments that are paid off and withdrawn. Tracking this 
distinction going forward, to the extent it is not presently being 
done, will require significant systems changes. In addition, it may 
not be possible to track this distinction retroactively.'').
---------------------------------------------------------------------------

    An alternative approach to the amendments regarding rating 
histories would be to require the inclusion of placements on credit 
watch in the rating histories, while still excluding ratings 
affirmations, which would be consistent with the rating actions subject 
to disclosure in histories under the baseline requirements. Among the 
three commenters that recommended that the scope of rating actions 
included in public rating histories be narrowed, two did not raise 
concerns about the inclusion of placements on credit watch.\919\ 
Academic research has found that credit watch announcements are 
associated with abnormal stock and bond returns, indicating that 
placing a rating on credit watch is a significant information 
event.\920\ Including these announcements in rating histories would 
thus allow persons to, for example, judge which NRSROs have 
historically been more likely to provide, and more timely at providing, 
this information to the users of credit ratings, and thus may increase 
the accountability, time sensitivity, and judiciousness of NRSROs in 
placing credit ratings on credit watch. However, while making 
information about placements on credit watch publicly available in the 
rating histories may benefit users of credit ratings that value this 
information, the fact that some users of credit ratings may value this 
information also means that excluding such information from rating 
histories may make subscribers to NRSRO services that include access to 
historical ratings data (including placements on credit watch) somewhat 
less likely to stop subscribing as an increasing amount of historical 
ratings data becomes publicly available. The Commission therefore 
believes that excluding placements on credit watch from the rating 
histories may reduce potential losses in NRSRO revenues from services 
that include access to their credit ratings and/or rating histories 
while still permitting users of credit ratings to use the public rating 
histories to conduct certain analyses (such as calculating alternative 
transition and default statistics) to evaluate and compare NRSRO 
performance.
---------------------------------------------------------------------------

    \919\ See ABA Letter; S&P Letter. Another commenter recommended 
that the Commission exclude both affirmations and placements on 
credit watch, as well as assignments of default status, from the 
definition of rating action. See Moody's Letter.
    \920\ See, e.g., Hand, Holthausen, and Leftwich, The Effect of 
Bond Rating Agency Announcements on Bond and Stock Prices; Chung, 
Frost, and Kim, Characteristics and Information Value of Credit 
Watches.
---------------------------------------------------------------------------

    Additional alternatives with respect to rating history disclosure 
would be to not permit a rating history for a credit rating to be 
removed from the data file fifteen years after the credit rating is 
withdrawn, or to shorten the retention period to ten years as suggested 
by a commenter.\921\ Under the first alternative, the retention period 
could be substantially increased or a history could be required to be 
retained permanently. In particular, because the amendments allow 
credit ratings to be removed from the histories fifteen years after 
they are withdrawn, any data that becomes available for periods over 
fifteen years in the past will not reflect a representative sample of 
the credit ratings of the NRSRO, since withdrawn credit ratings, 
including credit ratings withdrawn because of default, will be 
underrepresented in the sample of outstanding credit ratings in the 
rating histories for a period that is more than fifteen years in the 
past.\922\ Thus, the data files disclosed pursuant to the amendments 
will over time result in no more than fifteen years (and likely no more 
than thirteen or fourteen years, given the permitted grace periods) of 
data that is fully comprehensive and can therefore be used to calculate 
performance statistics or perform other analyses that require a 
representative sample of credit ratings. The data will, over time, 
become sufficient to produce, for example, five-year and twelve-year 
performance statistics using the single cohort approach or, for 
example, three-year performance statistics using the average cohort 
approach applied to the eleven annual cohorts beginning thirteen years 
ago. However, performance statistics using the data from ratings 
histories will be limited to cohorts of credit ratings over these 
thirteen or fourteen years of history and thus may not reflect as wide 
as a variety of economic conditions as may be desired.
---------------------------------------------------------------------------

    \921\ See DBRS Letter.
    \922\ See GAO Report 10-782, pp. 46, 98. See also id. at 98 
(stating that ``[t]o the extent that withdrawn ratings are not 
included in the data, users will not be able to generate withdrawal-
adjusted statistics and the data will underrepresent defaulted 
issuers and issues'' and recommending that ``withdrawn ratings are 
not removed from these disclosures'').
---------------------------------------------------------------------------

    Increasing the retention period would therefore benefit users of 
credit ratings interested in using the rating histories to perform 
analyses that require a representative sample of the credit ratings of 
the NRSRO outstanding as of a date or a series of dates that are more 
than thirteen or fourteen years in the past. However, as in the case of 
excluding data with respect to placements on credit watch, applying a 
shorter retention period may reduce potential losses to NRSROs of 
revenue from selling access to historical ratings data. Also, one NRSRO 
stated that ``the amount of data storage required'' to comply with a 
twenty-year retention requirement for the public rating histories 
``would be considerable.'' \923\ The Commission therefore believes that 
a fifteen-year retention requirement may reduce the burden on NRSROs, 
while still permitting users of credit ratings to use the public rating 
histories to conduct certain analyses (such as transition and default 
statistics that require up to thirteen or fourteen years of data, or 
comparisons over longer horizons of NRSRO performance with respect to 
the same obligor or instrument) to evaluate and compare NRSRO 
performance.
---------------------------------------------------------------------------

    \923\ See S&P Letter.
---------------------------------------------------------------------------

    For these reasons, the Commission also does not believe it would be 
appropriate to shorten the retention period to ten years as suggested 
by one commenter.\924\ A ten year retention period (rather than a 
fifteen year retention period) would further limit the utility of the 
rating histories in terms of being able to use the data to generate 
performance statistics that are different than the performance 
statistics that must be disclosed in Exhibit 1 to Form NRSRO.
---------------------------------------------------------------------------

    \924\ See DBRS Letter.
---------------------------------------------------------------------------

    A further alternative for rating history disclosure would be to 
increase or decrease the grace periods relative to the twelve- and 
twenty-four-month grace periods that are permitted for issuer-paid and 
other credit ratings respectively under the amendments. Longer 
permitted grace periods likely would reduce potential losses 
experienced by NRSROs in revenues

[[Page 55154]]

from services that include access to their credit ratings and/or rating 
histories. However, shorter grace periods would increase the benefits 
from the disclosure by making more, and more timely, information 
available to users of credit ratings for the purpose of evaluating and 
comparing the performance of NRSROs. The Commission believes it has 
appropriately balanced the costs and benefits of increasing or 
decreasing the grace periods in setting the grace periods permitted 
under the amendments.

F. Credit Rating Methodologies

    Section 932(a)(8) of the Dodd-Frank Act amended section 15E of the 
Exchange Act to add subsection (r).\925\ Section 15E(r) of the Exchange 
Act provides that the Commission shall prescribe rules, for the 
protection of investors and in the public interest, with respect to the 
procedures and methodologies, including qualitative and quantitative 
data and models, used by NRSROs that require each NRSRO to ensure that 
objectives identified in section 15E(r) are met.\926\ The Commission 
proposed to implement section 15E(r) in large part, through paragraph 
(a) of Rule 17g-8, which would require an NRSRO to establish, maintain, 
enforce, and document policies and procedures that are reasonably 
designed to ensure it meets the objectives identified in section 
15E(r).\927\ The intent was to provide flexibility for an NRSRO to 
establish policies and procedures that can be integrated with its 
procedures and methodologies for determining credit ratings, which vary 
across NRSROs.\928\ The proposed approach also was sensitive to the 
limitation in section 15E(c)(2) of the Exchange Act, given that the 
objectives set forth in section 15E(r) of the Exchange Act relate to 
the procedures and methodologies an NRSRO uses to determine credit 
ratings.\929\ The Commission also proposed an amendment to Rule 17g-2 
to apply the record retention and production requirements of that rule 
to the documentation of the policies and procedures that would be 
required under proposed paragraph (a) of Rule 17g-8.\930\
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    \925\ See Public Law 111-203, 932(a)(8); 15 U.S.C. 78o-7(r).
    \926\ The objectives are: (1) To ensure that credit ratings are 
determined using procedures and methodologies, including qualitative 
and quantitative data and models, that are (A) approved by the board 
of the NRSRO or a body performing a similar function; and (B) in 
accordance with the policies and procedures of the NRSRO for the 
development and modification of credit rating procedures and 
methodologies; (2) to ensure that when material changes to credit 
rating procedures and methodologies (including changes to 
qualitative and quantitative data and models) are made, that (A) the 
changes are applied consistently to all credit ratings to which the 
changed procedures and methodologies apply; (B) to the extent that 
changes are made to credit rating surveillance procedures and 
methodologies, the changes are applied to then-current credit 
ratings by the NRSRO within a reasonable time period determined by 
the Commission, by rule; and (C) the NRSRO publicly discloses the 
reason for the change; and (3) to notify users of credit ratings (A) 
of the version of a procedure or methodology, including the 
qualitative methodology or quantitative inputs, used with respect to 
a particular credit rating; (B) when a material change is made to a 
procedure or methodology, including to a qualitative model or 
quantitative inputs; (C) when a significant error is identified in a 
procedure or methodology, including a qualitative or quantitative 
model, that may result in credit rating actions; and (D) of the 
likelihood of a material change described in subparagraph (B) 
resulting in a change in current credit ratings. See 15 U.S. C. 78o-
7(r)(1) through (3).
    \927\ See paragraph (a) of Rule 17g-8, as proposed; Nationally 
Recognized Statistical Rating Organizations, 76 FR at 33452-33465. 
As discussed below, the Commission proposed to implement section 
15E(r)(3)(A) of the Exchange Act (which addresses notice of the 
version of a procedure or methodology used with respect to a 
particular credit rating) also through paragraph (a) of Rule 17g-7, 
as proposed. See Nationally Recognized Statistical Rating 
Organizations, 76 FR at 33459.
    \928\ See Nationally Recognized Statistical Rating 
Organizations, 76 FR at 33452.
    \929\ See id. at 33452. See also 15 U.S.C. 78o-7(r); 15 U.S.C. 
78o-7(c)(2) (providing, in pertinent part, that the Commission may 
not regulate the substance of credit ratings or the procedures and 
methodologies by which any NRSRO determines credit ratings).
    \930\ See Nationally Recognized Statistical Rating 
Organizations, 76 FR at 33456.
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1. Paragraph (a) of New Rule 17g-8
    As proposed, paragraph (a) of Rule 17g-8 would require an NRSRO to 
establish, maintain, enforce, and document policies and procedures that 
are reasonably designed to ensure that it achieves the objectives 
identified in section 15E(r) of the Exchange Act.\931\ In particular, 
the prefatory text of paragraph (a) would require an NRSRO to 
establish, maintain, enforce, and document policies and procedures that 
are reasonably designed to ensure that it meets the objectives 
identified in paragraphs (a)(1), (2), (3), (4), and (5).\932\ The rule 
text in proposed paragraphs (a)(1), (2), (3), (4), and (5) of Rule 17g-
8 largely mirrored the statutory text of section 15E(r) of the Exchange 
Act.\933\
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    \931\ See proposed paragraph (a) of Rule 17g-8; Nationally 
Recognized Statistical Rating Organizations, 76 FR at 33542.
    \932\ See proposed prefatory text of paragraph (a) of Rule 17g-
8; Nationally Recognized Statistical Rating Organizations, 76 FR at 
33542.
    \933\ Compare paragraphs (a)(1), (2), (3), (4), and (5) of Rule 
17g-8, as proposed, with 15 U.S. C. 78o-7(r)(1) through (3).
---------------------------------------------------------------------------

    The Commission is adopting the prefatory text of paragraph (a) of 
Rule 17g-8 as proposed.\934\ The final rule requires an NRSRO to 
establish, maintain, enforce, and document policies and procedures 
reasonably designed to ensure that it meets the objectives identified 
in paragraphs (a)(1), (2), (3), (4), and (5) of the rule.
---------------------------------------------------------------------------

    \934\ See prefatory text of paragraph (a) of Rule 17g-8.
---------------------------------------------------------------------------

    One commenter stated that the proposal appropriately recognizes 
that procedures and methodologies vary across NRSROs and thus there is 
a need for flexibility to establish policies and procedures that can be 
integrated with the NRSRO's existing credit rating methodologies.\935\ 
Some commenters expressed general opposition to the proposal on the 
basis of cost.\936\ One of these commenters stated that certain aspects 
of the proposals, including those regarding credit rating 
methodologies, would compound barriers to entry, and that many of the 
rules would be expensive and burdensome to implement.\937\ More 
specifically, this commenter stated that the Commission should take 
into account the dominance of very large players and expand exemptions 
for small NRSROs designed to level the competitive field.\938\
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    \935\ See ICI Letter.
    \936\ See A.M. Best Letter; Kroll Letter. Alternatively, another 
commenter expressed the view that rule should, in general, be 
strengthened by explicitly requiring NRSROs to assign higher risk to 
products issued by financial institutions with a track record of 
issuing poor quality assets. See Levin Letter. This recommendation 
is beyond the scope of the proposal and could implicate section 
15E(c)(2) of the Exchange Act. See 15 U.S. C. 78o-7(c)(2) (which, 
among other things, prohibits the Commission from regulating the 
substance of credit ratings and the procedures and methodologies by 
which any NRSRO determines credit ratings).
    \937\ See Kroll Letter.
    \938\ See id.
---------------------------------------------------------------------------

    In response, the Commission notes that the final rule is designed 
to meet the rulemaking mandate of section 15E(r) of the Exchange Act in 
a manner that provides flexibility to NRSROs to design the required 
policies and procedures. Consequently, an NRSRO can tailor and scale 
its policies and procedures to its business model, size, and the scope 
of its activities as well as to its procedures and methodologies for 
determining credit ratings, which should mitigate concerns to some 
degree about the costs of the final rule and its potential to create 
barriers to entry for small credit rating agencies. The Commission also 
believes that the policies and procedures required under section 
15E(r), as implemented by the Commission in paragraph (a) of Rule 17g-
8, will promote the integrity and transparency of the procedures and 
methodologies NRSROs use to determine credit ratings by, for example,

[[Page 55155]]

promoting board oversight of these procedures and methodologies and 
requiring disclosure when material changes are made to them. 
Nonetheless, as discussed below in the economic analysis, the 
Commission acknowledges that these requirements will result in costs 
and that those costs could create competitive barriers.
    As proposed, paragraph (a)(1) of Rule 17g-8 would implement section 
15E(r)(1)(A) of the Exchange Act.\939\ This section identifies the 
objective of ensuring that credit ratings are determined using 
procedures and methodologies, including qualitative and quantitative 
data and models, that are approved by the board of the NRSRO, or a body 
performing a function similar to that of a board.\940\ Paragraph 
(a)(1), as proposed, would require an NRSRO to establish, maintain, 
enforce, and document policies and procedures reasonably designed to 
ensure that credit ratings are determined using procedures and 
methodologies, including qualitative and quantitative data and models, 
that are approved by the board of the NRSRO, or a body performing a 
function similar to that of a board.\941\ The Commission intended this 
requirement to operate in conjunction with section 15E(t)(3)(A) of the 
Exchange Act, which establishes a statutory requirement that the board 
of an NRSRO ``shall oversee'' the establishment, maintenance, and 
enforcement of the policies and procedures for determining credit 
ratings.\942\
---------------------------------------------------------------------------

    \939\ See paragraph (a)(1) of Rule 17g-8, as proposed; 
Nationally Recognized Statistical Rating Organizations, 76 FR at 
33453.
    \940\ See 15 U.S.C. 78o-7(r)(1)(A).
    \941\ See paragraph (a)(1) of Rule 17g-8, as proposed; 
Nationally Recognized Statistical Rating Organizations, 76 FR at 
33542.
    \942\ See 15 U.S.C. 78o-7(t)(3)(A); Nationally Recognized 
Statistical Rating Organizations, 76 FR at 33453.
---------------------------------------------------------------------------

    The Commission is adopting paragraph (a)(1) of Rule 17g-8, as 
proposed.\943\ The final rule requires an NRSRO to have policies and 
procedures that are reasonably designed to ensure that the procedures 
and methodologies it uses to determine credit ratings are approved by 
its board of directors or a body performing a function similar to that 
of a board of directors.\944\ In relation to this requirement in 
paragraph (a)(1), section 15E(t)(3)(A) of the Exchange Act (as 
discussed above) contains a self-executing requirement that the board 
of an NRSRO ``shall oversee'' the ``establishment, maintenance, and 
enforcement of the policies and procedures for determining credit 
ratings.'' \945\ Consequently, as discussed in the proposing release, 
the policies and procedures required pursuant to paragraph (a)(1) of 
Rule 17g-8, as adopted, must be reasonably designed to ensure that the 
NRSRO's board carries out this statutorily mandated 
responsibility.\946\ In addition, section 15E(t)(5) of the Exchange Act 
provides that the Commission may permit an NRSRO to delegate 
responsibilities required in section 15E(t) to a committee if the 
Commission finds that compliance with the provisions of that section 
present an unreasonable burden on a small NRSRO.\947\ In this case, the 
policies and procedures required pursuant to paragraph (a)(1) of Rule 
17g-8, as adopted, must be reasonably designed to ensure the NRSRO's 
committee carries out the responsibility to oversee the establishment, 
maintenance, and enforcement of the NRSRO's procedures and 
methodologies for determining credit ratings.\948\
---------------------------------------------------------------------------

    \943\ See paragraph (a)(1) of Rule 17g-8.
    \944\ See id.
    \945\ See 15 U.S.C. 78o-7(t)(3)(A).
    \946\ See Nationally Recognized Statistical Rating 
Organizations, 76 FR at 33453.
    \947\ See 15 U.S.C. 78o-7(t)(5).
    \948\ See 15 U.S.C. 78o-7(t)(3)(A).
---------------------------------------------------------------------------

    One commenter stated that the proposal appropriately meets the 
Exchange Act mandate.\949\ Another commenter cited the high costs 
associated with having an independent board and stated that given those 
high costs the scope of board functions should not be inadvertently 
expanded.\950\ This commenter also stated that it would have been 
helpful for the final rule to provide greater guidance to confirm that 
the board is not required to approve or pass judgment on, for example, 
``qualitative and quantitative data and models.'' \951\ A second 
commenter stated that a periodic approval process is more consistent 
with the board of directors' oversight role and provides the board of 
directors a better opportunity to provide well-planned and meaningful 
guidance that would be better at creating consistency in best practices 
across the NRSRO.\952\ A third commenter stated that responsibility for 
the development of ratings criteria, methodologies, and models ``should 
be in the hands of experienced ratings professionals'' and that the 
board should be responsible for approving the policies and procedures 
that are used to develop the NRSROs' criteria, methodologies, and 
models.\953\ The commenter did not interpret the proposal to require 
the board to approve the criteria, methodologies, or models themselves, 
stating that any such requirement would not be feasible given the vast 
amounts of continually developing criteria used by NRSROs.\954\
---------------------------------------------------------------------------

    \949\ See S&P Letter.
    \950\ See Kroll Letter. Section 15E(t)(2) of the Exchange Act 
prescribes a self-executing requirement that at least one half of 
the members of an NRSRO's board must be independent. See 15 U.S.C 
78o-7(t)(2).
    \951\ See Kroll Letter.
    \952\ See Morningstar Letter.
    \953\ See S&P Letter.
    \954\ See id.
---------------------------------------------------------------------------

    In response to the comments, the Commission notes that section 
15E(t)(3)(A) of the Exchange Act provides that the board of an NRSRO 
shall oversee the establishment, maintenance, and enforcement of 
policies and procedures for determining credit ratings.\955\ 
Consequently, the self-executing requirement in the statute governs the 
responsibility of the board. Paragraph (a)(1) of Rule 17g-8 governs the 
responsibility of the NRSRO to have policies and procedures reasonably 
designed to ensure that the board carries out this responsibility. In 
terms of complying with the statutory requirement to oversee rating 
policies and procedures, the Commission recognizes that the board 
cannot be involved in managing the day-to-day affairs of the NRSRO. 
There must be an appropriate balance between the board's 
responsibilities as a governing body and the responsibilities of the 
NRSRO's managers as supervisors of the daily activities of the NRSRO. 
As a practical matter, an NRSRO will need to appropriately allocate 
responsibilities to the NRSRO's board and to the NRSRO's managers with 
respect to the implementation of rating procedures and methodologies, 
with the board exercising its statutory responsibility to oversee the 
establishment, maintenance, and enforcement of the NRSRO's policies and 
procedures for determining credit ratings. Consequently, the Commission 
does not expect board members to undertake the detailed work of 
developing rating procedures and methodologies.
---------------------------------------------------------------------------

    \955\ See 15 U.S.C. 78o-7(t)(3)(A).
---------------------------------------------------------------------------

    Further, as discussed above, section 15E(t)(5) of the Exchange Act 
provides exception authority under which the Commission may permit an 
NRSRO to delegate responsibilities of the board required in section 
15E(t) to a committee if the Commission finds that compliance with the 
provisions of that section present an unreasonable burden on a small 
NRSRO.\956\ The ability to request an exception under section 15E(t)(5) 
provides a means for a small NRSRO to seek relief to delegate

[[Page 55156]]

responsibilities to a committee if the potential costs and burdens 
associated with the requirements of section 15E(t) of the Exchange 
Act--including the requirement that the board oversee the 
establishment, maintenance, and enforcement of the policies and 
procedures for determining credit ratings--are an unreasonable 
burden.\957\
---------------------------------------------------------------------------

    \956\ See 15 U.S.C. 78o-7(t)(5).
    \957\ The Commission will respond to such requests in a manner 
similar to requests for relief under section 36 of the Exchange Act. 
See 15 U.S.C. 78mm. Further information about requesting relief 
under section 36 of the Exchange Act is available at http://www.sec.gov/rules/exempt.shtml.
---------------------------------------------------------------------------

    Commenters also questioned whether the board of directors would 
need to have members with expertise in rating methodologies.\958\ One 
of these commenters stated that the rule should require the NRSRO to 
appoint at least one board member with quantitative financial analysis 
expertise.\959\ Section 15E(t)(3)(A) of the Exchange Act, while 
mandating that the NRSRO's board must ``oversee'' the establishment, 
maintenance, and enforcement of the NRSRO's policies and procedures for 
determining credit ratings, does not address whether the board must 
include a member with specific expertise in this area.\960\ Similarly, 
section 15E(r)(1)(A) of the Exchange also does not address board 
expertise and, consequently, neither does paragraph (a)(1) of Rule 17g-
8.\961\ In complying with the statute and rule, an NRSRO and its 
shareholders will need to strike an appropriate balance between board 
members who have generalized experience and those who have more 
specific experience with aspects of the NRSRO's business activities, 
including with rating methodologies.
---------------------------------------------------------------------------

    \958\ See, e.g., AFSCME Letter (expressing concerns that the 
board may not possess the necessary expertise, particularly in 
quantitative analysis, to carry out the oversight function specified 
in paragraph (a)(1) of Rule 17g-8); COPERA Letter (expressing 
similar concerns); Morningstar Letter.
    \959\ See AFSCME Letter.
    \960\ See 15 U.S.C. 78o-7(t)(3)(A). The statute does require the 
NRSRO to have independent board members, some of whom must be users 
of credit ratings of NRSROs. See 15 U.S.C. 78o-7(t)(2)(A).
    \961\ See 15 U.S.C. 78o-7(r)(1)(A).
---------------------------------------------------------------------------

    Paragraph (a)(2) of Rule 17g-8, as proposed, would implement 
section 15E(r)(1)(B) of the Exchange Act.\962\ This section identifies 
the objective of ensuring that credit ratings are determined using 
procedures and methodologies, including qualitative and quantitative 
data and models, that are in accordance with the policies and 
procedures of the NRSRO for the development and modification of credit 
rating procedures and methodologies.\963\ As proposed, paragraph (a)(2) 
would require an NRSRO to establish, maintain, enforce, and document 
policies and procedures reasonably designed to ensure that the 
procedures and methodologies, including qualitative and quantitative 
data and models, that the NRSRO uses to determine credit ratings are 
developed and modified in accordance with the policies and procedures 
of the NRSRO.\964\
---------------------------------------------------------------------------

    \962\ See paragraph (a)(2) of Rule 17g-8, as proposed; 
Nationally Recognized Statistical Rating Organizations, 76 FR at 
33453.
    \963\ See 15 U.S.C. 78o-7(r)(1)(B).
    \964\ See paragraph (a)(2) of Rule 17g-8, as proposed; 
Nationally Recognized Statistical Rating Organizations, 76 FR at 
33542.
---------------------------------------------------------------------------

    The Commission is adopting paragraph (a)(2) of Rule 17g-8 as 
proposed.\965\ Section 15E(c)(3)(A) of the Exchange 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.'' \966\ Consequently, section 15E(c)(3)(A) establishes 
a statutory requirement that an NRSRO have an internal control 
structure that governs the implementation of rating procedures and 
methodologies.\967\ In addition, paragraph (a)(2) of Rule 17g-8 
establishes a complementary requirement that an NRSRO have policies and 
procedures reasonably designed to ensure that rating procedures and 
methodologies are developed and modified in accordance with the NRSRO's 
procedures for developing and modifying rating procedures and 
methodologies.\968\
---------------------------------------------------------------------------

    \965\ See paragraph (a)(2) of Rule 17g-8.
    \966\ See 15 U.S.C. 78o-7(c)(3)(A) (emphasis added).
    \967\ See id.
    \968\ See paragraph (a)(2) of Rule 17g-8.
---------------------------------------------------------------------------

    Two commenters supported the proposal.\969\ In contrast, one 
commenter suggested the Commission take a different approach than was 
proposed in paragraph (a)(2) of Rule 17g-8.\970\ Specifically, this 
commenter recommended that the rule establish a ``committee assessment 
function'' devoted to analyzing the performance of rating 
committees.\971\ In response, the Commission notes that the rulemaking 
mandate in section 15E(r)(1)(B) of the Exchange Act addresses ensuring 
that the NRSRO uses rating procedures and methodologies that are in 
accordance with the NRSRO's procedures and methodologies for developing 
and modifying such procedures and methodologies.\972\ In other words, 
the statute is concerned with ensuring that the NRSRO follows its 
processes for developing and modifying rating procedures and 
methodologies. The commenter's suggestion for a committee assessment 
function addresses the performance of rating committees in determining 
credit ratings (that is, in applying the rating procedures and 
methodologies). Consequently, the Commission considers the commenter's 
proposal outside the scope of this rulemaking.
---------------------------------------------------------------------------

    \969\ See ICI Letter; S&P Letter.
    \970\ See Harrington Letter.
    \971\ See id.
    \972\ See 15 U.S.C. 78o-7(r)(1)(B).
---------------------------------------------------------------------------

    Paragraph (a)(3)(i) of Rule 17g-8, as proposed, would implement 
section 15E(r)(2)(A) of the Exchange Act.\973\ This section identifies 
the objective of ensuring that, when material changes are made to 
rating procedures and methodologies (including changes to qualitative 
and quantitative data and models), the changes are applied consistently 
to all credit ratings to which the changed procedures and methodologies 
apply.\974\ As proposed, paragraph (a)(3)(i) would require an NRSRO to 
establish, maintain, enforce, and document policies and procedures 
reasonably designed to ensure that material changes to the procedures 
and methodologies, including changes to qualitative and quantitative 
data and models, the NRSRO uses to determine credit ratings are applied 
consistently to all credit ratings to which the changed procedures and 
methodologies apply.\975\
---------------------------------------------------------------------------

    \973\ See paragraph (a)(3)(i) of Rule 17g-8, as proposed; 
Nationally Recognized Statistical Rating Organizations, 76 FR at 
33453.
    \974\ See 15 U.S.C. 78o-7(r)(2)(A).
    \975\ See paragraph (a)(3)(i) of Rule 17g-8, as proposed; 
Nationally Recognized Statistical Rating Organizations, 76 FR at 
33542-33543.
---------------------------------------------------------------------------

    Paragraph (a)(3)(ii) of Rule 17g-8, as proposed, would implement 
section 15E(r)(2)(B) of the Exchange Act.\976\ This section identifies 
the objective of ensuring that when material changes are made to rating 
procedures and methodologies (including changes to qualitative and 
quantitative data and models), to the extent that changes are made to 
credit rating surveillance procedures and methodologies, the changes 
are applied to then-current credit ratings by the NRSRO within a 
reasonable time period determined by the Commission, by rule.\977\ As 
proposed, paragraph (a)(3)(ii) would require an NRSRO to establish, 
maintain, enforce, and document policies and procedures reasonably 
designed to ensure that material changes to the procedures and 
methodologies, including changes to qualitative and

[[Page 55157]]

quantitative data and models, the NRSRO uses to determine credit 
ratings are, to the extent that the changes are to surveillance or 
monitoring procedures and methodologies, applied to then-current credit 
ratings within a reasonable period of time taking into consideration 
the number of ratings impacted, the complexity of the procedures and 
methodologies used to determine the credit ratings, and the type of 
obligor, security, or money market instrument being rated.\978\ The 
proposed rule text differed from the text of section 15E(r)(2)(B) of 
the Exchange Act because it provided that the changes must be applied 
to then-current credit ratings within a reasonable period of time 
taking into consideration the number of credit ratings impacted, the 
complexity of the procedures and methodologies used to determine the 
credit ratings, and the type of obligor, security, or money market 
instrument being rated.\979\
---------------------------------------------------------------------------

    \976\ See paragraph (a)(3)(ii) of Rule 17g-8, as proposed; 
Nationally Recognized Statistical Rating Organizations, 76 FR at 
33453-33454.
    \977\ See 15 U.S.C. 78o-7(r)(2)(B).
    \978\ See paragraph (a)(3)(ii) of Rule 17g-8, as proposed; 
Nationally Recognized Statistical Rating Organizations, 76 FR at 
33543.
    \979\ See paragraph (a)(3)(ii) of Rule 17g-8, as proposed; 15 
U.S.C. 78o-7(r)(2)(B). The proposed rule text was designed to 
implement the rulemaking provision in section 15E(r)(2)(B) that the 
changes are to be applied to then-current credit ratings by the 
NRSRO within a reasonable time period determined by the Commission, 
by rule. See Nationally Recognized Statistical Rating Organizations, 
76 FR at 33453-33454.
---------------------------------------------------------------------------

    The Commission is adopting paragraphs (a)(3)(i) and (ii) of Rule 
17g-8 with modifications to paragraph (a)(3)(i) to clarify the 
requirements of the rule in response to comment.\980\ Specifically, one 
commenter stated that the provision appropriately meets the 
requirements of the Exchange Act but asked the Commission to clarify 
that paragraph (a)(3)(i) is applicable only to changes to procedures 
and methodologies that may impact new credit ratings, and that the 
implementation of changes affecting existing ratings are addressed 
separately in paragraph (a)(3)(ii).\981\ The commenter's interpretation 
of paragraph (a)(3)(i) is incorrect. The Commission intended this 
paragraph to address the procedures and methodologies an NRSRO uses to 
determine new credit ratings and to make adjustments to current credit 
ratings. Otherwise, the policies and procedures required under 
paragraph (a)(3)(i) would not address the consistent treatment of 
current credit ratings. However, to remove any ambiguity, the text of 
paragraph (a)(3)(i) has been modified to clarify that the paragraph 
applies to ``current and future credit ratings.'' \982\
---------------------------------------------------------------------------

    \980\ See paragraph (a)(3)(i) and (ii) of Rule 17g-8.
    \981\ See S&P Letter.
    \982\ See paragraph (a)(3)(i) of Rule 17g-8.
---------------------------------------------------------------------------

    Another commenter questioned whether the provision was appropriate 
given the commenter's view that an NRSRO cannot ensure that changes are 
applied consistently to all credit ratings to which the changed 
procedures and methodologies apply because qualitative assessments 
differ from credit rating committee to credit rating committee.\983\ 
The Commission acknowledges that rating procedures and methodologies 
commonly incorporate qualitative analysis that introduces a degree of 
subjectivity to the rating process. The final rule is not intended to 
interfere with the qualitative process that is part of determining a 
credit rating. Rather, it is designed to ensure that an NRSRO does not 
apply different rating procedures and methodologies when determining 
credit ratings with respect to types of obligors or obligations that 
are intended to be subject to the same rating procedures and 
methodologies. If, for example, an NRSRO changes a rating procedure or 
methodology for determining initial credit ratings for RMBS, the 
policies and procedures of the NRSRO must be reasonably designed to 
ensure that the NRSRO does not continue to use the old procedure or 
methodology to determine initial credit ratings for some RMBS and the 
new procedure or methodology to determine initial credit ratings for 
other RMBS.\984\
---------------------------------------------------------------------------

    \983\ See Harrington Letter.
    \984\ Similarly, if the NRSRO changes a procedure or methodology 
for monitoring credit ratings of RMBS, the policies and procedures 
of the NRSRO under paragraph (a)(3)(i) must be reasonably designed 
to ensure that it does not continue to use the old procedure or 
methodology to monitor some RMBS and the new procedure or 
methodology to monitor other RMBS.
---------------------------------------------------------------------------

    The Commission is making modifications to paragraph (a)(3)(ii) of 
Rule 17g-8 from the rule text as proposed.\985\ As stated above, one 
commenter asked the Commission to clarify that paragraph (a)(3)(i) is 
applicable only to changes to procedures and methodologies that may 
impact new credit ratings, and that the implementation of changes 
affecting current ratings are addressed separately in paragraph 
(a)(3)(ii).\986\ As discussed above, the commenter's interpretation of 
paragraph (a)(3)(i) was not correct and the paragraph has been modified 
to clarify that it applies to current and future credit ratings. 
However, the commenter is correct that paragraph (a)(3)(ii) was 
intended to apply to current credit ratings. Specifically, the 
Commission intended paragraph (a)(3)(ii) to address the timeframe in 
which an NRSRO must apply an updated procedure or methodology for 
performing surveillance or monitoring of credit ratings to current 
credit ratings to which the changed procedure or methodology applies. 
For example, if the NRSRO changes the methodology for monitoring credit 
ratings of RMBS, paragraph (a)(3)(i) of the final rule requires the 
firm to have policies and procedures that are reasonably designed to 
ensure that it uses the updated methodology to monitor all RMBS credit 
ratings going forward.\987\ The change in methodology, however, may 
require the NRSRO to adjust the current credit ratings assigned to 
RMBS. Paragraph (a)(3)(ii), as proposed, was intended to address the 
timeframe in which an NRSRO must apply the updated methodology to 
current credit ratings to determine whether they should be adjusted. 
The Commission has modified the text of paragraph (a)(3)(ii) to make 
this more clear. Specifically, the final rule requires an NRSRO to 
establish, maintain, enforce, and document policies and procedures 
reasonably designed to ensure that material changes to the procedures 
and methodologies, including changes to qualitative and quantitative 
data and models, the NRSRO uses to determine credit ratings are, to the 
extent that the changes are to surveillance or monitoring procedures 
and methodologies, applied to current credit ratings to which the 
changed procedures or methodologies apply within a reasonable period of 
time, taking into consideration the number of credit ratings impacted, 
the complexity of the procedures and methodologies used to determine 
the credit ratings, and the type of obligor, security, or money market 
instrument being rated.\988\
---------------------------------------------------------------------------

    \985\ See paragraph (a)(3)(ii) of Rule 17g-8.
    \986\ See S&P Letter.
    \987\ See paragraph (a)(3)(i) of Rule 17g-8.
    \988\ See paragraph (a)(3)(ii) of Rule 17g-8 (emphasis added to 
highlight the modification).
---------------------------------------------------------------------------

    One commenter asked for clarification as to what time period 
constitutes a ``reasonable period'' for applying changed surveillance 
or monitoring procedures and methodologies to current credit 
ratings.\989\ Two commenters supported the decision not to prescribe a 
timeframe given the variables surrounding such a change (for example, 
number of impacted credit ratings).\990\ Another commenter acknowledged 
the need for flexibility with respect to the timeframe but expressed 
the concern that absent any guidance there would continue to be 
insufficient resources made available for surveillance and monitoring 
of credit

[[Page 55158]]

ratings.\991\ Two commenters argued that the Commission must establish 
a firm deadline for the application of revised rating methodologies or 
surveillance procedures to current credit ratings to ensure NRSROs act 
promptly.\992\ Another commenter, more generally, urged the Commission 
to require prompt re-testing after the NRSRO makes any such material 
changes.\993\
---------------------------------------------------------------------------

    \989\ See DBRS Letter.
    \990\ See S&P Letter; DBRS Letter.
    \991\ See AFSCME Letter.
    \992\ See Better Markets Letter; CFA/AFR Letter.
    \993\ See Levin Letter.
---------------------------------------------------------------------------

    In response to the comments that the rule should prescribe a 
specific timeframe in which the review must take place or prescribe 
what constitutes a reasonable period of time, the Commission is not 
persuaded that doing so would be feasible or appropriate. For example, 
some NRSROs have hundreds of thousands of credit ratings outstanding in 
certain classes of credit ratings, whereas others have fewer than one 
thousand.\994\ Consequently, if the specified timeframe was too short, 
an NRSRO with a large number of credit ratings might need to rush to 
meet the deadline. This could negatively impact the quality of the 
review of the credit ratings subject to the changed surveillance or 
monitoring procedures and methodologies and could result in adjustments 
to those credit ratings that were not the result of thorough analysis. 
If the specified timeframe was too long, an NRSRO with relatively few 
credit ratings would have a ``safe harbor'' that allowed the firm to 
act more slowly to apply the changed surveillance procedures and 
methodologies to current credit ratings than was necessary.\995\ 
Consequently, the final rule retains the proposed requirement that the 
updated surveillance or monitoring procedure or methodology must be 
applied to the current credit ratings to which the changed procedure or 
methodology applies within a reasonable period of time, taking into 
consideration the number of credit ratings impacted, the complexity of 
the procedures and methodologies used to determine the credit ratings, 
and the type of obligor, security, or money market instrument being 
rated. The question of whether the NRSRO has acted within a reasonable 
period of time will depend on factors such as the number of credit 
ratings an NRSRO has outstanding that would be impacted by the change.
---------------------------------------------------------------------------

    \994\ See, e.g., 2013 Annual Staff Report on NRSROs, p. 8.
    \995\ See Harrington Letter (raising this concern).
---------------------------------------------------------------------------

    Another commenter stated that the Commission should clarify the 
manner in which changes in rating procedures and methodologies would 
apply to current credit ratings.\996\ More specifically, the commenter 
explained that proposed paragraph (a)(3)(i) of Rule 17g-8 did not 
address whether an NRSRO applying changed procedures or methodologies 
to outstanding credit ratings must re-rate the transaction based upon 
the information available at the time of the initial rating or whether 
the process should include performance information received after that 
time.\997\ The commenter also stated that the NRSRO should not apply 
changes in procedures or methodologies to current credit ratings 
without a change in the performance of the credit rating.\998\ In 
response, the Commission notes that the final rule does not require the 
NRSRO to adjust the outstanding credit ratings impacted by the changed 
rating procedure or methodology; nor does it specify on what basis an 
NRSRO should adjust an outstanding credit rating.\999\ Rather, it 
requires the NRSRO to have policies and procedures reasonably designed 
to ensure that changes to surveillance or monitoring procedures and 
methodologies are applied to current credit ratings to which the 
changed procedures or methodologies apply within a reasonable 
timeframe. The question of whether an outstanding credit rating must be 
adjusted after the application of the changed procedures or 
methodologies will depend solely on the NRSRO's procedures and 
methodologies. Based on those procedures and methodologies, the NRSRO 
may adjust an existing credit rating because of the change in the 
procedure or methodology, because of a change in circumstances that 
impacts the creditworthiness of the obligor or issuer that is subject 
to the credit rating, or a combination of these factors. This decision, 
however, will be based solely on the NRSRO's procedures and 
methodologies.\1000\
---------------------------------------------------------------------------

    \996\ See FSR Letter.
    \997\ See id.
    \998\ See id.
    \999\ As discussed above, in implementing section 15E(r) of the 
Exchange Act, the Commission has been sensitive to the limitation in 
section 15E(c)(2) of the Exchange Act. See 15 U.S.C. 78o-7(c)(2) 
(which, among other things, prohibits the Commission from regulating 
the substance of credit ratings and the procedures and methodologies 
by which any NRSRO determines credit ratings).
    \1000\ See 15 U.S.C. 78o-7(c)(2).
---------------------------------------------------------------------------

    Paragraph (a)(4)(i) of Rule 17g-8, as proposed, would implement 
sections 15E(r)(2)(C), 15E(r)(3)(B), and 15E(r)(3)(D) of the Exchange 
Act.\1001\ Section 15E(r)(2)(C) identifies the objective of ensuring 
that when material changes are made to rating procedures and 
methodologies (including changes to qualitative and quantitative data 
and models), the NRSRO publicly discloses the reason for the 
change.\1002\ Section 15E(r)(3)(B) identifies the objective of ensuring 
that an NRSRO notifies users of credit ratings when a material change 
is made to a procedure or methodology, including to a qualitative model 
or quantitative input.\1003\ Section 15E(r)(3)(D) identifies the 
objective of ensuring that the NRSRO notifies users of credit ratings 
when a material change is made to a procedure or methodology, including 
to a qualitative model or quantitative input, of the likelihood the 
change will result in a change in current credit ratings.\1004\ The 
Commission proposed to implement these sections in paragraph (a)(4)(i) 
of Rule 17g-8, which would require an NRSRO to establish, maintain, 
enforce, and document policies and procedures reasonably designed to 
ensure that the NRSRO promptly publishes on an easily accessible 
portion of its corporate Internet Web site material changes to the 
procedures and methodologies, including to qualitative models or 
quantitative inputs, the NRSRO uses to determine credit ratings, the 
reason for the changes, and the likelihood the changes will result in 
changes to any ``current ratings.'' \1005\
---------------------------------------------------------------------------

    \1001\ See paragraph (a)(4)(i) of Rule 17g-8, as proposed; 
Nationally Recognized Statistical Rating Organizations, 76 FR at 
33454.
    \1002\ See 15 U.S.C. 78o-7(r)(2)(C).
    \1003\ See 15 U.S.C. 78o-7(r)(3)(B).
    \1004\ See 15 U.S.C. 78o-7(r)(3)(D).
    \1005\ See paragraph (a)(4)(i) of Rule 17g-8, as proposed; 
Nationally Recognized Statistical Rating Organizations, 76 FR at 
33543.
---------------------------------------------------------------------------

    The Commission is adopting paragraph (a)(4)(i) of Rule 17g-8 with a 
minor modification to make terminology throughout the rule 
consistent.\1006\ As adopted, paragraph (a)(4)(i) requires the NRSRO to 
have policies and procedures that are reasonably designed to ensure 
that the NRSRO promptly publishes on an easily accessible portion of 
its corporate Internet Web site material changes to the procedures and 
methodologies, including to qualitative models or quantitative inputs, 
the NRSRO uses to determine credit ratings, the reason for the changes, 
and the likelihood the changes will result in changes to any current 
credit ratings.\1007\
---------------------------------------------------------------------------

    \1006\ See paragraph (a)(4)(i) of Rule 17g-8. The modification 
adds the word ``credit'' after the word ``current'' and before the 
word ``ratings'' to consistently use the term ``credit ratings'' 
throughout the rule.
    \1007\ See paragraph (a)(4)(i) of Rule 17g-8.
---------------------------------------------------------------------------

    Paragraph (a)(4)(ii) of Rule 17g-8, as proposed, would implement 
section

[[Page 55159]]

15E(r)(3)(C) of the Exchange Act.\1008\ This section provides that the 
Commission's rules shall require an NRSRO to notify users of credit 
ratings when a significant error is identified in a procedure or 
methodology, including a qualitative or quantitative model, that may 
result in credit rating actions.\1009\ As proposed, paragraph 
(a)(4)(ii) would require the NRSRO to establish, maintain, enforce, and 
document policies and procedures reasonably designed to ensure that the 
NRSRO promptly publishes on an easily accessible portion of its 
corporate Internet Web site significant errors identified in a 
procedure or methodology, including a qualitative or quantitative 
model, the NRSRO uses to determine credit ratings that may result in a 
change in the current ratings.\1010\
---------------------------------------------------------------------------

    \1008\ See paragraph (a)(4)(ii) of Rule 17g-8, as proposed; 
Nationally Recognized Statistical Rating Organizations, 76 FR at 
33454.
    \1009\ See 15 U.S.C. 78o-7(r)(3)(C).
    \1010\ See paragraph (a)(4)(ii) of Rule 17g-8, as proposed; 
Nationally Recognized Statistical Rating Organizations, 76 FR at 
33543.
---------------------------------------------------------------------------

    The Commission is adopting paragraph (a)(4)(ii) of Rule 17g-8 with 
a minor modification. As proposed, the rule provided, in pertinent 
part, that the NRSRO must publish ``significant errors'' identified in 
a rating procedure or methodology. The proposal was intended to notify 
users of the NRSRO's credit ratings when a significant error is 
identified.\1011\ One potential reading of the text, however, was that 
it required publication of the actual error. This was not intended. 
Further, publication of the error without context--rather than 
notification that an error was identified--could diminish the value of 
the disclosure. For example, if the error was in the code of a 
quantitative model, the disclosure of the code containing the error 
without identifying that it contained an error likely would not inform 
users of the NRSRO's credit ratings that there was an error. 
Consequently, the final rule is modified to provide for the prompt 
publication of notice of the existence of a significant error. More 
specifically, the final rule requires an NRSRO to have policies and 
procedures that are reasonably designed to ensure that the NRSRO 
promptly publishes on an easily accessible portion of its corporate 
Internet Web site notice of the existence of a significant error 
identified in a procedure or methodology, including a qualitative or 
quantitative model, the NRSRO uses to determine credit ratings that may 
result in a change to current credit ratings.\1012\
---------------------------------------------------------------------------

    \1011\ See Nationally Recognized Statistical Rating 
Organizations, 76 FR at 33453.
    \1012\ See paragraph (a)(4)(ii) of Rule 17g-8 (emphasis added to 
highlight the modification).
---------------------------------------------------------------------------

    A number of commenters addressed paragraph (a)(4) of Rule 17g-8, as 
proposed.\1013\ Some commenters stated that Internet Web site 
publication would help ensure that NRSROs communicate information 
pertaining to material changes in procedures and methodologies, as well 
as significant errors in the procedures and methodologies, to investors 
and other users of credit ratings in a timely manner.\1014\ One 
commenter opposed the provision in paragraph (a)(4) of Rule 17g-8 
requiring NRSROs to publish material changes and significant errors on 
an easily accessible portion of the NRSRO's corporate Internet Web 
site.\1015\ The commenter argued that the statute requires more direct 
notification than Internet Web site publication, which could include 
allowing users to sign up for alerts.\1016\ The Commission believes 
that specifying publication on an easily accessible portion of the 
NRSRO's Internet Web site is the most direct and cost effective way to 
provide an opportunity for all potentially interested parties to have 
access to the required disclosures.\1017\ This does not preclude an 
NRSRO from offering additional disclosure services such as alerts or 
third parties from offering alert services based on the disclosures an 
NRSRO publishes.
---------------------------------------------------------------------------

    \1013\ See Barnard Letter; CFA/AFR Letter; DBRS Letter; Gardner 
Letter; Harrington Letter; ICI Letter; Levin Letter; S&P Letter.
    \1014\ See DBRS Letter; Harrington Letter; ICI Letter; S&P 
Letter.
    \1015\ See CFA/AFR Letter.
    \1016\ See id.
    \1017\ See DBRS Letter (supporting Web site-based disclosure); 
Harrington Letter (same); ICI Letter (same).
---------------------------------------------------------------------------

    One NRSRO stated that it would be helpful for the Commission to 
provide guidance as to when either a material change or significant 
error would trigger the disclosures.\1018\ This commenter stated that 
significant errors should be disclosed if there is a reasonable 
likelihood that correction of the error will result in a change to 
current credit ratings. In contrast, another commenter stated that the 
Commission should not attempt to define the phrase significant error as 
any imposition of an arbitrary definition could result in situations 
where an NRSRO must identify errors that are minor and a correction 
does not result in a rating action.\1019\
---------------------------------------------------------------------------

    \1018\ See DBRS Letter.
    \1019\ See S&P Letter.
---------------------------------------------------------------------------

    The question of whether a change is material or an error is 
significant will depend on the facts and circumstances and, most 
importantly, on the impacted rating procedure or methodology (which 
vary across NRSROs). In general, the Commission believes that a change 
to a rating procedure or methodology would be material if there is a 
substantial likelihood that reasonable users of the NRSRO's credit 
ratings would find notice of the change important information in terms 
of assessing the rating procedure or methodology.\1020\ The Commission 
believes that an error in a rating procedure or methodology would be 
significant if there is a substantial likelihood that reasonable users 
of the NRSRO's credit ratings would find notice of the error important 
information in terms of assessing the impact the error had on credit 
ratings determined using the rating procedure or methodology that 
contained the error.\1021\
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    \1020\ See DBRS Letter (suggested that a change to a rating 
methodology should be considered material if there is a substantial 
likelihood that a reasonable investor or other user of the credit 
ratings would consider the change to be important in evaluating the 
affected credit ratings).
    \1021\ See id. (stating an error should be disclosed if there is 
a reasonable likelihood that correction of the error will result in 
a change to current credit ratings).
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    Finally, paragraph (a)(5) of Rule 17g-8, as proposed, would 
implement section 15E(r)(3)(A) of the Exchange Act.\1022\ This section 
provides that the Commission's rules shall require an NRSRO to notify 
users of credit ratings of the version of a procedure or methodology, 
including the qualitative methodology or quantitative inputs, used with 
respect to a particular credit rating.\1023\ As proposed, paragraph 
(a)(5) would require the NRSRO to establish, maintain, enforce, and 
document policies and procedures reasonably designed to ensure that the 
NRSRO discloses the version of a credit rating procedure or 
methodology, including the qualitative methodology or quantitative 
inputs, used with respect to a particular credit rating.\1024\
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    \1022\ See paragraph (a)(5) of Rule 17g-8, as proposed; 
Nationally Recognized Statistical Rating Organizations, 76 FR at 
33454-33455.
    \1023\ See 15 U.S.C. 78o-7(r)(3)(A).
    \1024\ See paragraph (a)(5) of Rule 17g-8, as proposed; 
Nationally Recognized Statistical Rating Organizations, 76 FR at 
33543. In addition, because this would be a rating-by-rating 
disclosure, the Commission proposed, as discussed below in section 
II.G.3. of this release, that disclosure of the version of a credit 
rating procedure or methodology be part of the rule implementing 
section 15E(s) of the Exchange Act. See 15 U.S.C. 78o-7(s). Section 
15E(s) specifies, among other things, that the Commission adopt 
rules requiring an NRSRO to generate a form to be included with the 
publication of a credit rating. See Nationally Recognized 
Statistical Rating Organizations, 76 FR at 33459-33460 (discussing 
paragraph (a)(1)(ii)(B) of Rule 17g-7, as proposed).

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[[Page 55160]]

    The Commission is adopting paragraph (a)(5) of Rule 17g-8 as 
proposed.\1025\ Specifically, the final rule requires an NRSRO to have 
policies and procedures that are reasonably designed to ensure that it 
discloses the version of a credit rating procedure or methodology, 
including the qualitative methodology or quantitative inputs, used with 
respect to a particular credit rating.\1026\
---------------------------------------------------------------------------

    \1025\ See paragraph (a)(5) of Rule 17g-8.
    \1026\ See id.
---------------------------------------------------------------------------

    One commenter requested clarification that the requirement to 
publish the version of the criteria used for a particular credit rating 
applies only when there is an action on the credit rating, such as an 
upgrade, downgrade, or withdrawal.\1027\ A second commenter stated that 
the rule should require the NRSRO to publicly provide, along with the 
publication of the credit rating, disclosure about the credit rating 
and the methodology used to determine it.\1028\
---------------------------------------------------------------------------

    \1027\ See S&P Letter.
    \1028\ See Gardner Letter.
---------------------------------------------------------------------------

    The Commission is implementing section 15E(r)(3)(A) of the Exchange 
Act through paragraph (a)(5) of Rule 17g-8 and paragraph (a)(1)(ii)(B) 
of Rule 17g-7. Paragraph (a)(1)(ii)(B) of Rule 17g-7, as discussed 
below in section II.G.3. of this release, requires that the form to be 
included with the publication of certain rating actions include a 
disclosure of the version of the credit rating procedure or methodology 
used to determine the credit rating.\1029\ The policies and procedures 
required by paragraph (a)(5) of Rule 17g-8 must address the NRSRO's 
compliance with the disclosure requirement in Rule 17g-7. In response 
to the comments about when the version of the credit rating procedure 
or methodology used to determine the credit rating must be disclosed, 
Rule 17g-7 specifies when the form containing the disclosure of the 
version of the credit rating procedure or methodology used to determine 
the credit rating must be published by the NRSRO: Upon the taking of 
one of the rating actions identified in the rule (for example, an 
initial credit rating or an upgrade or a downgrade of an outstanding 
credit rating).\1030\
---------------------------------------------------------------------------

    \1029\ See paragraph (a)(1)(ii)(B) of Rule 17g-7.
    \1030\ See id.
---------------------------------------------------------------------------

    A third commenter expressed concern that the proposal would provide 
NRSROs with a defense for developing poor opinions on 
creditworthiness.\1031\ More specifically, the commenter stated that, 
based on his experience, reference to published methodologies has given 
at least one NRSRO a defense for having formed poor opinions on CDOs 
and RMBS.\1032\ The commenter also questioned the underlying rationale 
of the rule insofar as NRSRO methodologies are already freely 
accessible and transparent.\1033\ In response, the Commission notes 
that the statutory directive is clear: The rule must require each NRSRO 
to notify users of credit ratings of the version of a procedure or 
methodology, including the qualitative methodology or quantitative 
inputs, used with respect to a particular credit rating.\1034\ To 
address the commenter's concern, the Commission would need to do the 
opposite and prohibit an NRSRO from notifying users of credit ratings 
of the version of a procedure or methodology, including the qualitative 
methodology or quantitative inputs, used with respect to a particular 
credit rating. This would be inconsistent with the statutory 
requirement that the rule provide for notification.
---------------------------------------------------------------------------

    \1031\ See Harrington Letter.
    \1032\ See id.
    \1033\ See id.
    \1034\ See 15 U.S.C. 78o-7(r)(3)(A).
---------------------------------------------------------------------------

2. Amendment to Rule 17g-2
    The Commission proposed adding paragraph (b)(13) to Rule 17g-2 to 
identify the policies and procedures an NRSRO is required to establish, 
maintain, enforce, and document pursuant to paragraph (a) of Rule 17g-8 
as a record that must be retained.\1035\ The one comment letter that 
addressed the proposal supported it.\1036\ The Commission is adding 
paragraph (b)(13) to Rule 17g-2 as proposed.\1037\ This will provide a 
means for the Commission to monitor the NRSROs' compliance with 
paragraph (a) of Rule 17g-8. The record must be retained until three 
years after the date the record is replaced with an updated record in 
accordance with the amendment to paragraph (c) of Rule 17g-2 discussed 
above in section II.A.2. of this release.\1038\
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    \1035\ See paragraph (b)(13) of Rule 17g-2, as proposed; 
Nationally Recognized Statistical Rating Organizations, 76 FR at 
33539. See also section 17(a)(1) of the Exchange Act, which requires 
an NRSRO to make and keep such records, and make and disseminate 
such reports, as the Commission prescribes by rule as necessary or 
appropriate in the public interest, for the protection of investors, 
or otherwise in furtherance of the Exchange Act. 15 U.S.C. 
78q(a)(1).
    \1036\ See DBRS Letter.
    \1037\ See paragraph (b)(13) of Rule 17g-2.
    \1038\ See paragraphs (b)(13) and (c) of Rule 17g-2.
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3. Economic Analysis
    This section builds on the economic analysis in section I.B. of 
this release by presenting a focused analysis of the potential economic 
effects that may derive from the specific amendments and new rule 
relating to credit rating methodologies.\1039\ The economic baseline 
that existed before today's amendments was one in which an NRSRO's 
board of directors must oversee the establishment, maintenance, and 
enforcement of the NRSRO's policies and procedures for determining 
credit ratings pursuant to Exchange Act section 15E(t)(3)(A).\1040\ The 
baseline that existed before today's amendments and new rule also was 
one in which NRSROs must establish, maintain, enforce, and document an 
effective internal control structure governing the implementation of 
and adherence to their methodologies for determining credit 
ratings.\1041\ NRSROs--under the baseline requirements--were not 
explicitly required to establish, maintain, enforce, document, and 
retain a record of policies and procedures relating to: (1) Board 
approval of the procedures and methodologies for determining credit 
ratings;\1042\ (2) the development and modification of the procedures 
and methodologies for determining credit ratings;\1043\ (3) applying 
material changes to the procedures and methodologies for determining 
credit ratings;\1044\ (4) publishing material changes to and notices of 
significant errors in the procedures and methodologies for determining 
credit ratings;\1045\ and (5) disclosing the version a procedure or 
methodology for determining credit ratings used with respect to a 
particular credit rating.\1046\
---------------------------------------------------------------------------

    \1039\ The economic analysis in section I.B. of this release 
discusses the primary economic impacts that may derive from the 
amendments and new rules being adopted today.
    \1040\ See 15 U.S.C. 78o-7(t)(3)(A).
    \1041\ See 15 U.S.C. 78o-7(c)(3)(A).
    \1042\ See paragraph (a)(1) of Rule 17g-8.
    \1043\ See paragraph (a)(2) of Rule 17g-8. As noted above, an 
NRSRO must establish, maintain, enforce, and document an effective 
internal control structure governing the implementation of their 
methodologies for determining credit ratings. See 15 U.S.C. 78o-
7(t)(3)(A).
    \1044\ See paragraph (a)(3) of Rule 17g-8.
    \1045\ See paragraph (a)(4) of Rule 17g-8.
    \1046\ See paragraph (a)(5) of Rule 17g-8.
---------------------------------------------------------------------------

    Relative to this baseline, the Commission believes that the 
amendments and new rule may result in a number of benefits. For 
example, implementing policies and procedures designed to ensure that 
the NRSRO's board of directors (or a body performing a similar 
function) oversees the establishment, maintenance, and enforcement of 
the NRSRO's policies and procedures for determining credit ratings in 
accordance with 15E(t)(3)(A) of the Exchange Act should promote the 
quality and consistency of the

[[Page 55161]]

procedures and methodologies. Similarly, taking steps to ensure that 
the procedures and methodologies for determining credit ratings are 
developed and modified pursuant to the NRSRO's policies and procedures 
also should promote the quality and consistency of the procedures and 
methodologies.
    Taking steps to ensure that material changes to the procedures and 
methodologies the NRSRO uses to determine credit ratings are applied 
consistently to all current and future credit ratings to which the 
changed procedures or methodologies apply should help ensure consistent 
and timely application of such changes and promote the integrity of the 
credit rating process. This should benefit users of credit ratings. In 
addition, taking steps to ensure that an NRSRO promptly publishes on an 
easily accessible portion of its Internet Web site information about 
material changes to the procedures and methodologies the NRSRO uses to 
determine credit ratings, the reason for the changes, and the 
likelihood the changes will result in changes to any current credit 
ratings should benefit investors and other users of credit ratings by 
increasing the transparency of the NRSROs' credit rating activities and 
providing additional information with which to assess the quality of a 
given NRSRO's credit rating processes. Similarly, taking steps to 
ensure that an NRSRO promptly publishes on an easily accessible portion 
of its corporate Internet Web site notice of the existence of a 
significant error identified in a procedure or methodology used to 
determine credit ratings also should benefit investors and other users 
of credit ratings by increasing the transparency of the NRSROs' credit 
rating activities and providing additional information with which to 
assess the quality of a given NRSRO's credit rating processes.
    The records NRSROs must keep pursuant to Rule 17g-2 will be used by 
Commission examiners to evaluate whether a given NRSRO's policies and 
procedures are reasonably designed and the NRSRO is complying with 
them. Compliance with these policies and procedures may increase the 
likelihood that NRSROs apply sound procedures and methodologies 
consistently to all applicable credit ratings and inform investors of 
these procedures and methodologies.
    Relative to the baseline, the Commission anticipates that the final 
rule will result in costs. NRSROs will need to expend resources to 
develop, document, enforce, and periodically modify the policies and 
procedures they establish pursuant to paragraph (a) of Rule 17g-8.
    As stated above, some commenters opposed the proposed rule on the 
basis of cost.\1047\ One of these commenters stated that certain 
aspects of the proposals, including those regarding credit rating 
methodologies, would compound barriers to entry, and that many of the 
rules would be expensive and burdensome to implement.\1048\ More 
specifically, this commenter stated that the Commission should take 
into account the dominance of very large players and expand small NRSRO 
exemptions designed to level the competitive field.\1049\
---------------------------------------------------------------------------

    \1047\ See A.M. Best Letter; Kroll Letter.
    \1048\ See Kroll Letter.
    \1049\ See Kroll Letter.
---------------------------------------------------------------------------

    In response, the Commission acknowledges that these requirements 
will result in costs, which could create competitive barriers. However, 
the Commission reiterates that the final rule is designed to meet the 
rulemaking mandate in section 15E(r) of the Exchange Act in a manner 
that provides flexibility to NRSROs in terms of designing the required 
policies and procedures. Consequently, an NRSRO can tailor its policies 
and procedures to its business model, size, and the scope of its 
activities as well as to its methodologies and procedures for 
determining credit ratings, which, to some degree, may mitigate 
concerns about the costs of the final rule and its potential to create 
barriers to entry for small credit rating agencies. These costs would 
likely be higher for NRSROs with more complex operations in terms of 
the quantity of credit ratings they issue, the different types of 
credit ratings they issue, and the number of locations from which they 
determine and issue credit ratings. Based on analysis for purposes of 
the PRA, the Commission estimates that paragraph (a) of Rule 17g-8 will 
result in total industry-wide one-time costs to NRSROs of approximately 
$566,000 and total industry-wide annual costs to NRSROs of 
approximately $142,000.\1050\
---------------------------------------------------------------------------

    \1050\ See section V.G. of this release (discussing 
implementation and annual compliance considerations). The one-time 
and annual costs are determined by monetizing internal hour burdens 
and adding external costs identified in the PRA analysis in section 
IV.D.7. of this release.
---------------------------------------------------------------------------

    Relative to the baseline, the amendments to Rule 17g-2 prescribing 
retention requirements for the documentation of the policies and 
procedures will result in costs to NRSROs. NRSROs already have 
recordkeeping systems in place to comply with the recordkeeping 
requirements in Rule 17g-2 before today's amendments. Therefore, the 
recordkeeping costs of this rule will be incremental to the costs 
associated with these existing requirements. Specifically, the 
incremental costs will consist largely of updating their record 
retention policies and procedures and retaining and producing the 
additional record. Based on analysis for purposes of the PRA, the 
Commission estimates that paragraph (b)(13) of Rule 17g-2 and the 
amendment to paragraph (c) of Rule 17g-2 will result in total industry-
wide one-time costs to NRSROs of approximately $12,000 and total 
industry-wide annual costs to NRSROs of approximately $3,000.\1051\
---------------------------------------------------------------------------

    \1051\ See section V.G. of this release (discussing 
implementation and annual compliance considerations). The one-time 
and annual costs are determined by monetizing internal hour burdens 
and adding external costs identified in the PRA analysis in section 
IV.D.3. of this release.
---------------------------------------------------------------------------

    The Commission believes that NRSROs will incur costs to apply 
material changes to ratings procedures and methodologies consistently 
to all current credit ratings to which the changed procedures or 
methodologies apply. This cost will likely vary significantly per 
occurrence depending on the number of credit ratings and the type of 
instruments affected by the change as well as the nature and extent of 
the change. In addition, the Commission believes that an NRSRO will 
incur costs when promptly publishing on an easily accessible portion of 
its Internet Web site information about material changes to procedures 
and methodologies, the likelihood such changes will result in changes 
to any current ratings, and notice of significant errors identified in 
a procedure or methodology in accordance with paragraphs (a)(4)(i) and 
(ii) of Rule 17g-8. Based on analysis for purposes of the PRA, the 
Commission estimates that paragraphs (a)(4)(i) and (ii) of Rule 17g-8 
will result in costs to NRSROs of approximately $5,700 per publication 
on their Web site.\1052\
---------------------------------------------------------------------------

    \1052\ See section V.G. of this release (discussing 
implementation and annual compliance considerations). The cost per 
publication is determined by monetizing internal hour burdens and 
adding external costs identified in the PRA analysis in section 
IV.D.7. of this release.
---------------------------------------------------------------------------

    A possible additional cost is that the final rule potentially could 
decrease the quality of credit ratings in circumstances where the 
subjective judgment of participants in the rating process could improve 
the quality of ratings. In order to ensure that material changes to 
ratings procedures and methodologies are applied consistently to all 
current credit ratings to which the changed procedures or methodologies 
apply ``within a reasonable timeframe''

[[Page 55162]]

in accordance with the new rule, an NRSRO may establish credit rating 
procedures and methodologies that diminish the ability of participants 
in the rating process to exercise subjective judgment, which could 
lengthen the rating process. As a result, the credit ratings may not 
benefit fully from the expertise of the analysts in the rating process, 
which could negatively impact the quality of the credit rating. This 
concern may be mitigated by the fact that the new rule does not require 
that the policies and procedures specify a specific timeframe to apply 
the changed procedure or methodology but rather requires that the 
change to be applied within a reasonable period of time, taking into 
consideration the number of credit ratings impacted, the complexity of 
the procedures and methodologies used to determine the credit ratings, 
and the type of obligor, security, or money market instrument being 
rated.
    The amendments and new rule should have a number of effects related 
to efficiency, competition, and capital formation.\1053\ First, these 
amendments could improve the quality and consistency of credit ratings 
as well as increasing the information available to users of credit 
ratings regarding rating procedures and methodologies. As a result, 
users of credit ratings could make more efficient investment decisions 
based on this higher-quality information. Market efficiency also could 
improve if this information is reflected in asset prices. Consequently, 
capital formation could improve as capital may flow to more efficient 
uses with the benefit of this enhanced information. Alternatively, the 
quality of credit ratings may decrease in certain circumstances if an 
NRSRO establishes credit rating procedures and methodologies that 
diminish the ability of participants in the rating process to exercise 
subjective judgment. In this case, the quality of credit ratings may 
decrease, which could decrease the efficiency of investment decisions 
made by users of credit ratings. Market efficiency and capital 
formation may also be adversely impacted if lower quality information 
is reflected in asset prices, which may impede the flow of capital to 
efficient uses. These amendments also will result in costs, some of 
which may have a component that is fixed in magnitude and does not vary 
with the size of the NRSRO. Therefore, the operating costs per credit 
rating of smaller NRSROs may increase relative to that of larger 
NRSROs. Consequently, the costs associated with these amendments may 
have a disproportionate impact on smaller NRSROs as suggested by 
commenters,\1054\ creating adverse effects on competition. For example, 
one commenter suggested that these requirements would require an NRSRO 
to review credit rating methodologies, which would place an undue 
burden on smaller NRSROs.\1055\ As a result of these amendments, the 
barriers to entry for credit rating agencies to register as an NRSRO 
might be higher for credit rating agencies, while some NRSROs, 
particularly smaller firms, may decide to withdraw from registration as 
an NRSRO. As discussed earlier, these costs also will depend on the 
complexity of operations within the NRSRO.
---------------------------------------------------------------------------

    \1053\ See section I.B.3. of this release (providing a broader 
discussion of the potential impacts of the amendments and new rules 
on efficiency, competition, and capital formation).
    \1054\ See A.M. Best Letter; Kroll Letter.
    \1055\ See A.M. Best Letter.
---------------------------------------------------------------------------

    Commenters have proposed a number of alternatives to the final 
rule. One alternative would be to require that NRSROs permit users of 
an NRSRO's credit ratings to sign up for alerts regarding material 
changes and significant errors in an NRSRO's procedures and 
methodologies, which, according to the commenter, ``would significantly 
improve communication.'' \1056\ As stated above, the Commission 
believes that publication on an easily accessible portion of the 
NRSRO's Internet Web site is the most direct and cost effective way to 
ensure that all potentially interested parties have access to the 
required disclosures. Therefore, this alternative without a requirement 
to also disclose the information on the NRSRO's Internet Web site could 
potentially have the result that fewer users of credit ratings are 
informed of changes and errors. For example, certain users of credit 
ratings may opt not to sign up for email notification in order to avoid 
receiving unwanted communications.
---------------------------------------------------------------------------

    \1056\ See CFA/AFR Letter.
---------------------------------------------------------------------------

    Another alternative would be for the Commission to establish a firm 
deadline for the application of revised rating methodologies or 
surveillance or monitoring procedures to current credit ratings to 
ensure that NRSROs act promptly, as suggested by commenters.\1057\ As 
stated above, the Commission is not persuaded that prescribing a 
specific timeframe in which the review must take place is feasible or 
appropriate. For example, some NRSROs have hundreds of thousands of 
credit ratings outstanding in certain classes of credit ratings, while 
others have fewer than one thousand.\1058\ In addition, there is 
variation across NRSROs in the level of resources available to apply 
these changes. For example, the number of credit analysts employed by 
each NRSRO ranges from fewer than ten to more than a thousand.\1059\ 
Consequently, mandating a timeframe that is too short could negatively 
impact the quality of the review of the credit ratings subject to the 
changed surveillance or monitoring procedures and methodologies and 
could result in adjustments to those credit ratings that are not the 
result of thorough analysis. In this case, this alternative could 
result in costs for users of credit ratings who may make credit-based 
decisions using incomplete or inaccurate information. In addition, an 
NRSRO with relatively fewer resources to make the required changes 
might need to incur costs such as hiring more staff to meet the 
deadline. If the mandated timeframe were too long, an NRSRO with 
relatively greater resources could take longer than necessary to apply 
the changed surveillance procedures and methodologies to impacted 
credit ratings.\1060\ In this case, this alternative could result in 
costs for users of credit ratings as information would be updated in a 
less timely fashion than will be the case under the new rule.
---------------------------------------------------------------------------

    \1057\ See Better Markets Letter; CFA/AFR Letter.
    \1058\ See Table 2 in section I.B. of this release.
    \1059\ See Table 1 in section I.B. of this release.
    \1060\ See Harrington Letter (raising this concern).
---------------------------------------------------------------------------

G. Form and Certifications to Accompany Credit Ratings

    Section 932(a)(8) of the Dodd-Frank Act amended section 15E of the 
Exchange Act to add paragraphs (q) and (s).\1061\ Section 15E(q)(2)(F) 
of the Exchange Act provides that the Commission's rules must require 
an NRSRO to include an attestation with any credit rating it issues 
affirming that no part of the rating was influenced by any other 
business activities, that the rating was based solely on the merits of 
the instruments being rated, and that such rating was an independent 
evaluation of the risks and merits of the instrument.\1062\ Sections 
15E(s)(1) through (4), among other things, contain provisions requiring 
Commission rulemaking with respect to disclosures an NRSRO must make 
with the publication of a credit rating.\1063\ The

[[Page 55163]]

Commission proposed paragraph (a) to Rule 17g-7, in large part, to 
implement sections 15E(q) and 15E(s) of the Exchange Act.\1064\
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    \1061\ See 15 U.S.C. 78o-7(q) and (s).
    \1062\ See 15 U.S.C. 78o-7(q)(2)(F).
    \1063\ See Public Law 111-203, 932(a)(8); 15 U.S.C. 78o-7(s)(1) 
through (4). Section 15E(s)(4) of the Exchange Act also establishes 
requirements and mandates rulemaking with respect to issuers and 
underwriters of asset-backed securities, NRSROs, and providers of 
third-party due diligence services with respect to third-party due 
diligence services relating to asset-backed securities. See 15 
U.S.C. 78o-7(s)(4)(A) through (D). As discussed in more detail below 
in section II.H. of this release, the Commission also proposed to 
implement section 15E(s)(4) of the Exchange Act through: (1) Rule 
15Ga-2; (2) amendments to Form ABS-15G; (3) Rule 17g-10; and (4) 
Form ABS Due Diligence-15E. Nationally Recognized Statistical Rating 
Organizations, 76 FR at 33465-33476.
    \1064\ See paragraph (a) of Rule 17g-7, as proposed; Nationally 
Recognized Statistical Rating Organizations, 76 FR at 33456-33465.
---------------------------------------------------------------------------

    Under the proposal, an NRSRO would be required to publish two items 
when taking a rating action: (1) A form containing information about 
the credit rating resulting from or subject to the rating action; and 
(2) any certification of a provider of third-party due diligence 
services received by the NRSRO that relates to the credit rating.\1065\ 
The proposal also included provisions prescribing the format of the 
form; the content of the form; and an attestation requirement for the 
form.\1066\ The Commission is adopting paragraph (a) to Rule 17g-7 with 
modifications in response to comments.\1067\
---------------------------------------------------------------------------

    \1065\ See paragraph (a) of Rule 17g-7, as proposed; Nationally 
Recognized Statistical Rating Organizations, 76 FR at 33456-33465.
    \1066\ See paragraph (a) of Rule 17g-7, as proposed; Nationally 
Recognized Statistical Rating Organizations, 76 FR at 33456-33465.
    \1067\ See paragraph (a) of Rule 17g-7.
---------------------------------------------------------------------------

1. Paragraph (a) of Rule 17g-7--Prefatory Text
    Section 15E(s)(1) of the Exchange Act provides that the Commission 
shall require, by rule, an NRSRO to prescribe a form to accompany the 
publication of each credit rating that discloses: (1) Information 
relating to the assumptions underlying the credit rating procedures and 
methodologies; the data that was relied on to determine the credit 
rating; and if applicable, how the NRSRO used servicer or remittance 
reports, and with what frequency, to conduct surveillance of the credit 
rating; and (2) information that can be used by investors and other 
users of credit ratings to better understand credit ratings in each 
class of credit rating issued by the NRSRO.\1068\ Section 15E(s)(2)(C) 
of the Exchange Act provides that the form shall be made readily 
available to users of credit ratings, in electronic or paper form, as 
the Commission may, by rule, determine.\1069\ Section 15E(s)(4)(D) of 
the Exchange Act provides that the Commission shall adopt rules 
requiring an NRSRO at the time it produces a credit rating to disclose 
any certifications from providers of third-party due diligence services 
to the public in a manner that allows the public to determine the 
adequacy and level of due diligence services provided by the third 
party.\1070\
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    \1068\ See 15 U.S.C. 78o-7(s)(1)(A) and (B).
    \1069\ See 15 U.S.C. 78o-7(s)(2)(C).
    \1070\ See 15 U.S.C. 78o-7(s)(4)(D).
---------------------------------------------------------------------------

    The Commission proposed to implement sections 15E(s)(1), 
15E(s)(2)(C), and 15E(s)(4)(D) of the Exchange Act, in large part, 
through the prefatory text of proposed paragraph (a) of Rule 17g-
7.\1071\ As proposed, the prefatory text provided that an NRSRO must 
publish two items when taking a rating action: (1) A form containing 
information about the credit rating resulting from or subject to the 
rating action;\1072\ and (2) any certification of a provider of third-
party due diligence services received by the NRSRO that relates to the 
credit rating.\1073\ The first sentence of the prefatory text further 
provided that an NRSRO must publish the form and certification, as 
applicable, when taking a rating action with respect to a credit rating 
assigned to an obligor, security, or money market instrument in a class 
of credit ratings for which the NRSRO is registered.\1074\ The second 
sentence of the prefatory text defined the term rating action for 
purposes of the rule to mean any of the following: The publication of 
an expected or preliminary credit rating assigned to an obligor, 
security, or money market instrument before the publication of an 
initial credit rating; an initial credit rating; an upgrade or 
downgrade of an existing credit rating (including a downgrade to, or 
assignment of, default); a placement of an existing credit rating on 
credit watch or review; an affirmation of an existing credit rating; 
and a withdrawal of an existing credit rating.\1075\ The third sentence 
of the prefatory text provided that the form and any applicable 
certifications must be published in the same medium and made available 
to the same persons who can receive or access the credit rating that is 
the result of the rating action or the subject of rating action.\1076\
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    \1071\ See prefatory text of paragraph (a) of Rule 17g-7, as 
proposed; Nationally Recognized Statistical Rating Organizations, 76 
FR at 33456-33457. As discussed below, the Commission proposed to 
implement section 15E(s)(1)(A)(iii) of the Exchange Act--which 
relates to the use of servicer or remittance reports--in paragraph 
(a)(1)(ii)(G) of Rule 17g-7, as proposed, because it specifies a 
particular item of information that would need to be disclosed in 
the form. See 15 U.S.C. 78o-7(a)(1)(i)(G); Nationally Recognized 
Statistical Rating Organizations, 76 FR at 33461.
    \1072\ See paragraph (a)(1) of Rule 17g-7, as proposed; 
Nationally Recognized Statistical Rating Organizations, 76 FR at 
33540.
    \1073\ See paragraph (a)(2) of Rule 17g-7, as proposed; 
Nationally Recognized Statistical Rating Organizations, 76 FR at 
33541-33542.
    \1074\ See prefatory text to paragraph (a) of Rule 17g-7, as 
proposed; Nationally Recognized Statistical Rating Organizations, 76 
FR at 33540.
    \1075\ See prefatory text to paragraph (a) of Rule 17g-7, as 
proposed; Nationally Recognized Statistical Rating Organizations, 76 
FR at 33540.
    \1076\ See prefatory text to paragraph (a) of Rule 17g-7, as 
proposed; Nationally Recognized Statistical Rating Organizations, 76 
FR at 33540.
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    The Commission is adopting the first sentence of the prefatory text 
of paragraph (a) of Rule 17g-7 with a modification in response to 
comment.\1077\ As adopted, this sentence provides that except as 
provided in paragraph (a)(3), an NRSRO must publish the items described 
in paragraphs (a)(1) (the form) and (a)(2) (third-party due diligence 
certifications), as applicable, when taking a rating action with 
respect to a credit rating assigned to an obligor, security, or money 
market instrument in a class of credit ratings for which the NRSRO is 
registered.\1078\
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    \1077\ See Fitch Letter; prefatory text of paragraph (a) of Rule 
17g-7 (first sentence). The modification, as discussed below, refers 
to an exemption the Commission is adopting from the publication 
requirement for certain rating actions that relate to a non-U.S. 
person and transactions that occur overseas. See paragraph (a)(3) of 
Rule 17g-7.
    \1078\ See prefatory text of paragraph (a) of Rule 17g-7 (first 
sentence).
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    The Commission is adopting the second sentence of the prefatory 
text of paragraph (a) of Rule 17g-7 with modifications to narrow the 
definition of rating action in response to comments.\1079\ Several 
commenters stated generally that the proposed definition is overly 
broad.\1080\ One NRSRO stated that a broad definition of rating action 
could limit disclosure by ``creating incentives for NRSROs to publish 
commentary about their credit ratings less frequently.''\1081\ 
Commenters stated that the proposed definition of rating action would 
make it difficult for NRSROs to release their credit ratings in a 
timely fashion.\1082\ One commenter stated that rating actions 
involving transaction documents that were finalized before the 
effective date of the rules should not be subject to the disclosure 
requirements.\1083\ An NRSRO stated that the amount of preparation time 
needed to comply with the rule will likely delay the issuance of 
ratings, ``particularly with respect to preliminary ratings.''\1084\ In 
contrast,

[[Page 55164]]

another commenter stated that including preliminary ratings on asset-
backed securities ratings will ensure that investors receive the 
information at a time when it is ``likely to be most useful to them in 
making an investment decision.'' \1085\
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    \1079\ See prefatory text of paragraph (a) of Rule 17g-7 (second 
sentence).
    \1080\ See A.M. Best Letter; ASF Letter; DBRS Letter; Deloitte 
Letter; FSR Letter; Moody's Letter; S&P Letter.
    \1081\ See Moody's Letter.
    \1082\ See DBRS Letter; FSR Letter.
    \1083\ See ABA Letter.
    \1084\ See S&P Letter.
    \1085\ See CFA/AFR Letter.
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    As explained below, commenters urged the Commission to eliminate 
from the definition of rating action: Preliminary credit ratings; 
placements of credit ratings on watch or review; affirmations and 
confirmations of credit ratings; and withdrawals of credit 
ratings.\1086\
---------------------------------------------------------------------------

    \1086\ See, e.g., A.M. Best Letter; ASF Letter; DBRS Letter; 
Deloitte Letter; FSR Letter; Moody's Letter; S&P Letter.
---------------------------------------------------------------------------

    One NRSRO commented that placing a credit rating on review should 
not be considered a rating action because a review is simply an 
indication of the potential for a future rating action, and is not 
itself a rating action.\1087\ Several commenters stated that some or 
all rating affirmations should not be included in the definition of a 
rating action.\1088\ One NRSRO stated that including rating 
affirmations would ``significantly'' increase the reporting burden on 
NRSROs, and would produce only a record that there was no change to the 
rating in question.\1089\ The NRSRO also suggested that if affirmations 
are included, they should refer only to a published announcement or 
written confirmation that the rating is being maintained at its current 
level. Another commenter stated that affirmations should be excluded 
unless they represent ``a comprehensive review of a transaction.'' 
\1090\ A different commenter stated that a ``confirmation,'' which is a 
type of affirmation that simply indicates that a particular action will 
not change a credit rating, should not constitute a rating action 
because disclosures associated with confirmations would only cover very 
minor document changes and add ``little value.''\1091\
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    \1087\ See Moody's Letter.
    \1088\ See A.M. Best Letter; ASF Letter; DBRS Letter; Deloitte 
Letter; FSR Letter; Moody's Letter; S&P Letter.
    \1089\ See S&P Letter.
    \1090\ See ASF Letter.
    \1091\ See FSR Letter.
---------------------------------------------------------------------------

    Two commenters stated that some or all withdrawals should not be 
included in the definition of a rating action.\1092\ One NRSRO stated 
that publishing the forms for withdrawals that are ``mechanical in 
nature and not based on a credit assessment or analysis'' could make it 
more difficult for market participants to locate significant 
information.\1093\
---------------------------------------------------------------------------

    \1092\ See Deloitte Letter; Moody's Letter.
    \1093\ See Moody's Letter.
---------------------------------------------------------------------------

    The Commission is sensitive to the burdens imposed by its rules, 
and in considering the comments discussed above has sought to balance 
the need for timely and robust disclosure with concerns about the costs 
that would result from the proposal. As discussed below, the Commission 
believes it is appropriate to narrow the definition of rating action 
from the proposed definition to include those actions that are made at 
a time when there is limited information about the rated obligor, 
security, or money market instrument and to other rating actions if 
they are linked to the performance of credit analysis. This will reduce 
the burden of complying with the rule. Nonetheless, the Commission 
recognizes that preparing the form in response to those rating actions 
that trigger the disclosure requirement will take time and that this 
could impact how quickly an NRSRO is able to publish the credit rating 
that results from or is the subject of the rating action. However, the 
Commission has balanced this concern with the directive of the statute 
(that the Commission adopt a rule requiring the form to be published 
with a credit rating) and the benefits of the increased transparency 
the disclosures in the form will provide to users of the NRSRO's credit 
ratings.\1094\ Moreover, an NRSRO should be able to draft significant 
portions of the form largely in tandem with the credit rating process 
and, therefore, the form and the final decision on the rating action 
generally should be completed simultaneously.
---------------------------------------------------------------------------

    \1094\ See, e.g., CFA/AFR Letter (``One reason rating agencies 
were able to play fast and loose with their own rating methodologies 
is that the ratings were a sort of `black box,' with little 
information made available to the users of those ratings about the 
assumptions that lay behind them or the data on which they were 
based. Dodd-Frank includes provisions to address this problem by 
requiring new disclosures to accompany the publication of a 
rating.'').
---------------------------------------------------------------------------

    In response to the comment to eliminate preliminary credit ratings 
from the definition of rating action, the Commission notes that this 
type of rating action and certain initial credit ratings (that is, 
those assigned to a newly formed obligor or newly issued security or 
money market instrument) are made at a time when there is little 
information available about the rated obligor, security, or money 
market instrument. Given the timing of these rating actions, the 
Commission agrees with comments that it is critical that investors and 
other users of credit ratings have access to the information that is 
required to be disclosed in the form and any applicable certifications 
on Form ABS Due Diligence-15E.\1095\ Consequently, the Commission is 
adopting the requirement that the form and certifications be published 
when the NRSRO publishes a preliminary or expected credit rating or an 
initial credit rating.\1096\
---------------------------------------------------------------------------

    \1095\ See CFA/AFR Letter (``Importantly, the Commission 
proposes to include preliminary ratings among the actions that would 
trigger the required disclosures. We strongly support this approach, 
which is essential to ensure that investors in ABS get the 
information at time [sic] when it is likely to be most useful to 
them in making an investment decision.''). As the Commission 
explained when adopting Rule 17g-7, the definition of credit rating 
in the note to the rule was designed to address pre-sale reports, 
which are typically issued by an NRSRO with respect to an asset-
backed security at the time the issuer commences the offering and 
typically include an expected or preliminary rating and a summary of 
the important features of a transaction. See Disclosure for Asset-
Backed Securities Required by Section 943 of the Dodd-Frank Wall 
Street Reform and Consumer Protection Act, 76 FR at 4503-4505 (Jan. 
26, 2011). Consequently, disclosure at the time of issuance of a 
pre-sale report is particularly important to investors, since such 
reports provide them with important information prior to the point 
at which they make an investment decision. See id.
    \1096\ See prefatory text of paragraph (a) of Rule 17g-7 (second 
sentence). The Commission requested comment in the proposing release 
as to whether the disclosures required by the proposed rule in the 
context of a new offering should be provided no later than at least 
five business days in advance of the first sale of securities in the 
offering. See Nationally Recognized Statistical Rating 
Organizations, 76 FR at 33457. In response, an NRSRO stated that 
requiring disclosures in a fixed timeframe is ``unrealistic'' 
because NRSROs often receive their information after the prospectus 
is filed and frequently assign ratings well after the actual closing 
and first sale of a transaction. S&P Letter. Another NRSRO and a 
commenter stated that the five business day requirement could 
potentially delay many issuances. See DBRS Letter; FSR Letter. In 
contrast, one commenter recommended that the Commission adopt the 
five business day requirement. See CFA/AFR Letter. The Commission 
believes at this time that the five business day requirement could 
raise practical issues and, therefore, is not adopting such a 
requirement. Consequently, the NRSRO must publish the form and any 
certifications at the same time the NRSRO publishes the result of 
the rating action.
---------------------------------------------------------------------------

    Some of the types of rating actions included in the proposed 
definition are not necessarily linked to the performance of credit 
analysis. In particular, placements of credit ratings on watch or 
review, certain types of affirmations of credit ratings, and certain 
types of withdrawals of credit ratings are not based on the NRSRO 
applying its rating procedures or methodologies and making a credit 
rating determination. In the case of a watch or review, the rating 
action precedes the application of the rating procedure or methodology, 
which, once completed, may result in an affirmation or an adjustment 
(upgrade or downgrade) to the credit rating. However, not all credit 
rating

[[Page 55165]]

affirmations are based on the NRSRO applying its rating procedures and 
methodologies.\1097\ Similarly, NRSROs withdraw credit ratings for a 
number of reasons that are unrelated to the performance of credit 
analysis, including that the obligation was paid off or the obligor 
stopped paying to be rated.\1098\
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    \1097\ See ASF Letter (stating that a ``rating agency consent'' 
or ``rating agency confirmation'' simply confirms that a specific 
contractual change will not result in adverse effect on an existing 
rating and arguing that these ``statements do not reflect a 
comprehensive review of a transaction, unlike the type of review 
that would be undertaken in connection with an affirmation of a 
rating following on the placement of a rating on watch or 
review.'').
    \1098\ See Moody's Letter (stating that the requirement to 
publish a form should not apply in connection with the withdrawals 
of credit ratings that are mechanical in nature and not based on a 
credit assessment or analysis).
---------------------------------------------------------------------------

    In balancing the concerns of commenters about the burden of the 
rule against the need for timely and robust disclosure, the Commission, 
as stated above, believes it is appropriate to focus the disclosure 
requirement on rating actions that are based on the application of the 
NRSRO's procedures and methodologies for determining credit ratings. In 
this regard, much of the information required to be disclosed in the 
form under section 15E(s)(3) of the Exchange Act relates to the 
procedures, methodologies, and information used to determine the credit 
rating.\1099\ For these reasons, placements of credit ratings on watch 
or review have been removed from the definition of rating action.\1100\ 
In addition, the definition provides that an affirmation or withdrawal 
is a rating action if the affirmation or withdrawal is the result of a 
review of the credit rating assigned to the obligor, security, or money 
market instrument by the NRSRO using its procedures and methodologies 
for determining credit ratings.\1101\
---------------------------------------------------------------------------

    \1099\ See 15 U.S.C. 78o-7(s)(3). For example, the required 
disclosures include: (1) The version of the methodology used to 
determine the credit rating; and (2) the main assumptions and 
principles used in constructing the applicable rating procedures and 
methodologies.
    \1100\ See prefatory text of paragraph (a) of Rule 17g-7 (second 
sentence).
    \1101\ See id. An affirmation that results from a look-back 
review under paragraph (c) of Rule 17g-8 would be an affirmation 
that is the result of a review of the credit rating assigned to the 
obligor, security, or money market instrument by the NRSRO using its 
procedures and methodologies for determining credit ratings. In 
particular, the NRSRO would be applying the procedures required by 
paragraph (c)(1) of Rule 17g-8 to promptly determine whether the 
current credit rating assigned to the obligor, security, or money 
market instrument must be revised so that it no longer is influenced 
by a conflict of interest and is solely a product of the documented 
procedures and methodologies the NRSRO uses to determine credit 
ratings.
---------------------------------------------------------------------------

    For the foregoing reasons, the amendments have been modified from 
the proposal to eliminate placements of credit ratings on watch or 
review from the definition of rating action and to eliminate from the 
definition affirmations and withdrawals that are not based on the NRSRO 
applying its procedures and methodologies for determining credit 
ratings. Consequently, the second sentence--as adopted--provides that 
the term rating action ``means any of the following: The publication of 
an expected or preliminary credit rating assigned to an obligor, 
security, or money market instrument before the publication of an 
initial credit rating; an initial credit rating; an upgrade or 
downgrade of an existing credit rating (including a downgrade to, or 
assignment of, default); and an affirmation or withdrawal of an 
existing credit rating if the affirmation or withdrawal is the result 
of a review of the credit rating assigned to the obligor, security, or 
money market instrument by the NRSRO using applicable procedures and 
methodologies for determining credit ratings.'' \1102\
---------------------------------------------------------------------------

    \1102\ See prefatory text of paragraph (a) of Rule 17g-7 (second 
sentence).
---------------------------------------------------------------------------

    The Commission is making another modification to the proposed 
amendments that will reduce the burden of the adopted rule. 
Specifically, one NRSRO recommended that the temporary conditional 
exemption for foreign transactions from the requirements in paragraph 
(a)(3) of Rule 17g-5 be applied to the disclosure requirements in 
paragraph (a) of Rule 17g-7, as proposed.\1103\ The commenter stated 
that many foreign issuers lack the infrastructure to comply with the 
level of disclosure required by paragraphs (a)(1) and (a)(2) of Rule 
17g-7, as proposed.\1104\ The commenter stated further that, without an 
exemption, ``NRSROs either might be unable to issue a credit rating on 
non-U.S. securities or must withdraw as an NRSRO in order to continue 
rating certain non-U.S. securities.'' \1105\
---------------------------------------------------------------------------

    \1103\ See Fitch Letter. See Order Granting Temporary 
Conditional Exemption for Nationally Recognized Statistical Rating 
Organizations from Requirements of Rule 17g-5 Under the Securities 
Exchange Act of 1934 and Request for Comment, Exchange Act Release 
No. 62120 (May 19, 2010). See also Order Extending Temporary 
Conditional Exemption for Nationally Recognized Statistical Rating 
Organizations from Requirements of Rule 17g-5 Under the Securities 
Exchange Act of 1934 and Request for Comment, Exchange Act Release 
No. 70919 (Nov. 22, 2013) (most recent extension of the exemption).
    \1104\ See Fitch Letter.
    \1105\ See id.
---------------------------------------------------------------------------

    The Commission is persuaded that at this time the disclosure 
requirement should not apply to rating actions involving credit ratings 
of obligors or issuers whose securities or money market instruments 
will be offered or sold in transactions that occur exclusively outside 
the United States. As noted above, one commenter suggested that local 
laws could impede the ability of the NRSRO to obtain or disclose 
information about the issuer in accordance with the requirements of the 
proposed amendments. To address these types of concerns, the Commission 
is adding paragraph (a)(3) to Rule 17g-7 to provide an exemption from 
the requirements of paragraphs (a)(1) and (a)(2) for rating actions in 
which: (1) The rated obligor or issuer of the rated security or money 
market instrument is not a U.S. person (as defined under Securities Act 
Rule 902(k)); \1106\ and (2) the NRSRO has a reasonable basis to 
conclude that a security or money market instrument issued by the rated 
obligor or the issuer will be offered and sold upon issuance, and that 
any underwriter or arranger linked to the security or money market 
instrument will effect transactions in the security or money market 
instrument after issuance, only in transactions that occur outside the 
United States.\1107\ The wording of the exemption is modeled closely on 
the temporary conditional exemption from the requirements in paragraph 
(a)(3) of Rule 17g-5 the Commission has granted by order.\1108\

[[Page 55166]]

As stated above, the Commission is making a corresponding modification 
to the first sentence of the prefatory text of paragraph (a) of Rule 
17g-7, to add that an NRSRO must publish the items described in 
paragraphs (a)(1) and (a)(2) of Rule 17g-7 ``except as provided in 
paragraph (a)(3)'' of Rule 17g-7.\1109\
---------------------------------------------------------------------------

    \1106\ 17 CFR 230.902(k).
    \1107\ See paragraph (a)(3) of Rule 17g-7. If the rating action 
involves a credit rating of an obligor as an entity, the NRSRO must 
have a reasonable basis to conclude that any security or money 
market instrument of the obligor will be offered and sold upon 
issuance, and that any underwriter or arranger linked to the 
security or money market instrument will effect transactions of the 
security or money market instrument after issuance, only in 
transactions that occur outside the United States. For example, if 
some securities or money market instruments issued by the obligor 
are sold in transactions that occur in the United States, the 
exemption does not apply to rating actions involving the credit 
rating assigned to the obligor as an entity. In contrast, if the 
rating action involves a security or money market instrument, the 
NRSRO need only make the required conclusion with respect to the 
specific issuance.
    \1108\ See Order Granting Temporary Conditional Exemption for 
Nationally Recognized Statistical Rating Organizations from 
Requirements of Rule 17g-5 Under the Securities Exchange Act of 1934 
and Request for Comment, Exchange Act Release No. 62120 (May 19, 
2010). See also Order Extending Temporary Conditional Exemption for 
Nationally Recognized Statistical Rating Organizations from 
Requirements of Rule 17g-5 Under the Securities Exchange Act of 1934 
and Request for Comment, Exchange Act Release No. 70919 (Nov. 22, 
2013) (most recent extension of the exemption). In the original 
order, the Commission provided guidance on how an NRSRO may have a 
``reasonable basis'' for the purpose of the second prong of the 
conditional exemption. See Order Granting Temporary Conditional 
Exemption for Nationally Recognized Statistical Rating Organizations 
from Requirements of Rule 17g-5 Under the Securities Exchange Act of 
1934 and Request for Comment, Exchange Act Release No. 62120 (May 
19, 2010) (``The question of whether an NRSRO has a `reasonable 
basis' to conclude that the structured finance product will be 
offered and sold upon issuance, and [that] any arranger linked to 
the structured finance product will effect transactions of the 
structured finance product after issuance, in transactions that 
occur outside the United States will depend on the facts and 
circumstances of a given situation. In order to have a reasonable 
basis to make these conclusions, the NRSRO should discuss with any 
arranger linked to the structured finance product (i.e., the 
sponsor, underwriter, and issuer) how they intend to market and sell 
the structured finance product and how they intend to engage in any 
secondary market activities (i.e., re-sales) of the structured 
finance product. An NRSRO may choose to obtain from the arranger a 
representation upon which the NRSRO can reasonably rely that sales 
of the structured finance product will meet this condition. Factors 
relevant to the analysis of whether such reliance would be 
reasonable would include, but not be limited to: (1) Ongoing or 
prior failures by the arranger to adhere to its representations; or 
(2) a pattern of conduct by the arranger where it fails to promptly 
correct breaches of its representations.'').
    \1109\ See prefatory text of paragraph (a) of Rule 17g-7 (first 
sentence).
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    The Commission is adopting the third sentence of the prefatory text 
of paragraph (a) of Rule 17g-7 with technical modifications to improve 
its clarity.\1110\ This sentence provides that the items described in 
paragraphs (a)(1) and (a)(2) must be published in the same manner as 
the credit rating that is the result or subject of the rating action 
and made available to the same persons who can receive or access the 
credit rating that is the result or subject of the rating action.\1111\ 
In response to comments, the Commission agrees that an NRSRO may 
satisfy this requirement by publishing the form and any applicable 
certifications on its public Internet Web site if the credit rating is 
disseminated through the Web site as well.\1112\ In addition, if the 
NRSRO publishes the credit rating in a press release announcing the 
relevant rating action in addition to publishing the credit rating on 
its corporate Internet Web site, the NRSRO may make the form available 
through a clearly and prominently labeled hyperlink on the press 
release to the page on its corporate Internet Web site that contains 
the form and any applicable certifications.\1113\
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    \1110\ See prefatory text of paragraph (a) of Rule 17g-7 (third 
sentence).
    \1111\ See id. As proposed, the sentence provided: ``[t]he items 
described in paragraphs (a)(1) and (a)(2) of this section must be 
published in the same medium and made available to the same persons 
who can receive or access the credit rating that is the result of 
the rating action or that is the subject of the rating action.'' See 
Nationally Recognized Statistical Rating Organizations, 76 FR at 
33540.
    \1112\ See S&P Letter.
    \1113\ See DBRS Letter (``DBRS supports this part of the 
proposal, but asks the Commission to confirm that an NRSRO that 
publishes its credit ratings via an electronically disseminated 
press release can satisfy the disclosure requirement by hyperlinking 
the disclosure form and any applicable due diligence certifications 
to that press release.'').
---------------------------------------------------------------------------

    In addition, the final amendments, as proposed, require that the 
form and any applicable certifications on Form ABS Due Diligence-15E 
must be made available to the same persons who can receive or access 
the credit rating that is the result of the rating action.\1114\ 
Consequently, if the NRSRO publishes credit ratings for free on its 
corporate Internet Web site, it must make the form and certifications 
similarly available.\1115\ Alternatively, if the NRSRO operates under 
the subscriber-pay business model, it must make the form and 
certifications available to its subscribers.\1116\
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    \1114\ See prefatory text of paragraph (a) of Rule 17g-7 (third 
sentence).
    \1115\ See Nationally Recognized Statistical Rating 
Organizations, 76 FR at 33457.
    \1116\ See id. at 33457.
---------------------------------------------------------------------------

    Finally, one commenter suggested the assessment of financial 
penalties for each day that NRSROs do not post the form when taking a 
rating action.\1117\ The Commission has authority to take appropriate 
action against an NRSRO that fails to comply with the requirements of 
paragraph (a) of Rule 17g-7. Further, as discussed above in section 
II.D.1. of this release, the Exchange Act provides a wide range of 
fines, penalties, and other sanctions applicable to NRSROs for 
violations of any section of the Exchange Act (including section 15E) 
and the rules under the Exchange Act (including the rules under section 
15E).\1118\ The Commission therefore does not believe that providing 
for additional penalties is necessary.
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    \1117\ See Gardner Letter.
    \1118\ See 15 U.S.C. 78o-7(d); 15 U.S.C. 78u; 15 U.S.C. 78u; 15 
U.S.C. 78u-2; 15 U.S.C. 78u-3; 15 U.S.C. 78ff.
---------------------------------------------------------------------------

2. Paragraph (a)(1)(i) of Rule 17g-7--Format of the Form
    To implement sections 15E(s)(2)(A) and (B) of the Exchange Act, the 
Commission proposed paragraph (a)(1)(i) of Rule 17g-7, which would 
describe the required format of the form to accompany the publication 
of a rating action.\1119\ In particular, section 15E(s)(2)(A) of the 
Exchange Act provides that the form developed by the NRSRO shall be 
easy to use and helpful for users of credit ratings to understand the 
information contained in the report.\1120\ The Commission proposed 
paragraph (a)(1)(i)(A) of Rule 17g-7 to implement this section of the 
statute.\1121\ This paragraph--as proposed--mirrored the statutory text 
by providing that the form generated by the NRSRO would need to be easy 
to use and helpful for users of credit ratings to understand the 
information contained in the form.\1122\
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    \1119\ See paragraph (a)(1) of Rule 17g-7, as proposed; 
Nationally Recognized Statistical Rating Organizations, 76 FR at 
33458.
    \1120\ See 15 U.S.C. 78o-7(s)(2)(A).
    \1121\ See paragraph (a)(1) of Rule 17g-7, as proposed; 
Nationally Recognized Statistical Rating Organizations, 76 FR at 
33458.
    \1122\ See paragraph (a)(1)(i)(A) of Rule 17g-7, as proposed; 
Nationally Recognized Statistical Rating Organizations, 76 FR at 
33540.
---------------------------------------------------------------------------

    Section 15E(s)(2)(B) of the Exchange Act provides that the 
quantitative content required to be disclosed in the form and 
identified in section 15E(s)(3)(B) must be directly comparable across 
types of securities.\1123\ As discussed below, section 15E(s)(3) of the 
Exchange Act identifies qualitative and quantitative information that 
must be included in the form.\1124\ The Commission proposed that the 
quantitative content specified in section 15E(s)(3)(B) of the Exchange 
Act must be disclosed in the form pursuant to paragraphs (a)(1)(ii)(K), 
(L), and (M) of Rule 17g-7, as proposed.\1125\ Consequently, paragraph 
(a)(1)(i)(B) of Rule 17g-7, as proposed, required the form generated by 
the NRSRO to be in a format that provides the content described in 
paragraphs (a)(1)(ii)(K), (L), and (M) of Rule 17g-7 in a manner that 
is directly comparable across types of obligors, securities, and money 
market instruments.\1126\
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    \1123\ See 15 U.S.C. 78o-7(s)(3)(B).
    \1124\ See 15 U.S.C. 78o-7(s)(3).
    \1125\ See paragraphs (a)(1)(ii)(K), (L), and (M) of Rule 17g-7, 
as proposed; Nationally Recognized Statistical Rating Organizations, 
76 FR at 33458-33646.
    \1126\ See paragraph (a)(1)(i)(B) of Rule 17g-7, as proposed; 
Nationally Recognized Statistical Rating Organizations, 76 FR at 
33540. While the statutory text refers only to ``securities,'' 
section 3(a)(60) of the Exchange Act defines the term credit rating 
to mean an ``assessment of the creditworthiness of an obligor as an 
entity or with respect to specific securities or money market 
instruments.'' See 15 U.S.C. 78c(a)(60). Consequently, proposed 
paragraph (a)(1)(i)(B) of Rule 17g-7 also referred to ``obligors'' 
and ``money market instruments'' to ensure that it applies to all 
types of credit ratings and to be consistent with the Commission's 
rules for NRSROs, which commonly apply to credit ratings of 
``obligors, securities, and money market instruments.'' Nationally 
Recognized Statistical Rating Organizations, 76 FR at 33458, n.411.
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    The Commission is adopting the proposal with modifications in 
response to comments.\1127\ The modifications are

[[Page 55167]]

designed to respond to comments recommending that the rule prescribe a 
standard format for presenting the information in the form.\1128\
---------------------------------------------------------------------------

    \1127\ See paragraph (a)(1)(i) of Rule 17g-7.
    \1128\ See id.
---------------------------------------------------------------------------

    In particular, as proposed, the rule would require that the form, 
among other things, must be in a format that is easy to use and helpful 
for users of credit ratings to understand.\1129\ However, the proposal 
did not prescribe a form into which NRSROs would input information or 
provide more specificity as to how the information in the form must be 
presented. Two commenters recommended that the format of the form 
should be more standardized.\1130\ One commenter stated that 
standardization would simplify oversight and make the information in 
the form easier for investors to analyze.\1131\ The other commenter 
suggested standard headings and prescribing an order for the 
presentation of the information in the form.\1132\ The Commission 
agrees with the commenters that requiring the NRSROs to adhere to a 
more standardized format will assist users of the form in locating and 
analyzing items of information disclosed in the form. It also will 
facilitate the Commission's oversight of the disclosure requirements, 
as noted by the commenter. Consequently, paragraph (a)(1)(i) of Rule 
17g-7 provides that the form must be in a format that organizes the 
information required to be disclosed into numbered items that are 
identified by the type of information being disclosed and by a 
reference to the paragraph in Rule 17g-7 that specifies the information 
required to be disclosed, and are in the order that the paragraphs 
specifying the information to be disclosed are codified in Rule 17g-
7.\1133\ In addition, as adopted, paragraph (a)(1)(i) of Rule 17g-7 
contains a note providing details about this requirement--in 
particular, stating that a given item in the form should be identified 
by a title that identifies the type of information and references 
paragraph (a)(1)(ii)(A), (B), (C), (D), (E), (F), (G), (H), (I), (J), 
(K), (L), (M), (N), or (a)(2) of Rule 17g-7, based on the information 
being disclosed in the item.\1134\ The note provides the example that 
the item on the form containing the information specified in paragraph 
(a)(1)(ii)(C) of Rule 17g-7 should be captioned: ``Main Assumptions and 
Principles Used to Construct the Rating Methodology used to Determine 
the Credit Rating as required by Paragraph (a)(1)(ii)(C) of Rule 17g-
7.'' \1135\ The note also explains that the form must organize the 
items of information in the following order: Items 1 through 14 must 
contain the information specified in paragraphs (a)(1)(ii)(A) through 
(N) of Rule 17g-7, respectively, and item 15 must contain the 
certifications specified in paragraph (a)(2) of Rule 17g-7.\1136\
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    \1129\ See paragraph (a)(1)(i)(A) of Rule 17g-7, as proposed; 
Nationally Recognized Statistical Rating Organizations, 76 FR at 
33540.
    \1130\ See CFA/AFR Letter; Levin Letter.
    \1131\ See Levin Letter.
    \1132\ See CFA/AFR Letter.
    \1133\ See paragraph (a)(1)(i)(A) of Rule 17g-7, and the 
accompanying note to the paragraph. This approach, specifying the 
order in which the information must be presented, is consistent with 
the amendments to the instructions for Exhibit 1 to Form NRSRO being 
adopted today, which specify the order in which the Transition/
Default Matrices must presented in the Exhibit. See paragraph (2) of 
the instructions for Exhibit 1 to Form NRSRO. See also section 
II.E.1.c. of this release discussing the amendments to the 
instructions for Exhibit 1 to Form NRSRO.
    \1134\ See note to paragraph (a)(1)(i)(A) of Rule 17g-7. See 
also paragraphs (a)(1)(ii)(A) through (N) and (a)(2) of Rule 17g-7. 
As discussed below in section II.G.3. of this release, paragraphs 
(a)(1)(ii)(A) through (N) and (a)(2) of Rule 17g-7 specify the types 
of information that must be disclosed in the form.
    \1135\ See note to paragraph (a)(1)(i)(A) of Rule 17g-7.
    \1136\ See id.
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    Several NRSROs stated that a standardized form may discourage 
NRSROs from providing more transparency.\1137\ Another NRSRO stated 
that if formatted disclosure is ultimately required, ``the Commission 
should provide sufficient flexibility to allow for disclosure that is 
meaningful in the context provided.'' \1138\ The Commission believes 
the approach it has taken in prescribing a standardized format for 
presenting the information in the form without, for example, requiring 
that a prescribed form be filled out, strikes an appropriate balance in 
implementing section 15E(s)(2) of the Exchange Act between the 
comparability of the information provided across NRSROs and the 
flexibility to allow for meaningful disclosure. For example, the final 
amendments--while prescribing certain formatting requirements--
generally permit an NRSRO to design the form that will be used to make 
the disclosure. Thus, an NRSRO can tailor the form to specific classes 
or subclasses of credit ratings to provide more targeted information.
---------------------------------------------------------------------------

    \1137\ See DBRS Letter; Morningstar Letter; S&P Letter.
    \1138\ See Kroll Letter.
---------------------------------------------------------------------------

    The proposed amendments required that the form must be in a format 
that is easy to use and helpful for users of credit ratings to 
understand the information contained in the form.\1139\ The proposed 
rule text closely mirrored section 15E(s)(2)(A) of the Exchange 
Act.\1140\ The modifications discussed above prescribing a standard for 
presenting the information in the form are specifically designed to 
achieve the objective set forth in section 15E(s)(2)(A) and the 
proposed rule. However, the final amendments, as proposed, include the 
more general requirement that the form must be in a format that is 
``easy to use and helpful for users of credit ratings to understand the 
information contained in the form.'' \1141\ Because the presentation of 
the information has been prescribed, this format-related requirement 
will be more relevant to the narrative disclosures that are made in the 
items of the form. In particular, NRSROs must provide narrative 
disclosures that help users of credit ratings to understand the 
information. Several commenters stated that the form will result in 
boilerplate disclosure rather than more transparency.\1142\ Pursuant to 
the final amendments, NRSROs will need to make the disclosures as 
specific to the particular rating action, and as relevant to investors, 
as possible, and strike a reasonable balance between standardizing the 
disclosures and tailoring them to specific rating actions. While the 
Commission recognizes that some of the information to be disclosed in 
the form may be standardized for classes or subclasses of credit 
ratings, NRSROs must disclose information in the form in a manner that 
promotes greater understanding of how a credit rating was determined. 
Accordingly, the form must contain plainly worded and succinct 
disclosures that are easy to understand and not lengthy boilerplate 
disclaimers.
---------------------------------------------------------------------------

    \1139\ See paragraph (a)(1)(i)(A) of Rule 17g-7, as proposed; 
Nationally Recognized Statistical Rating Organizations, 76 FR 33540.
    \1140\ See 15 U.S.C. 78o-7(s)(2)(A).
    \1141\ See paragraph (a)(1)(i)(B) of Rule 17g-7.
    \1142\ See DBRS Letter; Morningstar Letter; S&P Letter.
---------------------------------------------------------------------------

    Finally, paragraph (a)(1)(i)(C) of Rule 17g-7, as proposed, 
provides that the form must be in a format that provides the content 
described in paragraphs (a)(1)(ii)(K), (L), and (M) of Rule 17g-7 in a 
manner that is directly comparable across types of obligors, 
securities, and money market instruments.\1143\ As discussed below in 
section II.G.3. of this release, these paragraphs of Rule 17g-7 require 
the disclosure of certain types of quantitative information as mandated 
by section 15E(s)(3)(B) of the Exchange

[[Page 55168]]

Act.\1144\ One commenter stated that it would be difficult, if not 
impossible, to make this information ``directly comparable'' across all 
NRSROs.\1145\ In response, the Commission notes that the final 
amendments require certain types of quantitative information to be 
comparable across types of obligors, securities, and money market 
instruments rated by the NRSRO (rather than across NRSROs).\1146\
---------------------------------------------------------------------------

    \1143\ See paragraph (a)(1)(i)(C) of Rule 17g-7.
    \1144\ See paragraphs (a)(1)(ii)(K) through (M) of Rule 17g-7; 
15 U.S.C. 78o-7(s)(3)(B).
    \1145\ See S&P Letter.
    \1146\ See paragraph (a)(1)(i)(C) of Rule 17g-7.
---------------------------------------------------------------------------

3. Paragraph (a)(1)(ii) of Rule 17g-7--Content of the Form
    Section 15E(s)(3) of the Exchange Act provides that the Commission 
shall require, by rule, that the form accompanying the publication of a 
credit rating contain specifically identified items of 
information.\1147\ In particular, section 15E(s)(3)(A) identifies eight 
items of ``qualitative content'' \1148\ and section 15E(s)(3)(B) 
identifies four items of ``quantitative content.'' \1149\ Because the 
statute specified the type of information to be included in the form, 
the Commission proposed rule text prescribing the required contents of 
the form that largely mirrored the statutory text.\1150\ In particular, 
the prefatory text of paragraph (a)(1)(ii) of Rule 17g-7, as proposed, 
provided that the form generated by the NRSRO must contain the 
information about the credit rating that is identified in paragraphs 
(a)(1)(ii)(A) through (N) of the rule.\1151\ The order of, and 
information required in, these paragraphs largely mirrored the 
provisions of section 15E(s)(3) of the Exchange Act.\1152\
---------------------------------------------------------------------------

    \1147\ See 15 U.S.C. 78o-7(s)(3).
    \1148\ See 15 U.S.C. 78o-7(s)(3)(A)(i) through (vii). Section 
(s)(3)(A)(ix) includes a ninth catchall item: Such additional 
information as the Commission may require. 15 U.S.C. 78o-
7(s)(3)(A)(ix).
    \1149\ See 15 U.S.C. 78o-7(s)(3)(B)(i) through (iv).
    \1150\ See paragraph (a)(1)(ii) of Rule 17g-7, as proposed; 
Nationally Recognized Statistical Rating Organizations, 76 FR at 
33458-33463.
    \1151\ See paragraph (a)(1)(ii) of Rule 17g-7, as proposed; 
Nationally Recognized Statistical Rating Organizations, 76 FR at 
33540.
    \1152\ See paragraphs (a)(1)(ii)(A) through (M) of Rule 17g-7; 
15 U.S.C. 78o-7(s)(3)(A)(i) through (vii) and (B)(i) through (iv).
---------------------------------------------------------------------------

    The Commission is adopting the prefatory text of paragraph 
(a)(1)(ii) of Rule 17g-7 without modification.\1153\ The paragraph 
provides that the form generated by the NRSRO must contain information 
about the credit rating identified in paragraphs (a)(1)(ii)(A) through 
(N).\1154\ Consequently, NRSROs are required to generate a form 
containing the prescribed information and publish it when taking a 
rating action (as defined in the prefatory text of paragraph (a) of 
Rule 17g-7).
---------------------------------------------------------------------------

    \1153\ See paragraph (a)(1)(ii) of Rule 17g-7. One NRSRO 
suggested that the prefatory text be modified to add the phrase ``to 
the extent applicable''. See Moody's Letter. The Commission is not 
making this modification because the specific disclosure provisions 
contain such limiters when the information to be disclosed may not 
be applicable in all cases. See, e.g., paragraphs (a)(1)(ii)(D), 
(G), (J), (L), (M), (N) of Rule 17g-7.
    \1154\ See paragraph (a)(1)(ii) of Rule 17g-7.
---------------------------------------------------------------------------

    Several commenters raised concerns that the proposed rule could 
require the disclosure of confidential or proprietary information 
regarding the NRSRO or an issuer.\1155\ The Commission does not intend 
that the rule require an NRSRO to disclose confidential or proprietary 
information in the form. As discussed above, the format of the form 
must be easy to use and helpful for users of credit ratings to 
understand the information contained in the form about the rating 
action.\1156\ NRSROs must provide narrative disclosures that are 
helpful for users of credit ratings to understand the information and, 
therefore, the form must contain plainly worded and succinct 
disclosures that are not overly detailed. An NRSRO must meet this 
standard through disclosures that are informative but at the same time 
the Commission does not expect an NRSRO to disclose confidential or 
proprietary information.
---------------------------------------------------------------------------

    \1155\ See, e.g., Barnard Letter; FSR Letter; Moody's Letter; 
Siff Letter; S&P Letter.
    \1156\ See paragraph (a)(1)(i)(B) of Rule 17g-7.
---------------------------------------------------------------------------

    As noted above, commenters suggested expanding the information 
required to be disclosed in the form. In particular, one commenter 
stated that the Commission should encourage NRSROs to provide 
additional information if they deem it appropriate,\1157\ another 
stated that NRSROs should provide further information that would enable 
investors to understand the significance of the disclosures,\1158\ and 
a third stated that NRSROs should be required to indicate the 
``projected time period during which the given rating was expected to 
be valid.'' \1159\ One commenter stated that some disclosure 
requirements should be expanded to provide in greater detail 
information that can be used by investors and other users of credit 
ratings.\1160\ Another commenter suggested further rulemaking to 
require NRSROs to disclose and explain the rationale behind proposed 
credit ratings to the rated entity prior to publication, provide a 
rated entity with the right to appeal a proposed credit rating, and 
give reasonable consideration to an appeal.\1161\
---------------------------------------------------------------------------

    \1157\ See ICI Letter.
    \1158\ See Better Markets Letter.
    \1159\ See Levin Letter.
    \1160\ See Better Markets Letter.
    \1161\ See Andrews Letter.
---------------------------------------------------------------------------

    In contrast, other commenters raised burden concerns with respect 
to the breadth of the information that the proposed rule required to be 
included in the form. One NRSRO urged the Commission not to extend the 
rule beyond what the statute requires.\1162\ Another NRSRO stated that 
although the form may be useful to investors, it must not be ``so 
lengthy and overburdened with detail that it loses its utility,'' and 
expressed a concern that the level of detail ``far surpasses what most 
users of credit ratings would find of practical use, while imposing 
unnecessary burdens on NRSROs.'' \1163\ A third NRSRO stated that 
disclosure should be limited to asset-backed securities ratings, 
indicating that expanding requirements to other ratings is ``extremely 
overburdensome'' and provides little information that is not already 
publicly available.\1164\
---------------------------------------------------------------------------

    \1162\ See DBRS Letter.
    \1163\ See S&P Letter.
    \1164\ See A.M. Best Letter.
---------------------------------------------------------------------------

    The Commission acknowledges that section 15E(s)(3) of the Exchange 
Act identifies a significant amount of information that the 
Commission's rule must require to be disclosed in the form.\1165\ This 
information will be helpful in providing transparency as to how an 
NRSRO determines credit ratings across all classes of credit ratings. 
This transparency should benefit users of credit ratings and could 
mitigate the risk of undue reliance on credit ratings by providing 
information about the limits of credit ratings. Further, because the 
statute was very specific regarding the information to be disclosed, 
the Commission has sought to model its rule closely on the statutory 
text. Accordingly, the Commission does not believe it would be 
appropriate to limit the disclosure requirements to rating actions 
involving asset-backed securities. Moreover, given the significant 
amount of information required to be disclosed, the Commission also 
does not believe it to be necessary at this time to expand the 
disclosure requirements as suggested by some commenters.
---------------------------------------------------------------------------

    \1165\ See 15 U.S.C. 78o-7(s)(3).
---------------------------------------------------------------------------

    The Commission also wants to emphasize that the information that 
must be disclosed in the form must relate to the rating action that is 
being taken. The NRSRO need not include in the disclosure information 
about the credit rating that is no longer up-to-date. For example, 
consistent with the statutory text, the rule text sometimes

[[Page 55169]]

uses the phrase ``to determine the credit rating.'' The Commission 
intended this to relate to the credit rating that is determined as a 
consequence of the rating action that triggers the disclosure 
requirement (a preliminary credit rating, an initial credit rating, an 
upgrade or downgrade of the credit rating, or certain affirmations or 
withdrawals of the credit rating). The objective is to provide 
investors and other users of credit ratings with helpful information 
about the rating action being taken with respect to the credit rating 
of the obligor, security, or money market instrument.
    Paragraph (a)(1)(ii)(A). Section 15E(s)(3)(A)(i) of the Exchange 
Act provides that, as required by Commission rule, an NRSRO shall 
disclose on the form the credit ratings produced by the NRSRO.\1166\ 
The Commission proposed to implement this section in paragraph 
(a)(1)(ii)(A) of Rule 17g-7.\1167\ This paragraph, as proposed, would 
require the NRSRO to include in the form the symbol, number, or score 
in the rating scale used by the NRSRO to denote the credit rating 
categories and notches within categories assigned to the obligor, 
security, or money market instrument that is the subject of the credit 
rating and the identity of the obligor, security, or money market 
instrument.\1168\
---------------------------------------------------------------------------

    \1166\ See 15 U.S.C. 78o-7(s)(3)(A)(i).
    \1167\ See paragraph (a)(1)(ii)(A) of Rule 17g-7, as proposed; 
Nationally Recognized Statistical Rating Organizations, 76 FR at 
33459.
    \1168\ See paragraph (a)(1)(ii)(A) of Rule 17g-7, as proposed; 
Nationally Recognized Statistical Rating Organizations, 76 FR 33540.
---------------------------------------------------------------------------

    The Commission is adopting paragraph (a)(1)(ii)(A) of Rule 17g-7 
with one modification from the proposal.\1169\ The paragraph provides 
that the form must contain the symbol, number, or score in the rating 
scale used by the NRSRO to denote credit rating categories and notches 
within categories assigned to the obligor, security, or money market 
instrument that is the subject of the credit rating and, as applicable, 
the identity of the obligor or the identity of the security or money 
market instrument and, in a modification from the proposal, must also 
contain, a description of the security or money market 
instrument.\1170\
---------------------------------------------------------------------------

    \1169\ See paragraph (a)(1)(ii)(A) of Rule 17g-7.
    \1170\ Id.
---------------------------------------------------------------------------

    The Commission stated in the proposing release that the identity of 
a security or money market instrument must be the name of the security 
or money market instrument, if applicable, and a description of the 
security or money market instrument.\1171\ In the proposing release, 
the Commission provided an example of how an NRSRO could identify a 
bond: ``senior unsecured debt issued by Company XYZ maturing in 2015.'' 
\1172\ Consistent with the discussion in the proposing release, the 
Commission has modified the rule text from the proposal to add that, in 
the case of a credit rating of a security or money market instrument, 
the NRSRO must include in the form ``the identity and a description of 
the security or money market instrument.'' \1173\
---------------------------------------------------------------------------

    \1171\ See Nationally Recognized Statistical Rating 
Organizations, 76 FR at 33459.
    \1172\ Id.
    \1173\ See paragraph (a)(1)(ii)(A) of Rule 17g-7.
---------------------------------------------------------------------------

    Two NRSROs commented on the requirement to identify the relevant 
obligor.\1174\ In the proposing release, the Commission stated its 
preliminary belief that the obligor's identity would be its legal name 
and any other name used in its business.\1175\ One NRSRO stated that it 
could be ``enormously burdensome'' for an NRSRO to learn and disclose 
all the business names that an obligor may use, and the additional 
information would add ``little benefit'' to those who use the form.'' 
\1176\ The other NRSRO stated that entry of legal names in its database 
has been problematic due to the inconsistent use of 
abbreviations.\1177\ Both NRSROs suggested that NRSROs should be 
permitted to determine the clearest way to identify obligors.\1178\ The 
Commission agrees with the commenters that an NRSRO should be permitted 
to determine the clearest way to identify an obligor. An NRSRO must 
disclose a name that clearly identifies the obligor.\1179\
---------------------------------------------------------------------------

    \1174\ See DBRS Letter; S&P Letter.
    \1175\ See Nationally Recognized Statistical Rating 
Organizations, 76 FR at 33459.
    \1176\ See DBRS Letter.
    \1177\ See S&P Letter.
    \1178\ See DBRS Letter; S&P Letter.
    \1179\ As discussed above in section II.G.2. of this release, 
the format of the form must be easy to use and helpful for users of 
credit ratings to understand the information contained in the form. 
See paragraph (a)(1)(i) of Rule 17g-7.
---------------------------------------------------------------------------

    Paragraph (a)(1)(ii)(B). Section 15E(r)(3)(A) of the Exchange Act 
provides that the Commission shall prescribe rules with respect to the 
procedures and methodologies used by NRSROs that require NRSROs to 
notify users of credit ratings of the version of a procedure or 
methodology, including the qualitative methodology or quantitative 
inputs, used with respect to a particular credit rating.\1180\ As 
discussed above in section II.F.1. of this release, the Commission 
proposed to implement this provision in Rules 17g-8 and 17g-7.\1181\ 
With respect to Rule 17g-7, proposed paragraph (a)(1)(ii)(B) would 
require an NRSRO to disclose on the form the version of the procedure 
or methodology used to determine the credit rating.\1182\
---------------------------------------------------------------------------

    \1180\ See 15 U.S.C. 78o-7(r)(3)(A).
    \1181\ See Nationally Recognized Statistical Rating 
Organizations, 76 FR 33454-33455, 33459.
    \1182\ See paragraph (a)(1)(ii)(B) of Rule 17g-7, as proposed; 
Nationally Recognized Statistical Rating Organizations, 76 FR at 
33540.
---------------------------------------------------------------------------

    The Commission is adopting paragraph (a)(1)(ii)(B) of Rule 17g-7 as 
proposed.\1183\ The paragraph provides that the NRSRO must include in 
the form the version of the procedure or methodology used to determine 
the credit rating.\1184\
---------------------------------------------------------------------------

    \1183\ See paragraph (a)(1)(ii)(B) of Rule 17g-7.
    \1184\ Id.
---------------------------------------------------------------------------

    Two NRSROs commented on paragraph (a)(1)(ii)(B) of Rule 17g-7, as 
proposed. \1185\ One NRSRO stated that disclosing the version of the 
procedure or methodology used to determine a credit rating could be 
accomplished by identifying the name of the procedure or methodology, 
the date the procedure was implemented, and a hyperlink to further 
information about the procedure or methodology.\1186\ The Commission 
agrees.\1187\
---------------------------------------------------------------------------

    \1185\ See DBRS Letter; S&P Letter.
    \1186\ See DBRS Letter.
    \1187\ See Nationally Recognized Statistical Rating 
Organizations, 76 FR at 33459 (``The Commission preliminarily 
believes that this disclosure could be made by identifying the name 
of the procedure or methodology (including any number used to denote 
the version), the date the procedure was implemented, and an 
Internet URL where further information about the procedure or 
methodology can be obtained.''). In the proposing release, the 
Commission provided an example of the disclosure. Id. at 33459 
(``For example, a disclosure could resemble: `RMBS Rating 
Methodology 3.0, implemented February 12, 2011. For further 
information go to [insert Web site address].'''). The Commission 
continues to believe this provides a useful example that NRSROs 
could use in making the required disclosure.
---------------------------------------------------------------------------

    A second NRSRO stated that the actual benefit to investors is 
slight because the required content can be accessed through the NRSRO's 
public Internet Web site.\1188\ As the Commission stated in the 
proposing release, section 15E(s)(1)(B) of the Exchange Act provides 
that the Commission shall require, by rule, each NRSRO to prescribe a 
form to accompany the publication of a credit rating that discloses 
information that can be used by investors and other users of credit 
ratings to better understand credit ratings in each class of credit 
rating issued by the NRSRO.\1189\

[[Page 55170]]

Disclosing in the form the version of the procedure or methodology used 
to determine the credit rating will promote this goal. For example, 
credit rating methodologies that are predominantly quantitative may 
rely on models to produce credit ratings. These models are periodically 
updated and released as newer or different versions of the previous 
model. Disclosing in the form the version of a model used to produce a 
credit rating with the credit rating is expected to help investors and 
other users of credit ratings better understand the credit rating and 
how the determination of the credit rating may differ from the 
determination of credit ratings of similar products using an earlier 
version of the model.
---------------------------------------------------------------------------

    \1188\ See S&P Letter.
    \1189\ See Nationally Recognized Statistical Rating 
Organizations, 76 FR at 33459; 15 U.S.C. 78o-7(s)(1)(B).
---------------------------------------------------------------------------

    Paragraph (a)(1)(ii)(C). Section 15E(s)(3)(A)(ii) of the Exchange 
Act provides that, as required by Commission rule, an NRSRO shall 
disclose on the form the main assumptions and principles used in 
constructing procedures and methodologies, including qualitative 
methodologies and quantitative inputs and assumptions about the 
correlation of defaults across underlying assets used in rating 
structured products.\1190\ The Commission proposed to implement this 
section through paragraph (a)(1)(ii)(C) of Rule 17g-7, which mirrored 
the statutory text.\1191\ The Commission is adopting paragraph 
(a)(1)(ii)(C) of Rule 17g-7 as proposed.\1192\ The paragraph provides 
that the NRSRO must include in the form the main assumptions and 
principles used in constructing the procedures and methodologies used 
to determine the credit rating, including qualitative methodologies and 
quantitative inputs, and, if the credit rating is for a structured 
finance product, assumptions about the correlation of defaults across 
the underlying assets.\1193\
---------------------------------------------------------------------------

    \1190\ See 15 U.S.C. 78o-7(s)(3)(A)(ii).
    \1191\ See paragraph (a)(1)(ii)(C) of Rule 17g-7, as proposed; 
Nationally Recognized Statistical Rating Organizations, 76 FR at 
33460, 33540. This paragraph, as proposed, would require the NRSRO 
to include in the form the main assumptions and principles used in 
constructing the procedures and methodologies used to determine the 
credit rating, including qualitative methodologies and quantitative 
inputs, and, if the credit rating is for a structured finance 
product, assumptions about the correlation of defaults across the 
underlying assets.
    \1192\ See paragraph (a)(1)(ii)(C) of Rule 17g-7.
    \1193\ Id.
---------------------------------------------------------------------------

    Three commenters addressed paragraph (a)(1)(ii)(C) of Rule 17g-7, 
as proposed.\1194\ One NRSRO stated that the Commission should 
harmonize this requirement with those of similar disclosures required 
in other jurisdictions, including the European Union.\1195\ The 
commenter, however, did not provide explicit suggestions as to how the 
rule text could be modified to provide for such harmonization. 
Consequently, the Commission is not modifying the text on this basis. 
Two commenters stated that the Commission should not require the 
disclosure of confidential or proprietary information belonging to 
either the NRSRO or the issuer, such as non-public financial 
information of an issuer.\1196\ The Commission does not intend that 
NRSROs will be required to disclose confidential or proprietary 
information to meet the requirements of paragraph (a)(1)(ii)(C) of Rule 
17g-7. As discussed earlier with respect to the format of the form, 
NRSROs must provide narrative disclosures that are helpful for users of 
credit ratings to understand the information. Accordingly, the form 
must contain plainly worded and succinct disclosures. However, the 
Commission does not expect the disclosures to include confidential or 
proprietary information.
---------------------------------------------------------------------------

    \1194\ See Barnard Letter; S&P Letter; Siff Letter.
    \1195\ See S&P Letter.
    \1196\ See Barnard Letter; Siff Letter.
---------------------------------------------------------------------------

    Paragraph (a)(1)(ii)(D). Section 15E(s)(3)(A)(iii) of the Exchange 
Act provides that, as required by Commission rule, an NRSRO shall 
disclose on the form the potential limitations of the credit ratings 
and the types of risks excluded from the credit ratings that the NRSRO 
does not comment on, including liquidity, market, and other 
risks.\1197\ The Commission proposed to implement this section through 
paragraph (a)(1)(ii)(D) of Rule 17g-7, which mirrored the statutory 
text.\1198\
---------------------------------------------------------------------------

    \1197\ See 15 U.S.C. 78o-7(s)(3)(A)(iii).
    \1198\ See paragraph (a)(1)(ii)(D) of Rule 17g-7, as proposed; 
Nationally Recognized Statistical Rating Organizations, 76 FR at 
33460, 33540. This paragraph, as proposed, would require the NRSRO 
to include in the form the potential limitations of the credit 
rating, including the types of risks excluded from the credit rating 
that the NRSRO does not comment on, including, as applicable, 
liquidity, market, and other risks.
---------------------------------------------------------------------------

    The Commission is adopting paragraph (a)(1)(ii)(D) of Rule 17g-7 as 
proposed.\1199\ The paragraph provides that the NRSRO must include in 
the form the potential limitations of the credit rating, including the 
types of risks excluded from the credit rating that the NRSRO does not 
comment on, including, as applicable, liquidity, market, and other 
risks.\1200\
---------------------------------------------------------------------------

    \1199\ See paragraph (a)(1)(ii)(D) of Rule 17g-7.
    \1200\ Id.
---------------------------------------------------------------------------

    Two commenters addressed paragraph (a)(1)(ii)(D) of Rule 17g-7, as 
proposed.\1201\ One NRSRO supported the rule text as proposed,\1202\ 
and another commenter stated that the disclosure should include more 
than a listing of the risks that are not assessed as part of the 
rating.\1203\ The Commission agrees with both commenters and notes that 
the rule as proposed and adopted requires the NRSRO to disclose the 
potential limitations of the credit rating, including the types of 
risks excluded from the credit rating that the NRSRO does not comment 
on, including, as applicable, liquidity, market, and other risks. 
Consequently, the risks excluded from the credit rating are only a part 
of the required disclosure. For example, the NRSRO also must disclose 
the limitations of the credit rating with respect to the risks the 
NRSRO does comment on, including credit risk.
---------------------------------------------------------------------------

    \1201\ See CFA/AFR Letter; S&P Letter.
    \1202\ See S&P Letter.
    \1203\ See CFA/AFR Letter.
---------------------------------------------------------------------------

    Paragraph (a)(1)(ii)(E). Section 15E(s)(3)(A)(iv) of the Exchange 
provides that, as required by Commission rule, an NRSRO shall disclose 
on the form information on the uncertainty of the credit rating, 
including: (1) Information on the reliability, accuracy, and quality of 
the data relied on in determining the credit rating; and (2) a 
statement relating to the extent to which data essential to the 
determination of the credit rating were reliable or limited, including 
any limits on the scope of historical data and any limits in 
accessibility to certain documents or other types of information that 
would have better informed the credit rating.\1204\ The Commission 
proposed to implement this section through paragraph (a)(1)(ii)(E) of 
Rule 17g-7, which mirrored the statutory text.\1205\
---------------------------------------------------------------------------

    \1204\ See 15 U.S.C. 78o-7(s)(3)(A)(iv).
    \1205\ See paragraph (a)(1)(ii)(E) of Rule 17g-7, as proposed; 
Nationally Recognized Statistical Rating Organizations, 76 FR at 
33460, 33540.
---------------------------------------------------------------------------

    The Commission is adopting paragraph (a)(1)(ii)(E) of Rule 17g-7 as 
proposed.\1206\ The paragraph provides that the form must contain 
information on the uncertainty of the credit rating, including: (1) 
Information on the reliability, accuracy, and quality of the data 
relied on in determining the credit rating; and (2) a statement 
relating to the extent to which data essential to the determination of 
the credit rating were reliable or limited, including any limits on the 
scope of historical data and any limits on accessibility to certain 
documents or other types of information that would have better informed 
the credit rating.\1207\
---------------------------------------------------------------------------

    \1206\ See paragraph (a)(1)(ii)(E) of Rule 17g-7.
    \1207\ Id.

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

[[Page 55171]]

    Two commenters addressed paragraph (a)(1)(ii)(E) of Rule 17g-7, as 
proposed.\1208\ One commenter stated that the Commission should require 
an NRSRO to address specifically the heightened uncertainty associated 
with ratings of offerings that do not have an extensive track record, 
complex or customized securities, or areas where the credit rating 
agency has limited data on which to base a rating.\1209\ The Commission 
agrees and believes the rule as proposed and adopted requires 
disclosure on the matters identified by the commenter in that it 
requires disclosures regarding limits on the scope of historical data 
and limits on the accessibility to certain documents or other types of 
information that would have better informed the credit rating.
---------------------------------------------------------------------------

    \1208\ See CFA/AFR Letter; S&P Letter.
    \1209\ See CFA/AFR Letter.
---------------------------------------------------------------------------

    One NRSRO stated that requiring NRSROs to provide overly detailed 
information regarding ```reliability,' `accuracy' and `quality''' of 
data, could result in extremely lengthy disclosures due to the number 
of types of data.\1210\ The NRSRO further stated that the Commission 
should harmonize this requirement with other jurisdictions' 
requirements by requiring only a statement about ``(i) whether 
essential data was available; (ii) whether such data was believed to be 
reliable; and (iii) any limitations on access to data for that 
transaction that differed from typical circumstances.'' \1211\ As 
discussed above, NRSROs must provide narrative disclosures that are 
helpful for users of credit ratings to understand the information and, 
therefore, the form must contain plainly worded and succinct 
disclosures that are not unnecessarily detailed. As for the suggestion 
to harmonize the rule with other jurisdictions' requirements, the text 
suggested by the commenter generally seems consistent with the proposed 
rule. Consequently, the Commission is not persuaded that it is 
necessary to modify the proposed rule in response to this 
comment.\1212\
---------------------------------------------------------------------------

    \1210\ See S&P Letter.
    \1211\ See id.
    \1212\ See 15 U.S.C. 78o-7(s)(3)(A)(iv).
---------------------------------------------------------------------------

    Paragraph (a)(1)(ii)(F). Section 15E(s)(3)(A)(v) of the Exchange 
Act provides that, as required by Commission rule, an NRSRO shall 
disclose on the form whether and to what extent third-party due 
diligence services have been used by the NRSRO, a description of the 
information that such third party reviewed in conducting due diligence 
services, and a description of the findings or conclusions of such 
third party.\1213\ The Commission proposed to implement this section 
through paragraph (a)(1)(ii)(F), which largely mirrored the statutory 
text.\1214\
---------------------------------------------------------------------------

    \1213\ See 15 U.S.C. 78o-7(s)(3)(A)(v).
    \1214\ See paragraph (a)(1)(ii)(F) of Rule 17g-7, as proposed; 
Nationally Recognized Statistical Rating Organizations, 76 FR at 
33460-33461, 33540. This paragraph, as proposed, would require the 
NRSRO to include in the form whether and to what extent third-party 
due diligence services were used by the nationally recognized 
statistical rating organization, a description of the information 
that such third party reviewed in conducting due diligence services, 
and a description of the findings or conclusions of such third 
party.
---------------------------------------------------------------------------

    Several commenters addressed paragraph (a)(1)(ii)(F) of Rule 17g-7, 
as proposed.\1215\ The Commission is adopting paragraph (a)(1)(ii)(F) 
of Rule 17g-7 with modifications in response to comments.\1216\
---------------------------------------------------------------------------

    \1215\ See ASF Letter; DBRS Letter; Deloitte Letter; Moody's 
Letter; PWC Letter; S&P Letter.
    \1216\ See paragraph (a)(1)(ii)(F) of Rule 17g-7.
---------------------------------------------------------------------------

    Two commenters stated that the rule should be confined in scope to 
credit ratings on asset-backed securities.\1217\ Two NRSROs stated that 
unless the person providing third-party due diligence services was 
engaged by the NRSRO, disclosure would be more appropriately made by 
the party that hired the due diligence provider.\1218\ One NRSRO stated 
that ``[i]ssuers and underwriters, not NRSROs, should pass through the 
third party's description of the information reviewed and the third 
party's findings and conclusions,'' but, if the NRSROs must disclose 
the information, the Commission should clarify that the disclosure 
requirement can be met by the NRSRO ``passing through the certification 
that the third party provides to the NRSRO.'' \1219\ In addition, one 
commenter stated that the final amendments should require that NRSROs 
``expressly restate'' specific findings and conclusions from third-
party due diligence reports to prevent them from being 
``mischaracterized or taken out of context.'' \1220\ Another commenter 
suggested that the words ``a description of the findings or 
conclusions'' should be revised to ``a summary of the findings and 
conclusions,'' because a ``summary'' better aligns with the requirement 
in proposed Form ABS Due Diligence-15E.\1221\ The commenter further 
stated that what should be provided is a summary of the findings and 
conclusions, not the findings and conclusions themselves, and ``there 
is no reason why the summary would not be substantially similar in each 
context.'' \1222\ One NRSRO stated that publishing the certification of 
the third-party due diligence provider with the form as required by 
paragraph (a)(2) of Rule 17g-7, as proposed, makes its use by the NRSRO 
``self-evident.'' \1223\
---------------------------------------------------------------------------

    \1217\ See Moody's Letter; PWC Letter.
    \1218\ See Moody's Letter; S&P Letter.
    \1219\ See Moody's Letter.
    \1220\ See Deloitte Letter.
    \1221\ See ASF Letter.
    \1222\ See id.
    \1223\ See DBRS Letter.
---------------------------------------------------------------------------

    The Commission is adopting the requirement that the form must 
contain information relating to due diligence services performed by a 
third party to implement section 15E(s)(3)(A)(v) of the Exchange 
Act.\1224\ This information will help investors and other users of 
credit ratings to understand how the NRSRO determined the credit 
rating. In response to the comments that paragraph (a)(1)(ii)(F) should 
be limited to rating actions involving asset-backed securities, the 
Commission interprets the text of the rule referring to ``due diligence 
services of a third party'' as meaning the type of due diligence 
services that are within the scope of Rule 17g-10, as adopted, and Form 
ABS Due Diligence-15E (which apply to third-party due diligence 
services only in connection with asset-backed securities).\1225\ 
Consequently, paragraph (a)(1)(ii)(F) is limited to rating actions 
involving Exchange Act-ABS.\1226\
---------------------------------------------------------------------------

    \1224\ See 15 U.S.C. 78o-7(s)(3)(A)(v).
    \1225\ See paragraph (d)(1) of Rule 17g-10 defining the term due 
diligence services to mean, in pertinent part, ``a review of the 
assets underlying an asset-backed security, as defined in section 
3(a)(79) of the [Exchange] Act . . .'' In addition, section 
15E(s)(4) of the Exchange Act is titled ``Due Diligence Services for 
Asset-Backed Securities.'' See 15 U.S.C. 78o-7(s)(4). Moreover, 
section 15E(s)(4)(A) provides that ``[t]he issuer or underwriter of 
any asset-backed security shall make publicly available the findings 
and conclusions of any third-party due diligence report obtained by 
the issuer or underwriter.'' See 15 U.S.C. 78o-7(s)(4)(A) (emphasis 
added). Consequently, as proposed, paragraph (a)(1)(ii)(F)--which 
refers to due diligence services--was intended to address due 
diligence services in the context of an asset-backed security.
    \1226\ As stated above in section I.B.1. of this release, the 
term Exchange Act-ABS as used throughout this release refers to an 
asset-backed security as defined in section 3(a)(79) of the Exchange 
Act. 15 U.S.C. 78c(a)(79).
---------------------------------------------------------------------------

    In response to comments, the Commission is modifying the rule from 
the proposal to permit the NRSRO to provide a cross-reference to a Form 
ABS Due Diligence-15E that is published with the form to meet part of 
the disclosure requirement in paragraph (a)(1)(ii)(F).\1227\ The 
Commission is persuaded by commenters that if an NRSRO used due 
diligence services of a third party it would be redundant, and 
potentially confusing, for the NRSRO to provide a description of the 
information that the third party reviewed in

[[Page 55172]]

conducting the due diligence services and a description of the findings 
or conclusions of the third party if that information is in a Form ABS 
Due Diligence-15E published with the form.\1228\
---------------------------------------------------------------------------

    \1227\ See paragraph (a)(1)(ii)(F)(2) of Rule 17g-7.
    \1228\ As discussed below in section II.H.3.c. of this release, 
Item 4 of Form ABS Due Diligence-15E requires the third party to 
provide a description of the due diligence performed that addresses 
the information that was reviewed and Item 5 requires the third 
party to provide a summary of the findings and conclusions of the 
review.
---------------------------------------------------------------------------

    In addition, as noted above, a commenter proposed modifying the 
rule to replace the phrase ``a description of the findings or 
conclusions'' to ``a summary of the findings and conclusions,'' because 
the commenter believed that a ``summary'' better aligns with the 
requirement in proposed Form ABS Due Diligence-15E and that, in each 
case, the rules should require a summary of the findings and 
conclusions (as opposed to the findings and conclusions 
themselves).\1229\ Item 5 of Form ABS Due Diligence-15E requires the 
third party to provide a ``summary of the findings and conclusions that 
resulted from the due diligence services.'' \1230\ The Commission 
agrees with the commenter and has therefore modified the proposal to 
replace the words ``description of the findings or conclusions of such 
third party'' with the words ``summary of the findings and conclusions 
of the third party.'' \1231\ However, if an NRSRO chooses to provide a 
summary of the findings and conclusions, the level of detail in the 
summary should be comparable to the level of detail a provider of 
third-party due diligence services provides in Form ABS Due Diligence-
15E, as the summary in the form can be a substitute for the NRSRO 
providing a summary.\1232\
---------------------------------------------------------------------------

    \1229\ See ASF Letter.
    \1230\ See Item 5 of Form ABS Due Diligence-15E.
    \1231\ See paragraph (a)(1)(ii)(F)(1) of Rule 17g-7.
    \1232\ The Commission, however, does not believe the rule as 
proposed (which required ``a description of the findings or 
conclusions'') and the rule as adopted (which requires a ``summary 
of the findings and conclusions'') contain standards that differ in 
any significant way. Under either standard, the NRSRO need not 
repeat the actual findings and conclusions but rather must provide a 
higher level disclosure about them.
---------------------------------------------------------------------------

    For these reasons, the final amendments provide that the form must 
contain whether and to what extent the NRSRO used due diligence 
services of a third party in taking the rating action, and, if the 
NRSRO used such services, either: (1) A description of the information 
that the third party reviewed in conducting the due diligence services 
and a summary of the findings and conclusions of the third party; or 
(2) a cross-reference to a Form ABS Due Diligence-15E executed by the 
third party that is published with the form, provided the cross-
referenced Form ABS Due Diligence-15E contains a description of the 
information that the third party reviewed in conducting the due 
diligence services and a summary of the findings and conclusions of the 
third party.\1233\
---------------------------------------------------------------------------

    \1233\ See paragraph (a)(1)(ii)(F) of Rule 17g-7.
---------------------------------------------------------------------------

    The Commission is not persuaded by the comment that publishing the 
certification of the third-party due diligence provider with the form 
as required by paragraph (a)(2) of Rule 17g-7, as proposed, makes its 
use by the NRSRO ``self-evident.'' \1234\ As discussed below in section 
II.G.5. of this release, section 15E(s)(4)(B) of the Exchange Act 
requires a third party providing due diligence services to an NRSRO, 
issuer, or underwriter with respect to an asset-backed security to 
provide a written certification to any NRSRO that produces a credit 
rating to which the due diligence services relate.\1235\ Section 
15E(s)(4)(D) of the Exchange Act provides that the Commission shall 
adopt rules requiring an NRSRO that receives a certification to 
disclose the certification to the public at the time at which the NRSRO 
produces a rating.\1236\ Paragraph (a)(2) of Rule 17g-7, as amended, 
implements section 15E(s)(4)(D) by requiring the NRSRO to publish with 
the form any certifications it receives. However, the NRSRO's receipt 
of the certification pursuant to section 15E(s)(4)(B) and publication 
of the certification pursuant to paragraph (a)(2) of Rule 17g-7, as 
amended, is not predicated on the NRSRO having used the due diligence 
services in determining the credit rating. Consequently, the final 
amendments retain the requirement for the NRSRO to include in the form 
whether and to what extent the NRSRO used due diligence services of a 
third party in taking the rating action.\1237\
---------------------------------------------------------------------------

    \1234\ See DBRS Letter.
    \1235\ See 15 U.S.C. 78o-7(s)(4)(B).
    \1236\ See 15 U.S.C. 78o-7(s)(4)(D).
    \1237\ See paragraph (a)(1)(ii)(F) of Rule 17g-7.
---------------------------------------------------------------------------

    Paragraph (a)(1)(ii)(G). Section 15E(s)(1)(A)(iii) of the Exchange 
Act provides that the Commission shall require, by rule, that the NRSRO 
disclose on the form information relating to, if applicable, how the 
NRSRO used servicer or remittance reports, and with what frequency, to 
conduct surveillance of the credit rating.\1238\ The Commission 
proposed to implement this section through paragraph (a)(1)(ii)(G) of 
Rule 17g-7, which mirrored the statutory text.\1239\
---------------------------------------------------------------------------

    \1238\ See 15 U.S.C. 78o-7(s)(1)(A)(iii).
    \1239\ See paragraph (a)(1)(ii)(G) of Rule 17g-7, as proposed; 
Nationally Recognized Statistical Rating Organizations, 76 FR at 
33461, 33540. This paragraph, as proposed, would require the NRSRO 
to include in the form, if applicable, how servicer or remittance 
reports were used, and with what frequency, to conduct surveillance 
of the credit rating.
---------------------------------------------------------------------------

    One commenter addressed paragraph (a)(1)(ii)(G) of Rule 17g-7, as 
proposed, by noting its support of the rule text as proposed.\1240\ The 
Commission is adopting paragraph (a)(1)(ii)(E) of Rule 17g-7 as 
proposed.\1241\ The paragraph provides that the NRSRO must include in 
the form, if applicable, how servicer or remittance reports were used, 
and with what frequency, to conduct surveillance of the credit 
rating.\1242\
---------------------------------------------------------------------------

    \1240\ See S&P Letter.
    \1241\ See paragraph (a)(1)(ii)(G) of Rule 17g-7. One commenter 
addressed this proposal and supported it. See S&P Letter.
    \1242\ See paragraph (a)(1)(ii)(G) of Rule 17g-7.
---------------------------------------------------------------------------

    Paragraph (a)(1)(ii)(H). Section 15E(s)(3)(A)(vi) of the Exchange 
Act provides that the Commission shall require, by rule, that the NRSRO 
disclose on the form a description of the data about any obligor, 
issuer, security, or money market instrument that were relied upon for 
the purpose of determining the credit rating.\1243\ The Commission 
proposed to implement this section through paragraph (a)(1)(ii)(H) of 
Rule 17g-7, which mirrored the statutory text.\1244\ The Commission is 
adopting paragraph (a)(1)(ii)(H) of Rule 17g-7 with a modification in 
response to comments.\1245\
---------------------------------------------------------------------------

    \1243\ See 15 U.S.C. 78o-7(s)(3)(A)(vi).
    \1244\ See paragraph (a)(1)(ii)(H) of Rule 17g-7, as proposed; 
Nationally Recognized Statistical Rating Organizations, 76 FR at 
33461, 33540-33541. This paragraph, as proposed, would require the 
NRSRO to include in the form a description of the data about any 
obligor, issuer, security, or money market instrument that were 
relied upon for the purpose of determining the credit rating.
    \1245\ See paragraph (a)(1)(ii)(H) of Rule 17g-7.
---------------------------------------------------------------------------

    One NRSRO stated that the requirement may result in ``effectively 
overloading'' investors with information and essentially ``reducing 
rather than enhancing'' the disclosure's value.\1246\ This commenter 
and another commenter expressed concerns that some data may be 
confidential or provided to the NRSRO under terms restricting public 
disclosure.\1247\ One commenter suggested that the Commission clarify 
that the requirement for a ``description of the data relied upon'' 
requires only a description of the general type of data and not of 
specific data, since specific data can be obtained

[[Page 55173]]

from the relevant offering documents.\1248\
---------------------------------------------------------------------------

    \1246\ See S&P Letter.
    \1247\ See FSR Letter; S&P Letter.
    \1248\ See FSR Letter.
---------------------------------------------------------------------------

    In response to these comments, the Commission notes, as stated 
above, that section 15E(s)(3)(A)(vi) of the Exchange Act provides that 
the Commission shall require, by rule, that the NRSRO disclose on the 
form a description of the data about any obligor, issuer, security, or 
money market instrument that were relied upon for the purpose of 
determining the credit rating.\1249\ Paragraph (a)(1)(ii)(H) of Rule 
17g-7, as proposed, was designed to implement the statute. Moreover, as 
discussed above, the form must disclose information that can be used by 
investors and other users of credit ratings to better understand credit 
ratings \1250\ and, therefore, the form must contain plainly worded and 
succinct disclosures that are not overly detailed. In this regard, the 
Commission did not intend to require that the form repeat verbatim all 
the data that were relied upon to determine the credit rating. Instead, 
it intended the form to include a ``description'' to help users of the 
credit rating to understand the types of data the NRSRO relied on. To 
make this more clear and address the commenter's concern, the 
Commission has modified the final amendments to require the NRSRO to 
include in the form a description of the types of data about any 
obligor, issuer, security, or money market instrument that were relied 
upon for the purpose of determining the credit rating.\1251\
---------------------------------------------------------------------------

    \1249\ See 15 U.S.C. 78o-7(s)(3)(A)(vi).
    \1250\ See 15 U.S.C. 78o-7(s)(1)(B).
    \1251\ See paragraph (a)(1)(ii)(H) of Rule 17g-7 (emphasis added 
to highlight the modification).
---------------------------------------------------------------------------

    Paragraph (a)(1)(ii)(I). Section 15E(s)(3)(A)(vii) of the Exchange 
Act provides that the Commission shall require, by rule, that the NRSRO 
disclose on the form a statement containing an overall assessment of 
the quality of information available and considered in producing a 
rating for the obligor, security, or money market instrument, in 
relation to the quality of information available to the NRSRO in rating 
similar issuances.\1252\ The Commission proposed to implement this 
section through paragraph (a)(1)(ii)(I) of Rule 17g-7, which largely 
mirrored the statutory text.\1253\
---------------------------------------------------------------------------

    \1252\ See 15 U.S.C. 78o-7(s)(3)(A)(vii).
    \1253\ See paragraph (a)(1)(ii)(I) of Rule 17g-7, as proposed; 
Nationally Recognized Statistical Rating Organizations, 76 FR at 
33461, 33541. This paragraph, as proposed, would require the NRSRO 
to include in the form a statement containing an overall assessment 
of the quality of information available and considered in 
determining the credit rating for the obligor, security, or money 
market instrument, in relation to the quality of information 
available to the NRSRO in rating similar obligors, securities, or 
money market instruments. The statute refers to ratings of ``similar 
issuances.'' However, a credit rating of an obligor commonly means 
the rating of the obligor as an entity rather than a rating of 
securities or money market instruments issued by the obligor. 
Consequently, the rating of an obligor may not relate to an 
``issuance'' of a particular security or money market instrument. 
Therefore, paragraph (a)(1)(ii)(I) of Rule 17g-7, as proposed, 
substituted the phrase ``similar obligors, securities, or money 
market instruments'' for the phrase ``similar issuances'' in the 
statutory text.
---------------------------------------------------------------------------

    The Commission is adopting paragraph (a)(1)(ii)(I) of Rule 17g-7 as 
proposed.\1254\ The paragraph provides that the NRSRO must include in 
the form a statement containing an overall assessment of the quality of 
information available and considered in determining the credit rating 
for the obligor, security, or money market instrument, in relation to 
the quality of information available to the NRSRO in rating similar 
obligors, securities, or money market instruments.\1255\
---------------------------------------------------------------------------

    \1254\ See paragraph (a)(1)(ii)(I) of Rule 17g-7.
    \1255\ Id.
---------------------------------------------------------------------------

    One NRSRO stated that the requirement to disclose an overall 
assessment of the quality of information used in its rating ``would 
present practical, and possibly contractual difficulties,'' and that 
the Commission should harmonize this requirement with other 
jurisdictions' requirements by requiring a statement about ``(i) 
whether essential data was available; (ii) whether such data was 
believed to be reliable; and (iii) any limitations on access to data 
for that transaction that differed from typical circumstances.'' \1256\ 
The commenter did not explain how the proposed requirement would 
present contractual difficulties but, as discussed above, the 
Commission does not intend the disclosure provisions in the rule to 
require NRSROs to disclose confidential or proprietary information. In 
terms of practical issues, as discussed above, the NRSROs must provide 
narrative disclosures in the form that are helpful for users of credit 
ratings to understand the information and, therefore, the form must 
contain plainly worded and succinct disclosures that are not overly 
detailed. Thus, the practical issue of having to make highly detailed 
disclosures is not implicated by the rule as proposed and adopted. As 
for the suggestion to harmonize the rule with other jurisdictions, the 
text suggested by the commenter generally seems aimed at requiring 
relatively similar disclosures though it does not explicitly require an 
assessment of the overall quality of information available to the NRSRO 
in rating similar obligors, securities, or money market instruments. 
Consequently, the Commission is not persuaded that it is necessary to 
implement the statute in a manner that deviates from the proposed 
rule.\1257\
---------------------------------------------------------------------------

    \1256\ See S&P Letter.
    \1257\ See 15 U.S.C. 78o-7(s)(3)(A)(vii).
---------------------------------------------------------------------------

    Paragraph (a)(1)(ii)(J). Proposed paragraph (a)(1)(ii)(J) of Rule 
17g-7 \1258\ would implement, in part, section 15E(s)(3)(A)(viii) of 
the Exchange Act, which provides that the Commission shall require, by 
rule, that the NRSRO disclose on the form information relating to 
conflicts of interest of the NRSRO.\1259\ The Commission proposed to 
identify three specific items of information that, at a minimum, an 
NRSRO would need to disclose in the form relating to conflicts of 
interest.\1260\
---------------------------------------------------------------------------

    \1258\ See paragraph (a)(1)(ii)(J) of Rule 17g-7, as proposed; 
Nationally Recognized Statistical Rating Organizations, 76 FR at 
33541.
    \1259\ See 15 U.S.C. 78o-7(s)(3)(A)(viii).
    \1260\ See paragraph (a)(1)(ii)(J) of Rule 17g-7, as proposed; 
Nationally Recognized Statistical Rating Organizations, 76 FR at 
33461-33462, 33541.
---------------------------------------------------------------------------

    First, proposed paragraph (a)(1)(ii)(J)(1) would require the NRSRO 
to include a classification of the credit rating as either solicited 
sell-side, solicited buy-side, or unsolicited.\1261\ The proposal 
defined solicited sell-side to mean that the credit rating was paid for 
by the obligor being rated or the issuer, underwriter, depositor, or 
sponsor of the security or money market instrument being rated.\1262\ 
The proposal defined solicited buy-side to mean that the credit rating 
was paid for by a person other than the obligor being rated or the 
issuer, underwriter, depositor, or sponsor of the security or money 
market instrument being rated.\1263\ The proposal defined an 
unsolicited credit rating to mean the NRSRO was not paid to determine 
the credit rating.\1264\ The Commission is

[[Page 55174]]

adopting paragraph (a)(1)(ii)(J)(1) of Rule 17g-7 with modifications in 
response to comments about these definitions.\1265\
---------------------------------------------------------------------------

    \1261\ See paragraph (a)(1)(ii)(J)(1) of Rule 17g-7, as 
proposed; Nationally Recognized Statistical Rating Organizations, 76 
FR at 33541.
    \1262\ See paragraph (a)(1)(ii)(J)(1)(i) of Rule 17g-7, as 
proposed; Nationally Recognized Statistical Rating Organizations, 76 
FR at 33541.
    \1263\ See paragraph (a)(1)(ii)(J)(1)(ii) of Rule 17g-7, as 
proposed; Nationally Recognized Statistical Rating Organizations, 76 
FR at 33541.
    \1264\ See paragraph (a)(1)(ii)(J)(1)(iii) of Rule 17g-7, as 
proposed; Nationally Recognized Statistical Rating Organizations, 76 
FR at 33541. The Commission further explained in the proposing 
release that the intent was to include credit ratings funded by 
selling subscriptions to access the credit ratings (so-called 
``subscriber-paid credit ratings''). See Nationally Recognized 
Statistical Rating Organizations, 76 FR at 33461-33462. However, if 
a subscriber paid the NRSRO to determine a credit rating for a 
specific obligor, security, or money market instrument, the credit 
rating would need to be classified as either solicited sell-side, if 
the subscriber also was the obligor, issuer, underwriter, depositor, 
or sponsor of the security or money market instrument being rated, 
or solicited buy-side if the subscriber was not the obligor, issuer, 
underwriter, depositor, or sponsor of the security or money market 
instrument being rated. Id.
    \1265\ See paragraph (a)(1)(ii)(J)(1) of Rule 17g-7.
---------------------------------------------------------------------------

    One NRSRO stated that equating the concept of solicitation with 
payment would result in confusion in the market, and that the 
definition should be harmonized with that of other jurisdictions, where 
an unsolicited credit rating is defined as one that is initiated by the 
credit rating agency and not requested by the issuer.\1266\ The 
Commission is persuaded that requiring the NRSRO to classify the credit 
rating using one of these terms could be confusing given other views as 
to what constitutes a solicited or unsolicited credit rating. Further, 
disclosing the conflict through a classification may not be as helpful 
as simply having the NRSRO include a statement in the form as to 
whether another person paid for the credit rating. For these reasons, 
the final amendments have been modified to exclude the specific terms 
proposed and instead require the NRSRO to include in the form, as 
applicable, a statement that the NRSRO was: (1) Paid to determine the 
credit rating by the obligor being rated or the issuer, underwriter, 
depositor, or sponsor of the security or money market instrument being 
rated; (2) paid to determine the credit rating by a person other than 
the obligor being rated or the issuer, underwriter, depositor, or 
sponsor of the security or money market instrument being rated; or (3) 
not paid to determine the credit rating.\1267\
---------------------------------------------------------------------------

    \1266\ See Moody's Letter.
    \1267\ See paragraph (a)(1)(ii)(J)(1) of Rule 17g-7. For the 
purpose of these disclosures, the Commission does not consider a 
subscriber to an NRSRO's credit ratings to be a person who paid for 
the credit rating simply because the subscriber paid a fee to access 
the credit ratings of the NRSRO. However, the NRSRO would need to 
state that it was paid to determine the credit rating if, for 
example, the subscriber paid for the credit rating because it was 
the obligor being rated or the issuer, underwriter, depositor, or 
sponsor of the security or money market instrument being rated, or 
the subscriber paid for determination of the credit rating because 
the subscriber was an investor or potential investor in the security 
or money market instrument and hired the NRSRO to rate the security 
or money market instrument.
---------------------------------------------------------------------------

    The second type of conflict disclosure was specified in proposed 
paragraph (a)(1)(ii)(J)(2) of Rule 17g-7.\1268\ Pursuant to this 
paragraph, if the credit rating was classified as either solicited 
sell-side or solicited buy-side, the NRSRO would be required to 
disclose whether the NRSRO provided services other than determining 
credit ratings to the person that paid for the credit rating during the 
most recently ended fiscal year.\1269\ The Commission is adopting 
paragraph (a)(1)(ii)(J)(2) of Rule 17g-7 with modifications in response 
to comments.\1270\
---------------------------------------------------------------------------

    \1268\ See paragraph (a)(1)(ii)(J)(2) of Rule 17g-7, as 
proposed; Nationally Recognized Statistical Rating Organizations, 76 
FR at 33541.
    \1269\ See paragraph (a)(1)(ii)(J)(2) of Rule 17g-7, as 
proposed.
    \1270\ See paragraph (a)(1)(ii)(J)(2) of Rule 17g-7.
---------------------------------------------------------------------------

    A commenter stated that the disclosure about other services 
provided by an NRSRO does not provide any basis to conclude that a 
rating may be compromised.\1271\ Another commenter strongly opposed the 
requirement due to the difficulty of shielding analysts from such 
information so as to promote independence in the credit rating 
process.\1272\ A third commenter supported the proposed requirement and 
added that the Commission should also require NRSROs to disclose the 
revenue they received from a particular issuer.\1273\
---------------------------------------------------------------------------

    \1271\ See S&P Letter.
    \1272\ See Moody's Letter.
    \1273\ See CFR/AFR Letter.
---------------------------------------------------------------------------

    The Commission does not agree with the commenter that being paid 
for other services does not present a potential conflict. As the 
Commission stated in the proposing release, clients paying an NRSRO for 
services in addition to determining credit ratings may pose an 
increased risk of exerting undue influence on the NRSRO with respect to 
its determination of credit ratings.\1274\ The Commission has adopted 
rules that address this conflict.\1275\ The proposed disclosure 
requirement about paying for other services was intended to complement 
these requirements.\1276\
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    \1274\ See Nationally Recognized Statistical Rating 
Organizations, 76 FR at 33461-33462. In this regard, the Commission 
notes that section 939H of the Dodd-Frank Act contains a sense of 
Congress that the Commission should exercise rulemaking authority 
under section 15E(h)(2)(B) of the Exchange Act to prevent improper 
conflicts of interest arising from employees of NRSROs providing 
services to issuers of securities that are unrelated to the issuance 
of credit ratings, including consulting, advisory, and other 
services. See Public Law 111-203, 939H. See also 2013 Staff Report 
on Credit Rating Agency Independence (a report on the potential 
conflict of interest that arises from a credit rating agency 
providing other services).
    \1275\ See 2013 Staff Report on Credit Rating Agency 
Independence, pp. 9-13 (summarizing and describing the relevant 
rules).
    \1276\ See Nationally Recognized Statistical Rating 
Organizations, 76 FR at 33461-33462.
---------------------------------------------------------------------------

    The Commission acknowledges the concern raised by the commenter 
about the objective of shielding analysts from information that could 
compromise their independence.\1277\ Nonetheless, the Commission 
believes that the proposed disclosure that the NRSRO was paid for other 
services is appropriate because it will provide users of credit ratings 
with relevant information about this conflict even when balanced 
against the concern that an analyst reading the report will learn that 
the NRSRO was paid for other services. If the NRSRO was required to 
disclose the amount of revenue received (as suggested by the third 
commenter), this concern that the analyst might be influenced by the 
disclosure would be increased.\1278\
---------------------------------------------------------------------------

    \1277\ See Moody's Letter.
    \1278\ See CFR/AFR Letter.
---------------------------------------------------------------------------

    For all of these reasons, the Commission is adopting the 
requirement that the NRSRO must include a disclosure in the form if it 
was paid for other services.\1279\ The Commission modified the final 
amendments to correspond to the modifications discussed above with 
respect to eliminating the proposed classification of the credit rating 
as either solicited or unsolicited. Specifically, the final amendments 
require the NRSRO, if applicable, to include in the form a statement 
that the NRSRO also was paid for services other than determining credit 
ratings during the most recently ended fiscal year by the person that 
paid the NRSRO to determine the credit rating.\1280\
---------------------------------------------------------------------------

    \1279\ See paragraph (a)(1)(ii)(J)(2) of Rule 17g-7.
    \1280\ Id.
---------------------------------------------------------------------------

    The third type of conflict disclosure was specified in 
(a)(1)(ii)(J)(3) and related to rating actions resulting from look-back 
reviews.\1281\ As discussed above in section II.C.1. of this release, 
the proposal would require the disclosure of information about a 
conflict of interest influencing a credit rating action discovered as a 
result of a look-back review conducted pursuant to section 15E(h)(4)(A) 
of the Exchange Act and proposed paragraph (c) of Rule 17g-8. Also, as 
discussed above in section II.C.1. of this release, the Commission is 
adopting paragraph (a)(1)(ii)(J)(3) of Rule 17g-7 with modifications in 
response to comments that eliminate the required disclosure that would 
have accompanied the placement of the credit rating on credit watch, 
modify the required disclosure with respect to estimating the impact of 
the conflict, and make certain related and technical 
modifications.\1282\
---------------------------------------------------------------------------

    \1281\ See paragraph (a)(1)(ii)(J)(3) of Rule 17g-7, as 
proposed; Nationally Recognized Statistical Rating Organizations, 76 
FR at 33541.
    \1282\ See paragraph (a)(1)(ii)(J)(3) of Rule 17g-7.
---------------------------------------------------------------------------

    Paragraph (a)(1)(ii)(K). Section 15E(s)(3)(B)(i) of the Exchange 
Act provides that the Commission shall require, by rule, that the NRSRO 
disclose on the form an explanation or measure of the potential 
volatility of the credit rating, including: (1) Any factors that might 
lead to a change in the credit rating; and (2) the magnitude of the

[[Page 55175]]

change that a user can expect under different market conditions.\1283\ 
The Commission proposed to implement this section through paragraph 
(a)(1)(ii)(K) of Rule 17g-7, which largely mirrored the statutory 
text.\1284\ The Commission is adopting paragraph (a)(1)(ii)(K) of Rule 
17g-7 with modifications in response to comment.\1285\
---------------------------------------------------------------------------

    \1283\ See 15 U.S.C. 78o-7(s)(3)(B)(i).
    \1284\ See paragraph (a)(1)(ii)(K) of Rule 17g-7, as proposed; 
Nationally Recognized Statistical Rating Organizations, 76 FR at 
33462, 33541. This paragraph, as proposed, would require the NRSRO 
to include in the form an explanation or measure of the potential 
volatility of the credit rating, including: (1) Any factors that 
might lead to a change in the credit rating; and (2) the magnitude 
of the change that could occur under different market conditions.
    \1285\ See paragraph (a)(1)(ii)(K) of Rule 17g-7.
---------------------------------------------------------------------------

    Three commenters addressed paragraph (a)(1)(ii)(K) of Rule 17g-7, 
as proposed.\1286\ An NRSRO suggested that the Commission modify the 
rule to require the disclosure of any factors that are ``reasonably 
likely to'' (rather than ``might'') lead to a change in the credit 
rating.\1287\ A second NRSRO stated that ``each NRSRO should decide for 
itself what conditions merit discussion in light of the characteristics 
of the rated instrument and whatever other information the NRSRO 
believes it is appropriate to take into account.'' \1288\ A third 
commenter stated that the Commission should require the NRSROs to be 
very specific about the events and the magnitude of those events that 
would cause ratings to be in ``error'' and provided a five percent drop 
in housing prices as an example.\1289\
---------------------------------------------------------------------------

    \1286\ See CFR/AFR Letter; DBRS Letter; S&P Letter.
    \1287\ See DBRS Letter.
    \1288\ See S&P Letter.
    \1289\ CFR/AFR Letter.
---------------------------------------------------------------------------

    The Commission agrees with the modifications suggested by the first 
commenter. The word ``might'' as used in the proposed rule text is 
imprecise and could lead to disclosures that seek to identify any 
conceivable factor that could lead to the change in the credit rating 
no matter how remote the possibility. This could diminish the 
usefulness of the disclosure by including information that is not 
highly relevant to understanding the credit rating and generally making 
the disclosure too long.
    Regarding the second comment, the magnitude of the change that 
could occur under different market conditions will depend on an NRSRO's 
procedures and methodologies for determining credit ratings that apply 
to the credit rating that is subject to the rating action.\1290\ 
Consequently, the required disclosure--as proposed and adopted--will be 
based on those procedures and methodologies and how they account for 
different market conditions. In other words, the NRSRO will need to 
``decide for itself'' the potential market conditions that could cause 
a change in the credit rating given its rating procedures and 
methodologies. However, to make this clear, the Commission is modifying 
the rule to specify that the different market conditions are those that 
are determined by the NRSRO to be relevant to the rating.\1291\
---------------------------------------------------------------------------

    \1290\ See, e.g., 2012 Staff Report on Credit Rating 
Standardization, pp. 25-29 (discussing the feasibility and 
desirability of standardizing the market stress conditions under 
which ratings are evaluated).
    \1291\ See paragraph (a)(1)(ii)(K)(2) of Rule 17g-7.
---------------------------------------------------------------------------

    Finally, the Commission generally agrees with the third commenter 
that the disclosure by the NRSRO must specify the factors (for example, 
market conditions) that would lead to a change in the credit rating. As 
discussed above, the NRSRO must disclose factors that might lead to a 
change in the credit rating. In doing so, the NRSRO must explain the 
factors.
    For these reasons, the final amendments require the NRSRO to 
include in the form an explanation or measure of the potential 
volatility of the credit rating, including: (1) Any factors that are 
reasonably likely to lead to a change in the credit rating; and (2) the 
magnitude of the change that could occur under different market 
conditions determined by the NRSRO to be relevant to the rating.\1292\
---------------------------------------------------------------------------

    \1292\ Id.
---------------------------------------------------------------------------

    Paragraph (a)(1)(ii)(L). Section 15E(s)(3)(B)(ii) of the Exchange 
Act provides that the Commission shall require, by rule, that the NRSRO 
disclose on the form information on the content of the credit rating, 
including: (1) The historical performance of the credit rating; and (2) 
the expected probability of default and the expected loss in the event 
of default.\1293\ The Commission proposed to implement this section 
through paragraph (a)(1)(ii)(L) of Rule 17g-7, which mirrored the 
statutory text.\1294\
---------------------------------------------------------------------------

    \1293\ See 15 U.S.C. 78o-7(s)(3)(B)(ii).
    \1294\ See paragraph (a)(1)(ii)(L) of Rule 17g-7, as proposed; 
Nationally Recognized Statistical Rating Organizations, 76 FR at 
33462, 33541. This paragraph, as proposed, would require the NRSRO 
to include in the form information on the content of the credit 
rating, including: (1) If applicable, the historical performance of 
the credit rating; and (2) the expected probability of default and 
the expected loss in the event of default.
---------------------------------------------------------------------------

    The Commission is adopting paragraph (a)(1)(ii)(L) of Rule 17g-7 as 
proposed.\1295\ The paragraph provides that the NRSRO must include in 
the form information on the content of the credit rating, including: 
(1) If applicable, the historical performance of the credit rating; and 
(2) the expected probability of default and the expected loss in the 
event of default.\1296\
---------------------------------------------------------------------------

    \1295\ See paragraph (a)(1)(ii)(L) of Rule 17g-7.
    \1296\ Id.
---------------------------------------------------------------------------

    Two NRSROs addressed paragraph (a)(1)(ii)(L) of Rule 17g-7, as 
proposed.\1297\ One stated that it supports the disclosure elements 
specified in this paragraph.\1298\ The other commenter stated that the 
proposal is sufficiently explicit, but indicated that its credit 
ratings do not connote a ``particular'' expectation of the probability 
of default.\1299\ The Commission recognizes that credit ratings 
generally are intended to indicate the relative degree of credit risk 
of an obligor or debt instrument rather than reflect a measure of a 
specific default probability or loss expectation.\1300\ The Commission 
does not expect NRSROs to alter the meanings of their credit ratings or 
rating procedures and methodologies to conform to the disclosure 
requirement. Rather, the Commission expects NRSROs to provide 
``information'' to the extent it is consistent with their procedures 
and methodologies for determining credit ratings, on the expected 
probability of default and expected loss in the event of default. This 
information could consist of, for example, historical default and loss 
statistics, respectively, for the class or subclass of the credit 
rating.
---------------------------------------------------------------------------

    \1297\ See Kroll Letter; S&P Letter.
    \1298\ See Kroll Letter.
    \1299\ See S&P Letter.
    \1300\ See 2012 Staff Report on Credit Rating Standardization, 
pp. 29-34 (discussing the feasibility and desirability of requiring 
a quantitative correspondence between credit ratings and a range of 
default probabilities and loss expectations under standardized 
conditions of economic stress).
---------------------------------------------------------------------------

    Paragraph (a)(1)(ii)(M). Section 15E(s)(3)(B)(iii) of the Exchange 
Act provides that the Commission shall require, by rule, that the NRSRO 
disclose on the form information on the sensitivity of the credit 
rating to assumptions made by the NRSRO, including: (1) Five 
assumptions made in the ratings process that, without accounting for 
any other factor, would have the greatest impact on a rating if the 
assumptions were proven false or inaccurate; and (2) an analysis, using 
specific examples, of how each of the five assumptions identified 
impacts a credit rating.\1301\ The Commission proposed to implement 
this section through paragraph (a)(1)(ii)(M) of Rule 17g-7, which 
mirrored the statutory

[[Page 55176]]

text.\1302\ The Commission is adopting paragraph (a)(1)(ii)(M) of Rule 
17g-7 with modifications in response to comments.\1303\
---------------------------------------------------------------------------

    \1301\ See 15 U.S.C. 78o-7(s)(3)(B)(iii).
    \1302\ See paragraph (a)(1)(ii)(M) of Rule 17g-7, as proposed; 
Nationally Recognized Statistical Rating Organizations, 76 FR at 
33541. This paragraph, as proposed, would require the NRSRO to 
include in the form information on the sensitivity of the credit 
rating to assumptions made by the NRSRO, including: (1) Five 
assumptions made in the ratings process that, without accounting for 
any other factor, would have the greatest impact on a credit rating 
if the assumptions were proven false or inaccurate; and (2) an 
analysis, using specific examples, of how each of the five 
assumptions impacts a rating.
    \1303\ See paragraph (a)(1)(ii)(M) of Rule 17g-7.
---------------------------------------------------------------------------

    Several commenters addressed paragraph (a)(1)(ii)(M) of Rule 17g-7, 
as proposed.\1304\ An NRSRO stated that the disclosure of assumptions 
will tend to become a ``mechanical exercise'' where disclosure is 
``sufficiently vague so as to be unimpeachable,'' but will not be 
useful.\1305\ Another NRSRO stated that it should be permissible to 
disclose fewer than five assumptions if fewer than five significant 
assumptions exist.\1306\ Two other NRSROs stated that it may be 
difficult to identify five single assumptions\1307\ because, according 
to one NRSRO, many assumptions are ``cross-dependent,'' and different 
assumptions may ``play out differently in various economic scenarios.'' 
\1308\ Another commenter stated that the Commission should also require 
NRSROs to disclose the sensitivity of the credit rating to several 
assumptions changing at the same time and the dependencies assumed 
between the assumptions.\1309\
---------------------------------------------------------------------------

    \1304\ See Barnard Letter; CFA/AFR Letter; DBRS Letter; Kroll 
Letter; Moody's Letter; Morningstar Letter; S&P Letter.
    \1305\ See Kroll Letter.
    \1306\ See Moody's Letter.
    \1307\ See Morningstar Letter; S&P Letter.
    \1308\ See S&P Letter.
    \1309\ See Barnard Letter.
---------------------------------------------------------------------------

    The Commission agrees with the commenter that an NRSRO should not 
disclose five assumptions if there are fewer than five assumptions that 
would have an impact on the credit rating if proven false or 
inaccurate. Otherwise, the disclosure could contain information that is 
potentially misleading by, for example, creating the impression the 
assumption is important when it is not. Consequently, the final 
amendments are modified to include a provision that the NRSRO need only 
disclose information on the assumptions that would have an impact on 
the credit rating if there are fewer than five such assumptions.\1310\ 
Specifically, the final amendments require the NRSRO to include in the 
form information on the sensitivity of the credit rating to assumptions 
made by the NRSRO, including: (1) Five assumptions made in the ratings 
process that, without accounting for any other factor, would have the 
greatest impact on the credit rating if the assumptions were proven 
false or inaccurate, provided that, if the NRSRO has made fewer than 
five such assumptions, it need only disclose information on the 
assumptions that would have an impact on the credit rating; and (2) an 
analysis, using specific examples, of how each of the assumptions 
impacts the credit rating.\1311\
---------------------------------------------------------------------------

    \1310\ See paragraph (a)(1)(ii)(M)(1) of Rule 17g-7. For the 
reasons stated above, the Commission believes this modification is 
necessary or appropriate in the public interest, and is consistent 
with the protection of investors. See 15 U.S.C. 78mm (providing the 
Commission with general exemptive authority).
    \1311\ See paragraph (a)(1)(ii)(M) of Rule 17g-7.
---------------------------------------------------------------------------

    In response to the comment that this disclosure will become 
``mechanical'' and not useful, the Commission--as stated above--expects 
NRSROs to make the disclosures as specific to the particular rating 
action, and as relevant to investors, as possible, and to strike a 
reasonable balance between standardizing the disclosures and tailoring 
them to specific rating actions. With respect to the comments on 
isolating the assumptions and the co-dependencies between assumptions, 
the Commission understands that certain assumptions may be co-
dependent. The NRSRO should provide an explanation of this co-
dependency in the disclosure of the assumptions to the extent it is 
relevant to understanding how they would impact the credit rating.
    Paragraph (a)(1)(ii)(N). Paragraph (a)(1)(ii)(N) of Rule 17g-7, as 
proposed, would contain the disclosure requirements in paragraphs (a) 
and (b) of Rule 17g-7 before today's amendments.\1312\ Specifically, 
this paragraph would provide that if the credit rating is issued with 
respect to an asset-backed security, as that term is defined in section 
3(a)(79) of the Exchange Act, the NRSRO must include in the form a 
description of: (1) The representations, warranties, and enforcement 
mechanisms available to investors; and (2) how they differ from the 
representations, warranties, and enforcement mechanisms in issuances of 
similar securities, each time there was a rating action with respect to 
an asset-backed security.\1313\ The Commission is adopting paragraph 
(a)(1)(ii)(N) of Rule 17g-7 with modifications in response to 
comments.\1314\
---------------------------------------------------------------------------

    \1312\ See paragraph (a)(1)(ii)(N) of Rule 17g-7, as proposed; 
Nationally Recognized Statistical Rating Organizations, 76 FR at 
33463, 33541; 17 CFR 240.17g-7.
    \1313\ See paragraph (a)(1)(ii)(N) of Rule 17g-7, as proposed.
    \1314\ See paragraph (a)(1)(ii)(N) of Rule 17g-7.
---------------------------------------------------------------------------

    Several commenters addressed paragraph (a)(1)(ii)(N) of Rule 17g-7, 
as proposed.\1315\ Two NRSROs objected to the frequency of the required 
disclosures under the proposed paragraph.\1316\ One NRSRO stated that, 
while the disclosures are relevant at the time an initial credit rating 
is published, the disclosures may not be relevant at later times 
because the representations, warranties, and enforcement mechanisms 
likely will not change in the course of a rated security's 
existence.\1317\ Another NRSRO stated that requiring the disclosures 
with each rating action ``unacceptably'' expands the disclosure 
requirement in Rule 17g-7 before today's amendments, which required the 
disclosures when a rating report is published, noting that some rating 
actions ``would not necessarily be accompanied by the issuance of a 
credit rating report.'' \1318\
---------------------------------------------------------------------------

    \1315\ See Mills Letter; DBRS II Letter; Kroll Letter; S&P 
Letter.
    \1316\ See Kroll Letter; S&P Letter.
    \1317\ See Kroll Letter.
    \1318\ See S&P Letter.
---------------------------------------------------------------------------

    One NRSRO stated that the disclosures required by Rule 17g-7 before 
today's amendments are ``enormously costly to the NRSROs'' and are ``of 
very little value to investors'' according to feedback from 
institutional clients and an analysis of the NRSRO's Internet Web site 
usage data.\1319\ This NRSRO suggested that the rule be modified to 
require disclosures that ``relate to the asset pool underlying the ABS 
transaction'' and which ``the issuer has disclosed in the prospectus, 
private placement memorandum or other offering document for that 
transaction.'' \1320\ Similarly, one commenter stated that the required 
disclosures should be limited to representations, warranties, and 
enforcement mechanisms that ``appear in the prospectus or other 
offering document for [the applicable] security'' because otherwise the 
information

[[Page 55177]]

would not be material to an investor's ability to make an informed 
decision.\1321\ Finally, an NRSRO suggested that the benchmarks for the 
representations, warranties, and enforcement mechanisms should be 
displayed in ``a dedicated area of the NRSROs' Web sites'' instead of 
in the form.\1322\
---------------------------------------------------------------------------

    \1319\ See DBRS II Letter. See also DBRS PRA Letter; Kroll PRA 
Letter; Moody's PRA Letter.
    \1320\ See DBRS II Letter. In support of its suggestion, the 
NRSRO cited the Senate Committee on Banking, Housing, and Urban 
Affairs, Committee Report No. 111-176, April 30, 2010 (``Senate 
Banking Committee Report''), stating that the deficiencies in the 
securitization process that the applicable provision of the Dodd-
Frank Act was designed to address ``included the fact that 
`investors in asset-backed securities could not assess the risks of 
the underlying assets, particularly when those assets were 
resecuritized into complex instruments like collateralized debt 
obligations.''' DBRS II Letter (quoting Senate Banking Committee 
Report at 35-37).
    \1321\ See Mills Letter.
    \1322\ See DBRS II Letter.
---------------------------------------------------------------------------

    The Commission has modified the final amendments in response to 
some of these comments and consistent with the Commission's objective 
of making the information in the form disclosed with a credit rating 
helpful to investors and other users of credit ratings in understanding 
how the credit rating was determined. The first significant 
modification is to narrow the disclosure requirement so that it 
addresses the representations, warranties, and enforcement mechanisms 
available to investors which were disclosed in the prospectus, private 
placement memorandum, or other offering documents for the asset-backed 
security and that relate to the asset pool underlying the asset-backed 
security. The Commission agrees with commenters that this is highly 
relevant information for investors. Therefore, focusing the disclosure 
requirement in this way may make the required disclosure more relevant 
and useful to investors and other users of credit ratings than the 
disclosures required under Rule 17g-7 before today's amendments. 
Specifically, paragraph (a)(1)(ii)(N) of Rule 17g-7 requires an NRSRO, 
if the credit rating is assigned to an asset-backed security as defined 
in section 3(a)(79) of the Exchange Act, to disclose in the form 
information on: (1) The representations, warranties, and enforcement 
mechanisms available to investors which were disclosed in the 
prospectus, private placement memorandum, or other offering documents 
for the asset-backed security and that relate to the asset pool 
underlying the asset-backed security; and (2) how they differ from the 
representations, warranties, and enforcement mechanisms in issuances of 
similar securities.\1323\
---------------------------------------------------------------------------

    \1323\ See paragraph (a)(1)(ii)(N)(1) of Rule 17g-7. As noted 
above, one NRSRO suggested that the benchmarks for the 
representations, warranties, and enforcement mechanisms should be 
displayed in ``a dedicated area of the NRSROs' Web sites'' instead 
of in the form. See DBRS II Letter. In response, the Commission 
notes that the final amendments require the NRSRO disclose in the 
form information on the representations, warranties, and enforcement 
mechanisms available to investors which were disclosed in the 
prospectus, private placement memorandum, or other offering 
documents for the asset-backed security and that relate to the asset 
pool underlying the asset-backed security, and how they differ from 
the representations, warranties, and enforcement mechanisms in 
issuances of similar securities. The Commission does not intend the 
rule to preclude including an Internet address where the benchmarks 
can be found on the NRSRO's Web site, provided the disclosure in the 
form meets the requirement in the rule. Moreover, to the extent the 
benchmarks are lengthy, this approach could make the form easier to 
use.
---------------------------------------------------------------------------

    The second significant modification is to reduce the frequency of 
the disclosure. As commenters stated, the proposal--by incorporating 
the requirements of Rule 17g-7 before today's amendments into the new 
form disclosure requirements--would increase the number of times an 
NRSRO would need to disclose the information about representations, 
warranties, and enforcement mechanisms. The Commission believes that 
the critical time for disclosing this information is when investors are 
making investment decisions about a new issuance, which would have no 
performance history. The Commission also believes the disclosure would 
be useful if there is a material change in the representations, 
warranties, or enforcement mechanisms after issuance because the change 
could be relevant to investment decisions made in the secondary market 
for the security. Finally, because Rule 17g-7 became effective on 
September 26, 2011, the final amendments provide that the requirement 
to make the disclosure after a material change is triggered only if the 
rating action involves an asset-backed security that was initially 
rated by the NRSRO on or after September 26, 2011. This will further 
limit the burden associated with the rule. It also will address the 
practical issue of an NRSRO having to make a disclosure involving 
historical information that it may not have collected and retained 
because it was not required to make the disclosure about the 
representations, warranties, or enforcement mechanisms when it 
initially rated the asset-backed security. For these reasons, the final 
amendments require the information to be disclosed if the rating action 
is a preliminary credit rating or an initial credit rating or if the 
rating action is the first one taken after a material change in the 
representations, warranties, or enforcement mechanisms and the rating 
action involves an asset-backed security that was initially rated by 
the NRSRO on or after September 26, 2011.\1324\
---------------------------------------------------------------------------

    \1324\ See paragraph (a)(1)(ii)(N)(2) of Rule 17g-7.
---------------------------------------------------------------------------

4. Paragraph (a)(1)(iii) of Rule 17g-7--Attestation
    Section 15E(q)(2)(F) of the Exchange Act provides that the 
Commission's rules must require an NRSRO to include an attestation with 
any credit rating it issues affirming that no part of the rating was 
influenced by any other business activities, that the rating was based 
solely on the merits of the instruments being rated, and that such 
rating was an independent evaluation of the risks and merits of the 
instrument.\1325\ While section 15E(q) relates to the disclosure of 
information about the performance of credit ratings, the Commission 
proposed that this attestation provision would more appropriately be 
implemented with respect to all disclosures that must be made when a 
specific rating action is published.\1326\ Accordingly, the Commission 
proposed that the attestation be included in the form accompanying a 
credit rating.\1327\
---------------------------------------------------------------------------

    \1325\ See 15 U.S.C. 78o-7(q)(2)(F).
    \1326\ See paragraph (a)(1)(iii) of Rule 17g-7, as proposed; 
Nationally Recognized Statistical Rating Organizations, 76 FR 33464-
33465, 33541.
    \1327\ See 15 U.S.C. 78o-7(s); 15 U.S.C. 78o-7(q).
---------------------------------------------------------------------------

    As proposed, an NRSRO would be required to attach to the form with 
each rating action a signed statement by a person within the NRSRO 
stating that the person has responsibility for the credit rating and, 
to the best knowledge of the person: (1) No part of the credit rating 
was influenced by any other business activities; (2) the credit rating 
was based solely upon the merits of the obligor, security, or money 
market instrument being rated; and (3) the credit rating was an 
independent evaluation of the risks and merits of the obligor, 
security, or money market instrument.\1328\ Thus, the proposed rule 
text mirrored the statutory text in terms of the representations that 
would be included in the attestation.\1329\
---------------------------------------------------------------------------

    \1328\ See paragraphs (a)(1)(iii)(A) through (C) of Rule 17g-7, 
as proposed; Nationally Recognized Statistical Rating Organizations, 
76 FR at 33541.
    \1329\ See 15 U.S.C. 78o-7(q)(2)(F).
---------------------------------------------------------------------------

    The Commission received several comments that addressed the 
proposal.\1330\ One commenter stated that the ``strong'' attestation 
requirement is a ``valuable enhancement'' because it promotes increased 
accountability and ``more meaningful disclosures.'' \1331\ One NRSRO 
endorsed the attestation requirement substantially as proposed.\1332\ 
Two NRSROs were concerned that the attestation requirement would result 
in an employee or officer being personally liable for a rating 
action.\1333\ One

[[Page 55178]]

NRSRO stated that a ratings committee already attests to the rating's 
independence by signing its internal rating forms and stated ``[t]hus, 
such an attestation is already part and parcel of the ratings package 
that is . . . available to Commission staff during their annual exams, 
or at any other time.'' \1334\ One NRSRO suggested that rather than an 
attestation, the NRSRO should be required to disclose the name of the 
chair of the rating committee because doing so is an implicit 
attestation that the credit rating was determined in accordance with 
the NRSRO's rating procedures and methodologies.\1335\
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    \1330\ See A.M. Best Letter; Better Markets Letter; DBRS Letter; 
Moody's Letter; Morningstar Letter; S&P Letter.
    \1331\ See Better Markets Letter.
    \1332\ See DBRS Letter.
    \1333\ See A.M. Best Letter; Morningstar Letter. While the 
Commission understands the commenters' concerns about potential 
liability, the Commission believes the attestation requirement is an 
important provision that will promote analytic independence. The 
Commission does not believe it would be necessary or appropriate in 
the public interest, or consistent with the protection of investors, 
to refrain from implementing section 15E(q)(2)(F) of the Exchange 
Act, which, as discussed above, requires rulemaking establishing an 
attestation requirement. See 15 U.S.C. 78mm. Further, the Commission 
notes that, consistent with all other provisions of the Exchange Act 
and rules that impose an obligation on an entity, there is a 
potential for secondary liability for an individual that aids and 
abets, or causes, a violation.
    \1334\ See A.M. Best Letter.
    \1335\ See S&P Letter.
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    The Commission is adopting paragraph (a)(1)(iii) of Rule 17g-7 with 
one modification in response to comments. Specifically, one NRSRO 
suggested that the wording of the proposed attestation--because it used 
the phrase ``risks and merits''--could inadvertently lead users of 
credit ratings to believe that credit ratings address other types of 
risk, such as liquidity risk, market value risk, or price 
volatility.\1336\ The commenter suggested the phrase ``credit risk'' be 
used instead.
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    \1336\ See Moody's Letter.
---------------------------------------------------------------------------

    The Commission agrees. Credit ratings are assessments of 
creditworthiness.\1337\ Consequently, the attestation should reference 
credit risk so as not to be misleading. In addition, the NRSRO should 
have the flexibility to designate the individual who will execute the 
certification, as more than one individual within the NRSRO may have 
responsibility for the rating action.\1338\ For these reasons, the 
final amendments provide that the NRSRO must attach to the form a 
signed statement by a person within the NRSRO stating that the person 
has responsibility for the rating action and, to the best knowledge of 
the person: (1) No part of the credit rating was influenced by any 
other business activities; (2) the credit rating was based solely upon 
the merits of the obligor, security, or money market instrument being 
rated; and (3) the credit rating was an independent evaluation of the 
credit risk of the obligor, security, or money market instrument.\1339\
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    \1337\ See 15 U.S.C. 78o-7(c)(60) (defining a credit rating to 
mean ``an assessment of the creditworthiness of an obligor as an 
entity or with respect to specific securities or money market 
instruments'').
    \1338\ For example, if the rating action was determined through 
a rating committee, each of the individuals on the committee could 
be designated by the NRSRO as having responsibility for the rating 
action.
    \1339\ See paragraph (a)(1)(iii) of Rule 17g-7 (emphasis added 
to highlight the modification).
---------------------------------------------------------------------------

    The Commission does not believe the alternatives suggested by 
commenters--relying on internal records or disclosure of the identity 
of the rating committee chair--would adequately implement the statute. 
As discussed above, section 15E(q)(2)(F) of the Exchange Act provides 
that the Commission's rules must require an NRSRO to include an 
attestation with any credit rating it issues affirming that no part of 
the rating was influenced by any other business activities, that the 
rating was based solely on the merits of the instruments being rated, 
and that such rating was an independent evaluation of the risks and 
merits of the instrument.\1340\ Consequently, the attestation must be 
included with the credit rating the NRSRO issues rather than being 
documented in an internal record. Further, the Commission believes that 
having an individual attest to the information disclosed in the form 
will promote analytical independence. In particular, the individual 
executing the attestation will want to ensure that it contains no 
untrue or inaccurate statements. Consequently, the individual will have 
an incentive to take steps to verify that the credit rating was not 
influenced by any other business activities, was based solely on the 
merits of the instruments being rated, and was an independent 
evaluation of the risks and merits of the instrument. Moreover, if the 
individual does not believe such an attestation can be truthfully made, 
the individual will have a reason to refuse to make the attestation. 
This could prevent the NRSRO from taking a rating action that, for 
example, was inappropriately influenced by conflicts of interest 
arising from business considerations.
---------------------------------------------------------------------------

    \1340\ See 15 U.S.C. 78o-7(q)(2)(F).
---------------------------------------------------------------------------

    The Commission is not persuaded that disclosing the name of the 
rating chair would provide an implicit attestation that that no part of 
the credit rating was influenced by any other business activities, that 
the rating was based solely on the merits of the instruments being 
rated, and that such rating was an independent evaluation of the risks 
and merits of the instrument. Moreover, as discussed above, having an 
individual execute the attestation will promote analytical 
independence. Accordingly, the final amendments (as was proposed) 
require that the form include an attestation executed by an individual 
responsible for the rating action.
    Finally, one NRSRO stated that every NRSRO should be able to 
determine who within the NRSRO should be responsible for making the 
proposed attestation.\1341\ The Commission agrees with the commenter 
that the NRSRO has flexibility to select the appropriate person within 
the NRSRO to execute the attestation, provided the person has 
responsibility for the credit rating. For example, the analyst or 
another member of the rating committee could execute the attestation.
---------------------------------------------------------------------------

    \1341\ See DBRS Letter.
---------------------------------------------------------------------------

5. Paragraph (a)(2) of Rule 17g-7--Third-Party Due Diligence 
Certification
    As discussed in more detail below in section II.H. of this release, 
section 15E(s)(4)(B) of the Exchange Act requires a third party 
providing due diligence services to an NRSRO, issuer, or underwriter 
with respect to an Exchange Act-ABS to provide a written certification 
to any NRSRO that produces a credit rating to which the due diligence 
services relate.\1342\ Section 15E(s)(4)(D) of the Exchange Act 
provides that the Commission shall adopt a rule requiring an NRSRO that 
receives a certification from a provider of third-party due diligence 
services to disclose the certification to the public in a manner that 
allows the public to determine the adequacy and level of the due 
diligence services provided by the third party.\1343\ The Commission 
proposed to implement section 15E(s)(4)(D) through paragraph (a)(2) of 
Rule 17g-7, as proposed.\1344\ As proposed, paragraph (a)(2) identified 
the second item of information an NRSRO would need to publish with a 
credit rating when taking a rating action: Any written certification 
related to the credit rating received from a third-party provider of 
due diligence services pursuant to section 15E(s)(4)(B) of the Exchange 
Act.\1345\ The proposed approach was intended to provide disclosure of 
the certification to the public in a manner that allows the

[[Page 55179]]

public to determine the adequacy and level of the due diligence 
services provided.\1346\
---------------------------------------------------------------------------

    \1342\ See 15 U.S.C. 78o-7(s)(4)(B). As stated above in section 
I.B.1. of this release, the term Exchange Act-ABS as used throughout 
this release refers to an asset-backed security as defined in 
section 3(a)(79) of the Exchange Act. 15 U.S.C. 78c(a)(79).
    \1343\ See 15 U.S.C. 78o-7(s)(4)(D).
    \1344\ See paragraph (a)(2) of Rule 17g-7, as proposed; 
Nationally Recognized Statistical Rating Organizations, 76 FR at 
33465, 33541.
    \1345\ See paragraph (a)(2) of Rule 17g-7, as proposed.
    \1346\ See Nationally Recognized Statistical Rating 
Organizations, 76 FR at 33465.
---------------------------------------------------------------------------

    The Commission received a number of comment letters regarding 
proposed paragraph (a)(2) of Rule 17g-7.\1347\ An NRSRO stated that 
requiring the NRSRO to deliver ``information and commentary generated 
by other market participants'' may lead to confusion about ``the 
appropriate role of NRSROs,'' \1348\ and another NRSRO stated that the 
proposed requirements may cause NRSROs to ``include in their rating 
disclosure form information that they believe is not from a reliable 
source and that they did not use in their rating analysis.'' \1349\ The 
second NRSRO also stated that ``NRSROs do not typically engage third-
party due diligence providers'' and ``obtaining and disclosing this 
certification should be the obligation of the issuer.''\1350\ On the 
other hand, two commenters expressed their support for requiring NRSROs 
to disclose information related to third-party due diligence 
reviews.\1351\ Another commenter stated that only the NRSRO is in a 
position to know which reports it used in issuing a credit 
rating.\1352\ A fourth commenter stated that the due diligence 
providers have a ``limited role'' in the transaction and that ``the 
onus for making the certification publicly available should rest solely 
with the NRSRO.'' \1353\
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    \1347\ See ASF Letter; CII Letter; Clayton Letter; Levin Letter; 
Moody's Letter; Morningstar Letter; S&P Letter.
    \1348\ See Moody's Letter.
    \1349\ See S&P Letter.
    \1350\ Id.
    \1351\ See CII Letter; Levin Letter.
    \1352\ See ASF Letter.
    \1353\ See Clayton Letter.
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    The Commission is adopting paragraph (a)(2) of Rule 17g-7 with 
modifications designed to address comments made in the context of 
proposed Rule 17g-10.\1354\ Specifically, the final amendments are 
modified to explicitly reference Form ABS Due Diligence-15E.\1355\ In 
addition, the final amendments are modified to correspond to 
modifications to Rule 17g-10 (discussed below) to provide that an NRSRO 
must publish with a rating action any executed Form ABS Due Diligence-
15E containing information about the security or money market 
instrument subject to the rating action that is received by the NRSRO 
or obtained by the NRSRO through an Internet Web site maintained by the 
issuer, sponsor, or underwriter of the security or money market 
instrument pursuant to paragraph (a)(3) of Rule 17g-5. As discussed 
below in section II.H.2.c. of this release, the Commission is modifying 
Rule 17g-10 from the proposal to provide that a person employed to 
provide third-party due diligence services can meet its statutory 
obligation to provide the written certification relating to those 
services to any NRSRO that produces a credit rating to which such 
services relate by promptly responding to a written request from an 
NRSRO for the executed Form ABS Due Diligence-15E and promptly 
delivering the Form ABS Due Diligence-15E to the issuer, sponsor, or 
underwriter of the security or money market instrument that maintains 
the relevant Internet Web site pursuant to Rule 17g-5.\1356\ Further, 
the Commission is amending Rule 17g-5 to provide for the issuer, 
sponsor, or underwriter to represent that it will promptly post the 
Form ABS Due Diligence-15E to the Internet Web site it maintains under 
paragraph (a)(3) of Rule 17g-5.\1357\
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    \1354\ See paragraph (a)(2) of Rule 17g-7. See also section 
II.H.2. of this release (discussing the ``safe harbor'' provision 
that incorporates the use of the Internet Web site maintained by the 
issuer, sponsor, or underwriter of the security or money market 
instrument pursuant to paragraph (a)(3) of Rule 17g-5).
    \1355\ See paragraph (a)(2) of Rule 17g-7. As proposed, the 
paragraph referred to ``any certification.''
    \1356\ See paragraph (c) of Rule 17g-10.
    \1357\ See paragraph (a)(3)(iii)(E) of Rule 17g-5.
---------------------------------------------------------------------------

    As discussed above, two NRSROs raised concerns about requiring the 
NRSRO to disclose the due diligence certifications.\1358\ The 
Commission notes that section 15E(s)(4)(D) of the Exchange Act provides 
that the Commission shall adopt a rule requiring an NRSRO that receives 
a certification from a provider of third-party due diligence services 
to disclose the certification to the public in a manner that allows the 
public to determine the adequacy and level of the due diligence 
services provided by the third party.\1359\ Moreover, the Commission 
believes that the information contained in Form ABS Due Diligence-15E 
will be useful to investors and to other users of the NRSRO's credit 
ratings. Therefore, disclosing the information in the form that will 
accompany the credit rating will associate the information with the 
credit rating. This will make it easier for investors and other users 
of credit ratings to locate the information and it will promote their 
use of the information in evaluating the credit rating and asset-backed 
security that is the subject of the rating action. For these reasons, 
the Commission does not believe it would be necessary or appropriate in 
the public interest, or consistent with the protection of investors to 
exempt NRSROs from the requirement to include the due diligence 
certifications with their forms.\1360\
---------------------------------------------------------------------------

    \1358\ See Moody's Letter; S&P Letter.
    \1359\ 15 U.S.C. 15E(s)(4)(D).
    \1360\ See 15 U.S.C. 78mm (providing the Commission with 
exemptive authority).
---------------------------------------------------------------------------

6. Economic Analysis
    This section builds on the economic analysis in section I.B. of 
this release by presenting a focused analysis of the potential economic 
effects that may derive from the specific amendments relating to the 
forms and certifications that an NRSRO must publish when taking certain 
rating actions.\1361\ The baseline that existed before today's 
amendments was one in which NRSROs were not required by Commission 
rules to publish specified information when taking a rating action. 
However, today's amendments contain requirements for the disclosure of 
certain types of information with the publication of certain rating 
actions that an applicant or NRSRO was required, before these 
amendments, to report generally with respect to all of its credit 
ratings on Form NRSRO. For example, before today's amendments, the 
instructions for Exhibit 2 to Form NRSRO required the disclosure of a 
general description of the procedures and methodologies used by the 
NRSRO to determine credit ratings. This description must address, among 
other items, the quantitative and qualitative models and metrics and 
the public and non-public sources of information, including data and 
analysis provided by third-party vendors, used to determine credit 
ratings. This information was not, however, required to be disclosed at 
the level of individual rating actions, so users of credit ratings 
interested in a particular rating action may not have known, for 
example, the ``version of the procedure or methodology used'' or the 
``types of data . . . that were relied on'' to determine the credit 
rating in question, as required to be disclosed with the publication of 
certain credit rating actions under the amendments.
---------------------------------------------------------------------------

    \1361\ The economic analysis in section I.B. of this release 
discusses the primary economic impacts that may derive from the 
amendments and new rules being adopted today. The economic effects 
related to the certification of third-party due diligence providers 
are discussed below in more detail in section II.H.4. of this 
release.
---------------------------------------------------------------------------

    Before today's amendments, some NRSROs provided, but were not 
required by the Commission to provide, additional disclosures on their 
public Web sites with respect to all of their credit ratings, such as a 
description of

[[Page 55180]]

the intended informational content of their credit ratings and a 
general discussion of the uncertainty and risk factors to which their 
credit ratings are subject. Also, in some public press releases and 
reports to subscribers issued in connection with rating actions, NRSROs 
have discussed certain risk factors specific to a given rating action 
or provided information or Web addresses directing interested persons 
to the descriptions of methodologies that are relevant for that 
particular rating action, though such disclosures were not required.
    Relative to this baseline, the amendments being adopted today may 
benefit users of credit ratings because the forms may provide new 
information specific to a given rating action or may clearly direct 
users of credit ratings to information that may already have been 
available. Specifically, as discussed above, the information provided 
in the forms will include, among other things: (1) Information about 
the content of the credit rating; (2) the main assumptions and 
principles and the version of the methodology used to determine the 
credit rating; (3) a description of the types of data that were relied 
on and whether due diligence services and servicer or remittance 
reports were used for the purpose of determining the credit rating; (4) 
information relating to potential conflicts of interest; and (5) 
information about the potential limitations, uncertainty, sensitivity 
to assumptions, and potential volatility of the credit rating.\1362\
---------------------------------------------------------------------------

    \1362\ See paragraph (a)(1)(ii) of Rule 17g-7 (prescribing the 
information that must be disclosed in the form).
---------------------------------------------------------------------------

    The disclosure of this information and the other required content 
of the forms may benefit users of credit ratings by allowing them to 
better understand how credit ratings are produced and the information 
content of credit ratings, including how these factors vary across 
NRSROs. Also, the information disclosed in the form--particularly 
information about the potential limitations, uncertainty and potential 
volatility of the credit rating, the sensitivity of the credit rating 
to assumptions made by the NRSRO, and information regarding the due 
diligence services used in rating Exchange Act-ABS--may discourage 
undue reliance on credit ratings by investors and other users of credit 
ratings in making investment and other credit-based decisions. The 
disclosures, and particularly the attestation requirement, also may 
encourage enhanced integrity in the production of credit ratings.
    If the forms increase the ability of users of credit ratings to 
compare the assumptions, data, and due diligence relied on by different 
NRSROs, the adopted rules and amendments may have beneficial 
competitive effects by enhancing the reputation of NRSROs that users of 
credit ratings view as being more thorough or as providing more 
informative credit ratings on the basis of these reviews. Also, to the 
extent that the forms allow investors to more accurately interpret the 
information conveyed by credit ratings, they may result in more 
efficient investment decisions and higher overall market 
efficiency.\1363\ However, the benefits of the forms may be limited to 
the extent that standardized language and a high level of narrative in 
the forms limit the amount of useful information that can readily be 
acquired from the disclosures or the extent to which the information 
may be easily compared across NRSROs.
---------------------------------------------------------------------------

    \1363\ See section I.B.3. of this release (providing a broader 
discussion of the potential impacts of the amendments and new rules 
on efficiency, competition, and capital formation).
---------------------------------------------------------------------------

    The amendments will result in compliance costs to NRSROs. The 
Commission believes that NRSROs will be able to develop disclosures 
that are standardized to some degree for particular types of credit 
ratings and, when they publish individual rating actions, to tailor 
those disclosures appropriately to each such rating action. NRSROs will 
therefore bear one-time costs to develop a template for the form and to 
produce any disclosures that can be standardized across and within 
various credit rating classes, asset classes, and types of rating 
actions. As part of this process, NRSROs will likely identify the 
required disclosure items that, based on their individual credit rating 
methodologies and procedures, may share common elements across these 
various subgroups. For example, some or all of the disclosure required 
by paragraph (a)(1)(ii)(C) of Rule 17g-7 (with respect to the main 
assumptions and principles used in constructing the procedures and 
methodologies used to determine the credit rating) can likely be 
standardized across credit ratings generated using the same procedures 
and methodologies. NRSROs may then have to draft, review, and finalize 
any such common components of these disclosures.
    NRSROs will bear additional one-time costs to establish systems, 
protocols, and procedures for generating and publishing the form, 
attestation, and certifications when required. These systems, 
protocols, and procedures may include processes by which the latest 
versions of any standardized components of the disclosures will be 
stored, retrieved, and input into the form when required. NRSROs may 
also have to consider how the other newly required information will be 
generated, including how analyses constructed in the process of 
applying their credit rating procedures and methodologies can be 
translated into some of the required disclosure and whether additional 
analyses may be required, as well as at what stage and by which staff 
the generation of this information will be undertaken. NRSROs also will 
need to establish systems, protocols, and procedures to ensure that the 
form is populated with the required information (including that any 
certifications received from a provider of third-party due diligence 
services are attached to the form) and that the form, attestation, and 
certifications are published with the associated credit rating.
    The amendments also will result in ongoing costs to NRSROs. At the 
time of any rating action that triggers the requirement, an NRSRO must 
produce disclosures for the particular rating action and compile these 
into the form. This process may include retrieving any applicable 
standardized components of the disclosure, revising this content if 
necessary to tailor it to the particular rating action, and generating 
and including any additional tailored content that is specific to the 
particular rating action. Some of the tailored components of the 
disclosure may be relatively straightforward because they are primarily 
factual in nature, such as the assigned credit rating, the identity of 
the obligor, security, or instrument, the version of the procedure or 
methodology used to determine the credit rating, and the required 
information relating to conflicts of interest. Other tailored 
components of the disclosure may require more consideration and the 
application of analysis that was produced in the course of producing 
the credit rating or the completion of additional analysis. Examples of 
required disclosure items that may require more consideration or 
analysis include the explanation or measure of the potential volatility 
of the credit rating and the information on the sensitivity of the 
credit rating to assumptions made by the NRSRO required by paragraphs 
(a)(1)(ii)(K) and (a)(1)(ii)(M) of Rule 17g-7.
    NRSROs also will bear ongoing costs to review the form, include any 
relevant hyperlinks, attach applicable attestations and certifications 
to the form, and to publish the form as required. Also, NRSROs will 
periodically need to update the

[[Page 55181]]

standardized components of the disclosures (for example, when 
methodologies are revised). The Commission's estimates of the total 
costs of these compliance efforts--which are based on analyses for 
purposes of the PRA--are provided below.
    The Commission received comments identifying costs and burdens, 
including significant administrative, recordkeeping, technological, and 
compliance costs, including costs associated with time spent by rating 
analysts and other NRSRO employees in complying with the proposed 
amendments.\1364\ Commenters also expressed concerns about the 
potential for the publication of confidential or proprietary 
information.\1365\ As stated above, the Commission is sensitive to the 
costs resulting from its rules. In this regard, the Commission has 
modified the amendments from the proposal in a number of ways to 
mitigate burdens. The Commission narrowed the scope of rating actions 
that will trigger the disclosure requirement and provided an exemption 
for certain rating actions involving foreign obligors or foreign-issued 
securities or money market instruments. The Commission also 
significantly reduced the reporting requirements relating to 
representations, warranties, and enforcement mechanisms. All of these 
modifications were made in response to concerns about burdens raised by 
commenters. The Commission also has clarified the type of information 
that is required to be included in the form, which may address concerns 
about burdens as well as concerns about the disclosure of confidential 
information raised by commenters.
---------------------------------------------------------------------------

    \1364\ See Kroll Letter; Morningstar Letter; S&P Letter.
    \1365\ See Barnard Letter; Siff Letter.
---------------------------------------------------------------------------

    One NRSRO commented that the Commission, in the proposing release, 
had underestimated the burden associated with the form because the 
proposed disclosure items would not be able to be standardized across 
rating actions or asset class types and would require an individual 
analysis of the rated transaction.\1366\ While the Commission 
encourages NRSROs to make the disclosures as specific to the particular 
rating action and as relevant to investors as possible, it also 
believes, as discussed above, that NRSROs will be able to develop 
disclosures that are standardized to some degree for particular types 
of credit ratings and, when they publish individual rating actions, to 
tailor those disclosures appropriately to each such rating action.
---------------------------------------------------------------------------

    \1366\ See Morningstar Letter.
---------------------------------------------------------------------------

    Compliance costs should vary across NRSROs due to differences in 
the number of sectors (such as asset classes, industries, and 
geographies) rated--which may affect the number of standardized 
disclosures that will be created--and the number of rating actions each 
year subject to the requirements, as well as the frequency with which 
the NRSROs change their approaches to producing credit ratings or the 
sectors for which they produce credit ratings, and any differences in 
the complexity of rating procedures and methodologies that may impact 
the complexity of the forms. However, based on analysis for purposes of 
the PRA, the Commission estimates that the amendments to paragraph (a) 
of Rule 17g-7 will result in total industry-wide one-time costs to 
NRSROs of approximately $15,613,000 and total industry-wide annual 
costs to NRSROs of approximately $196,783,000.\1367\
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    \1367\ See section V.H. of this release (discussing 
implementation and annual compliance considerations). The one-time 
and annual costs are determined by monetizing internal hour burdens 
and adding external costs identified in the PRA analysis in section 
IV.D.6. of this release.
---------------------------------------------------------------------------

    Given that some of the compliance costs associated with creating 
and revising standardized disclosures may not scale proportionately 
with size, and that costs should also vary across NRSROs for the other 
reasons listed above, these amendments may negatively affect 
competition through the disproportionate burden on small NRSROs and, 
for example, NRSROs with procedures and methodologies that would result 
in more complex disclosure.\1368\ The amendments also may result in 
other costs. The Commission received comments from NRSROs expressing 
concerns about potential delays in the issuance of ratings.\1369\ The 
Commission is sensitive to concerns that, in some instances, the need 
to draft and review these additional disclosures may delay NRSROs in 
publishing preliminary and initial credit ratings, may result in NRSROs 
taking fewer rating actions, may result in NRSROs taking more time to 
take rating actions in response to changing conditions, and may 
particularly extend the amount of time required for NRSROs to take 
steps which would require the NRSRO to revise the standardized language 
prepared for the disclosures for certain asset classes or other 
sectors, such as making appropriate changes to credit rating 
methodologies. Commenters also predicted a decline in the transparency 
of credit ratings over time due to the increased standardization of 
disclosure, and raised concerns that very extensive disclosures could 
overwhelm users of credit ratings or obfuscate key points.\1370\ As 
mentioned above, though section 15E(s)(3) identifies specific 
qualitative and quantitative information that must be included in the 
form, the Commission has modified the amendments from the proposals in 
a number of ways to mitigate burdens, which may reduce the likelihood 
or extent of such impacts. However, any such effects may reduce the 
information readily available to users of credit ratings and thus 
reduce the efficiency of their investment decisions and potentially the 
efficiency of the overall market.\1371\
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    \1368\ See section IV.D.6. of this release for the Commission's 
estimates of the different components of the compliance burden and a 
further discussion of how they may vary across NRSROs. See also 
section I.B.3. of this release (providing a broader discussion of 
the potential impacts of the amendments and new rules on efficiency, 
competition, and capital formation).
    \1369\ See S&P Letter; DBRS Letter.
    \1370\ See A.M. Best Letter; DBRS Letter; Kroll Letter; 
Morningstar Letter.
    \1371\ See section I.B.3. of this release (providing a broader 
discussion of the potential impacts of the amendments and new rules 
on efficiency, competition, and capital formation).
---------------------------------------------------------------------------

    The Commission considered the costs and benefits of reasonable 
alternatives to the amendments. Section 15E(s)(3) of the Exchange Act 
identifies a significant amount of information that the Commission's 
rule must require to be disclosed in the form. Because the statute is 
specific about the type of information to be included in the form, and 
the information thus detailed by the statute is quite comprehensive, 
the rule text prescribing the required contents of the form largely 
mirrors the statutory text. However, the Commission has applied some 
discretion with respect to the format of the form and which rating 
actions must be accompanied by the forms and certifications. One 
alternative to the approach in the amendments would be to prescribe a 
specific form in which NRSROs would input the information required by 
the amendments. Requiring NRSROs to use a standardized form could 
assist users of the form in locating and analyzing items of information 
disclosed. On the other hand, a standardized form with line items and 
fields to input information could cause NRSROs to provide disclosures 
that are less thorough or tailored to their individual approaches, 
which could reduce transparency. The Commission believes the approach 
it has taken in requiring that the content of the forms be disclosed in 
numbered items that are presented in a consistent

[[Page 55182]]

order across NRSROs, without, for example, requiring that a prescribed 
form be filled out, strikes an appropriate balance in implementing 
section 15E(s)(2) of the Exchange Act between the comparability of the 
information provided and the flexibility to allow for meaningful 
disclosure.
    Other alternatives would be, as the Commission proposed, to require 
the forms to be disclosed even with affirmations or withdrawals that 
are not based on the NRSRO applying its procedures and methodologies 
for determining credit ratings or, as the Commission proposed, to 
require broader disclosures of representations, warranties, and 
enforcement mechanisms. However, the additional information that these 
alternatives would make available to users of credit ratings would 
likely not be significant, while, as raised by several 
commenters,\1372\ the burden to create these additional disclosures 
could be substantial.
---------------------------------------------------------------------------

    \1372\ As discussed above, commenters raised concerns regarding 
the rating actions that would trigger the disclosure requirement. 
See A.M. Best Letter; ASF Letter; DBRS Letter; Deloitte Letter; FSR 
Letter; Moody's Letter; S&P Letter. Commenters also raised concerns 
regarding the disclosures of representations, warranties and 
enforcement mechanisms. See DBRS II Letter. See also DBRS PRA 
Letter; Kroll PRA Letter; Moody's PRA Letter.
---------------------------------------------------------------------------

H. Third-Party Due Diligence for Asset-Backed Securities

    Section 932(a)(8) of the Dodd-Frank Act amended section 15E of the 
Exchange Act to add paragraph (s)(4), ``Due diligence services for 
asset-backed securities,'' which contains four provisions regarding due 
diligence services relating to an Exchange Act-ABS.\1373\ Specifically, 
section 15E(s)(4)(A) requires the issuer or underwriter of any asset-
backed security to make publicly available the findings and conclusions 
of any third-party due diligence report obtained by the issuer or 
underwriter.\1374\ Section 15E(s)(4)(B) requires that in any case in 
which third-party due diligence services are employed by an NRSRO, 
issuer, or underwriter, the person providing the due diligence services 
shall provide written certification in a format provided in section 
15E(s)(4)(C) to any NRSRO that produces a rating to which such services 
relate.\1375\ Section 15E(s)(4)(C) requires the Commission to establish 
the appropriate format and content for the written certifications 
required under section 15E(s)(4)(B) to ensure that providers of due 
diligence services have conducted a thorough review of data, 
documentation, and other relevant information necessary for an NRSRO to 
provide an accurate credit rating.\1376\ Finally, as discussed above in 
section II.G.5. of this release, section 15E(s)(4)(D) of the Exchange 
Act directs the Commission to adopt rules requiring an NRSRO, at the 
time at which it produces a credit rating, to disclose the 
certification required by section 15E(s)(4)(B) to the public in a 
manner that allows the public to determine the adequacy and level of 
due diligence services provided by a third party.\1377\
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    \1373\ See Public Law 111-203, 932(a)(8); 15 U.S.C. 78o-7(s)(4). 
As stated above in section I.B.1. of this release, the term Exchange 
Act-ABS as used throughout this release refers to an asset-backed 
security as defined in section 3(a)(79) of the Exchange Act. 15 
U.S.C. 78c(a)(79).
    \1374\ See 15 U.S.C. 78o-7(s)(4)(A).
    \1375\ See 15 U.S.C. 78o-7(s)(4)(B).
    \1376\ See 15 U.S.C. 78o-7(s)(4)(C).
    \1377\ See 15 U.S.C. 78o-7(s)(4)(D).
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    The Commission proposed amendments to Rule 314 of Regulation S-T 
and Form ABS-15G, and proposed Rule 15Ga-2 to implement section 
15E(s)(4)(A) of the Exchange Act.\1378\ The Commission proposed 
amendments to Rule 17g-7 and proposed Rule 17g-10 and related Form ABS 
Due Diligence-15E to implement sections 15E(s)(4)(B), (C), and (D) of 
the Exchange Act.\1379\ The proposals, comments received on the 
proposals, and final rules are discussed below.
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    \1378\ See Nationally Recognized Statistical Rating 
Organizations, 76 FR at 33466-33471.
    \1379\ See id. at 33465, 33471-33476.
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1. New Rule 15Ga-2 and Amendments to Form ABS-15G
    The Commission re-proposed rules to implement section 15E(s)(4)(A) 
of the Exchange Act, which requires that an issuer or underwriter of 
any Exchange Act-ABS make publicly available the findings and 
conclusions of any third-party due diligence report obtained by the 
issuer or underwriter.\1380\ In October 2010, the Commission proposed 
to implement section 15E(s)(4)(A) of the Exchange Act as part of a set 
of rules proposed to implement section 945 of the Dodd-Frank Act.\1381\ 
After reviewing the comments to that proposal regarding issuer review 
of assets in offerings of asset-backed securities,\1382\ the Commission 
was persuaded that section 15E(s)(4)(A) of the Exchange Act, when 
considered in the context of sections 15E(s)(4)(B), (C), and (D),\1383\ 
should be interpreted more narrowly than in the proposal.\1384\ 
Therefore, the Commission re-proposed Rule 15Ga-2 to require an issuer 
or underwriter of any Exchange Act-ABS that is to be rated by an NRSRO 
to furnish a Form ABS-15G \1385\ containing the findings and 
conclusions of any third-party due diligence report obtained by the 
issuer or underwriter.\1386\ The Commission also proposed that if Form 
ABS-15G was furnished by the issuer, it must be signed by the senior 
officer of the depositor in charge of securitization, and if Form ABS-
15G was furnished by the underwriter, then it must be signed by a duly 
authorized officer of the underwriter.\1387\
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    \1380\ See Nationally Recognized Statistical Rating 
Organizations, 76 FR at 33466-33471.
    \1381\ 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).
    \1382\ See, e.g., comment letters from the American Bar 
Association (stating that ``[section] 15E(s)(4)(A) was not intended 
to be applied to all manner of third-party due diligence reports 
that may be obtained by an issuer or underwriter, but instead was 
intended to be applied more narrowly, to any third-party due 
diligence report prepared for an ABS issuer or underwriter 
specifically for the purpose of sharing it with a given NRSRO'') and 
the National Association of Bond Lawyers. The comment letters are 
available at http://www.sec.gov/comments/s7-26-10/s72610.shtml.
    \1383\ See 15 U.S.C 78o-7(s)(4)(A) through (D), which relate to 
due diligence performed by third parties with respect to Exchange 
Act-ABS.
    \1384\ See Issuer Review of Assets in Offerings of Asset-Backed 
Securities, Securities Act Release No. 9176 (Jan. 20, 2011), 76 FR 
4231 (Jan. 25, 2011).
    \1385\ As discussed below, Form ABS-15G is being amended today 
to incorporate Rule 15Ga-2. Form ABS-15G was originally adopted for 
the purpose of providing disclosures required by the new disclosure 
requirements of Rule 15Ga-1 (17 CFR 240.15Ga-1). See Disclosure for 
Asset-Backed Securities Required by Section 943 of the Dodd-Frank 
Wall Street Reform and Consumer Protection Act, 76 FR at 4499-4501.
    \1386\ See Nationally Recognized Statistical Rating 
Organizations, 76 FR at 33466-33470, 33538. The Commission stated in 
the proposing release that the term issuer would mean the depositor 
or sponsor that participates in the issuance of Exchange Act-ABS, 
which was consistent with proposed Rule 17g-10, but did not include 
a definition of issuer within proposed Rule 15Ga-2. The Commission 
proposed to define the term third-party due diligence report to mean 
any report containing findings and conclusions relating to due 
diligence services as defined in paragraph (c)(1) of Rule 17g-10, as 
proposed. See id. at 33467, n.532.
    \1387\ See Nationally Recognized Statistical Rating 
Organizations, 76 FR at 33466-33470.
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    In addition, the Commission proposed that an issuer or underwriter 
would not need to furnish Form ABS-15G if it obtains a representation 
from an NRSRO engaged to produce a credit rating for the Exchange Act-
ABS that the NRSRO will publicly disclose the findings and conclusions 
of the third-party due diligence report obtained by the issuer or 
underwriter.\1388\ As proposed, the NRSRO's representation must state 
that it will make the disclosure with the publication of the credit 
rating five business days prior to the first sale in the offering in 
the form generated pursuant to proposed paragraph (a)(1) of Rule 17g-
7.\1389\ In this context, the Commission stated in the proposing 
release that the term publicly disclose

[[Page 55183]]

means to make the findings and conclusions readily available to any 
users of credit ratings.\1390\ Consequently, an NRSRO that agreed to 
make the findings and conclusions available only to its subscribers or 
prospective investors in the Exchange Act-ABS would not satisfy this 
proposed requirement. The Commission recognized, however, that there 
may be instances where, notwithstanding an issuer's or underwriter's 
reasonable reliance on a representation by an NRSRO, the NRSRO fails to 
make the required information publicly available in the form pursuant 
to proposed paragraph (a)(1) of Rule 17g-7 five business days prior to 
the first sale in the offering.\1391\ Therefore, the Commission 
proposed to require that if the NRSRO failed to make the information 
publicly available, an issuer or underwriter must furnish, two business 
days prior to the first sale in the offering, Form ABS-15G with the 
information required by proposed Rule 15Ga-2.\1392\
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    \1388\ See id. at 33466-33470, 33538.
    \1389\ See id.
    \1390\ See id. at 33468, n.534.
    \1391\ See id. at 33468. Under the proposal, an NRSRO's failure 
to disclose the certification would be a violation of the 
requirement in proposed paragraph (a)(2) of Rule 17g-7. See id. at 
33540-33541.
    \1392\ See id. at 33468, 33538.
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    The Commission did not propose to require that disclosure about a 
third-party due diligence report for registered Exchange Act-ABS 
transactions required by proposed Rule 15Ga-2 be provided in the 
prospectus because such information only pertains to the findings and 
conclusions of a third-party due diligence report relevant to the 
determination of a credit rating.\1393\ Under Rule 193,\1394\ on the 
other hand, if an issuer were to use the third-party due diligence 
report in connection with its review of disclosure in the prospectus 
about the pool assets as required under Rule 193, it would be required 
to include the findings and conclusions in the prospectus \1395\ and, 
if the issuer attributed the findings and conclusions to the third 
party, that third party's consent to be named as an expert in the 
registration statement would need to be obtained.\1396\
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    \1393\ See id. at 33469.
    \1394\ See 17 CFR 230.193. Rule 193 implemented section 945 of 
the Dodd-Frank Act by requiring that any issuer registering the 
offer and sale of an Exchange Act-ABS perform a review of the assets 
underlying the asset-backed security.
    \1395\ See 17 CFR 229.1111.
    \1396\ See Issuer Review of Assets in Offerings of Asset-Backed 
Securities, 76 FR 4238.
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    The Commission also proposed that Rule 15Ga-2 would apply to 
issuers and underwriters of both registered and unregistered offerings 
of Exchange Act-ABS.\1397\ Accordingly, if a municipal entity that 
sponsors or issues Exchange Act-ABS (``municipal Exchange Act-ABS'') or 
an underwriter of municipal Exchange Act-ABS obtained a third-party due 
diligence report, as defined by the proposed rule, and the municipal 
Exchange Act-ABS is to be rated by an NRSRO, the proposal noted that 
Rule 15Ga-2 would apply.\1398\ The Commission proposed to permit 
municipal securitizers of Exchange Act-ABS, or underwriters in the 
offering, to provide the information required by Form ABS-15G on the 
Electronic Municipal Market Access system (``EMMA'').\1399\
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    \1397\ See Nationally Recognized Statistical Rating 
Organizations, 76 FR at 33469.
    \1398\ See id. at 33469.
    \1399\ See id. at 33469, 33538.
---------------------------------------------------------------------------

    Commenters generally supported the overarching principle of 
proposed Rule 15Ga-2 but were mixed about the specifics of how the rule 
should be implemented.\1400\ As a result, the Commission is adopting 
Rule 15Ga-2 and revised Form ABS-15G with some revisions to address 
comments and to make clarifying changes.\1401\ Commenters generally 
agreed that Rule 15Ga-2 should only apply to an Exchange Act-ABS that 
is to be rated by an NRSRO.\1402\ The Commission continues to believe 
for the reasons stated in the proposing release that section 
15E(s)(4)(A) of the Exchange Act should be interpreted to relate only 
to Exchange Act-ABS that are rated.\1403\ Therefore, the Commission is 
adopting, generally as proposed, the requirement that an issuer or 
underwriter of any Exchange Act-ABS that is to be rated by an NRSRO 
must furnish a Form ABS-15G containing the findings and conclusions of 
any third-party due diligence report obtained by the issuer or 
underwriter, with modifications to provide limited exclusions for 
issuers and underwriters of Exchange Act-ABS in certain offshore 
transactions and municipal issuer offerings, as discussed further 
below.\1404\ Rule 15Ga-2 applies to Exchange Act-ABS transactions that 
are rated by an NRSRO regardless of who pays for the credit rating, and 
regardless of whether the Exchange Act-ABS is sold in a registered or 
unregistered transaction, as described in more detail below. Several 
commenters suggested that the issuer's or underwriter's requirement 
under Rule 15Ga-2 should apply only to third-party due diligence 
reports that were provided to an NRSRO.\1405\ The Commission is not, 
however, limiting the applicability of Rule 15Ga-2 as these commenters 
suggest. The Commission does not believe it is appropriate to limit the 
applicability of Rule 15Ga-2 in this manner because most, if not all, 
third-party due diligence reports will be made available to NRSROs 
pursuant to Rule 17g-10.\1406\ In the instance a third-party due 
diligence report that is obtained by the issuer or underwriter is not 
provided to an NRSRO under Rule 17g-10, the

[[Page 55184]]

Commission believes it is important for these reports to be made 
publicly available by the issuer or underwriter in accordance with Rule 
15Ga-2 in order for users of credit ratings to evaluate the level of 
due diligence obtained by the issuer or underwriter as compared to the 
due diligence services used by an NRSRO rating the securities. 
Similarly, the Commission is not persuaded to adopt the more 
restrictive interpretation suggested by some commenters that Rule 15Ga-
2 should only apply when a third-party due diligence report is both 
provided to an NRSRO and used by that NRSRO in its credit rating 
determination. The Commission understands there may be instances when 
the NRSRO may not actually use that third-party due diligence report in 
determining a credit rating; however, it is not clear that an issuer or 
underwriter would be able to determine whether a third-party due 
diligence report was actually used by the NRSRO.\1407\ Moreover, by not 
limiting Rule 15Ga-2 in this way, users of credit ratings will be able 
to determine if there are differences between the information provided 
to NRSROs, as disclosed under Rules 17g-7 and 17g-10, and the 
information obtained by the issuer or underwriter, as disclosed in 
accordance with Rule 15Ga-2, and evaluate the significance, if any, of 
those differences.
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    \1400\ See, e.g., CRE Letter (stating that it ``does not oppose 
the concept of third-party asset review and disclosure'' but stated 
that the proposed rule and form needed ``certain clarifications and 
modifications regarding disclosure requirements and logistics''); 
Deloitte Letter (stating that it ``support[s] the goals of 
transparency and accountability underlying Section 932, but 
[believes] it is essential that the Commission clarify certain 
aspects of the proposed rule'').
    \1401\ The modifications to proposed Form ABS-15G are technical 
rather than substantive and include: (1) Re-ordering the information 
supplied on the cover page to reflect the differences between Rule 
15Ga-1 filings and Rule 15Ga-2 furnishings; (2) changing ``file'' to 
``furnish'' wherever it relates to Rule 15Ga-2 requirements; (3) 
removing references to the proposed NRSRO representation allowance 
that is not being adopted; (4) revising the language in Item 2.02 to 
reflect that Rule 15Ga-2 refers to third-party due diligence reports 
obtained by the underwriter rather than third parties managed by the 
underwriter; and (5) adding ``Depositor'' as an option to the 
signature block. See Form ABS-15G.
    \1402\ See, e.g., ABA Letter; ASF Letter; CRE Letter; DBRS 
Letter; Deloitte Letter.
    \1403\ As explained in the proposing release, the Commission 
continues to believe that section 15E(s)(4)(A) should be interpreted 
in the context of the accompanying provisions of section 15E(s)(4) 
to relate to a particular type of report that is relevant to the 
determination of a credit rating by an NRSRO. See Nationally 
Recognized Statistical Rating Organizations, 76 FR at 33467-33469. 
This is in contrast with the October 2010 proposal, where Rule 15Ga-
2 was not limited to transactions rated by NRSROs. See Issuer Review 
of Assets in Offerings of Asset-Backed Securities, 75 FR at 64183.
    \1404\ As discussed below in section II.H.2. of this release, 
the term issuer as defined for purposes of Rule 17g-10, includes the 
sponsor or depositor that participates in the issuance of Exchange 
Act-ABS. See paragraph (d)(2) of Rule 17g-10.
    \1405\ See, e.g., Deloitte Letter; DBRS Letter. Some commenters 
further suggested that Rule 15Ga-2 should only apply if the third-
party due diligence report is actually used by the NRSRO. See ABA 
Letter (suggesting an additional recommendation that ``Rule 15Ga-2 
should not apply to an Exchange Act-ABS transaction in which the 
only rating that is issued is a rating that is paid for by a party 
other than the issuer, sponsor or underwriter''); ASF Letter; CRE 
Letter (stating that the third-party due diligence report should be 
material to the credit rating of the ABS in order for Rule 15Ga-2 to 
apply).
    \1406\ As discussed below in sections II.H.2. and II.H.3. of 
this release, Rule 17g-10 (which defines terms such as due diligence 
services) requires third-party due diligence providers to use new 
Form ABS Due Diligence-15E to make the written certification to be 
provided to the NRSRO under section 15E(s)(4)(B) of the Exchange 
Act. The form elicits information about the due diligence performed 
including a description of the work performed, a summary of the 
findings and conclusions of the third party, and the identification 
of any relevant NRSRO due diligence criteria that the third party 
intended to meet in performing the due diligence.
    \1407\ See, e.g., ASF Letter (stating that the ``issuer or 
underwriter would not or may not know whether: (a) An engaged NRSRO 
elected to disregard a report provided to it, (b) an engaged NRSRO 
accessed and considered a report provided to a different engaged 
NRSRO via its Rule 17g-5 Web site, (c) an engaged NRSRO directly 
retained a [third-party due diligence services] [p]rovider, or (d) a 
non-engaged NRSRO accessed and considered a report provided to an 
engaged NRSRO via its Rule 17g-5 Web site.'').
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    A few commenters suggested that section 15E(s)(4)(A) should not 
apply to privately offered, unregistered Exchange Act-ABS,\1408\ while 
one commenter suggested that the findings and conclusions of third-
party due diligence providers should not be made publicly available on 
EDGAR for private or confidential transactions.\1409\ After considering 
these comments, the Commission continues to believe that section 
15E(s)(4)(A) of the Exchange Act should be interpreted to apply to 
issuers and underwriters of both registered and unregistered offerings 
of Exchange Act-ABS. The Commission is not persuaded that Congress' use 
of the term underwriters was meant to limit the applicability of 
section 15E(s)(4)(A) to registered offerings, as the definition of 
underwriter in the Exchange Act is not explicitly limited to registered 
offerings.\1410\ Moreover, section 15E(s)(4)(A) uses the Exchange Act 
definition of asset-backed securities, which is much broader than the 
definition of asset-backed security in Regulation AB.\1411\ The 
definition of asset-backed security in section 3(a)(79) of the Exchange 
Act expressly includes securities that are almost exclusively offered 
in unregistered offerings, such as CDOs.\1412\ In other contexts where 
the Commission has adopted or proposed rules that apply to Exchange 
Act-ABS, those rules have been applied to both registered and 
unregistered offerings of asset-backed securities.\1413\ Moreover, the 
Commission believes there are sound policy reasons why both registered 
and unregistered Exchange Act-ABS offerings should be covered by 
section 15(E)(s)(4)(A) of the Exchange Act. The Commission believes 
that the benefits of making the findings and conclusions of third-party 
due diligence reports publicly available, which would include providing 
more information about the contents of these reports,\1414\ equally 
apply to registered or unregistered offerings since both types of 
offerings can be the subject of a credit rating.\1415\ The Commission 
continues to believe that, since section 15E(s)(4) relates to oversight 
of NRSROs and the ratings process and such oversight is not limited to 
registered offerings, it is not appropriate to exempt any particular 
issuers or underwriters who offer securities to U.S. investors if they 
receive a credit rating for the securities.\1416\
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    \1408\ See ABA Letter (commenting that the use of the terms 
underwriter and publicly available in section 932 of the Dodd-Frank 
Act makes the requirement fundamentally inconsistent with private 
placements). See also ASF Letter (suggesting that (1) Congress may 
have intended to exclude unregistered offerings by the use of the 
term underwriter and (2) ``[i]n the unregistered context, the timing 
related rationale for the issuer and underwriter's disclosure duty 
under Rule 15Ga-2 is entirely inapplicable'').
    \1409\ See S&P Letter. This commenter does not indicate if 
``private or confidential transactions'' means something other than 
unregistered offerings.
    \1410\ See section 3(c)(20) of the Exchange Act (15 USC 
78c(a)(20)) which refers to the definition of underwriter set forth 
in the Investment Advisers Act of 1940. See also section 202(a)(20) 
of the Investment Advisers Act of 1940 (15 USC 80b-2(a)(20)).
    \1411\ See Item 1101(c) of Regulation AB.
    \1412\ See 15 U.S.C. 78c(a)(79).
    \1413\ See, e.g., Disclosure for Asset-Backed Securities 
Required by Section 943 of the Dodd-Frank Wall Street Reform and 
Consumer Protection Act, 76 FR 4489.
    \1414\ As discussed below, the Commission believes this 
information would necessarily include the criteria against which the 
loans were evaluated, and how the evaluated loans compared to those 
criteria along with the basis for including any loans not meeting 
those criteria. See instruction to paragraph (a) of Rule 15Ga-2.
    \1415\ As noted above, one commenter suggested the rule should 
not apply to ``private or confidential transactions.'' To the extent 
such transactions are rated, the Commission believes the disclosures 
required by Rule 15Ga-2 would be equally beneficial to an assessment 
of the resulting credit ratings.
    \1416\ As discussed below, issuers and underwriters of municipal 
Exchange Act-ABS are being excluded from the requirements of Rule 
15Ga-2 but will continue to be subject to the statutory obligation 
under section 15E(s)(4)(A) to make the findings and conclusions of 
any third-party due diligence reports they obtain publicly 
available.
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    Commenters were also concerned that requiring issuers and 
underwriters to make information available for private placements would 
violate rules prohibiting general solicitation.\1417\ The Commission 
continues to believe, as explained in the proposing release,\1418\ that 
issuers and underwriters can disclose information required by Rule 
15Ga-2 without jeopardizing their reliance on private offering 
exemptions and safe harbors under the Securities Act, provided the only 
information made publicly available on Form ABS-15G is required by the 
rule, and the issuer does not otherwise use Form ABS-15G to offer or 
sell securities in a manner that conditions the market for offers or 
sales of its securities. Moreover, issuers are now permitted to engage 
in general solicitation or general advertising if they are offering and 
selling securities pursuant to Rule 506(c) or Rule 144A under the 
Securities Act, provided that all purchasers of the securities are 
accredited investors and the issuer has taken reasonable steps to 
verify that such purchasers are accredited investors, for Rule 506(c) 
offerings, or qualified institutional buyers, for Rule 144A 
offerings.\1419\
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    \1417\ See, e.g., ABA Letter.
    \1418\ See Nationally Recognized Statistical Rating 
Organizations, 76 FR at 33469.
    \1419\ See Eliminating the Prohibition Against General 
Solicitation and General Advertising in Rule 506 and Rule 144A 
Offerings, Securities Act Release No. 9415 (July 10, 2013), 78 FR 
44771 (July 24, 2013).
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    Commenters suggested that Rule 15Ga-2 should exclude offshore 
transactions.\1420\ The Commission agrees that, in light of the 
practical and legal considerations raised by commenters, certain 
offshore transactions should be exempted and is adopting revisions to 
provide that Rule 15Ga-2 as well as section 15E(s)(4)(A) will not apply 
to certain offshore offerings of Exchange Act-ABS,\1421\ consistent 
with revisions being adopted

[[Page 55185]]

in Rule 17g-7.\1422\ Under this exemption, the requirements of Rule 
15Ga-2 and section 15E(s)(4)(A) will not apply to an offering of 
Exchange Act-ABS if: (1) The offering is not required to be, and is 
not, registered under the Securities Act; (2) the issuer of the rated 
security is not a U.S. person (as defined under Securities Act Rule 
902(k)); \1423\ and (3) the security issued by the issuer will be 
offered and sold upon issuance, and that any underwriter or arranger 
linked to the security will effect transactions of the security after 
issuance, only in transactions that occur outside the United 
States.\1424\
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    \1420\ See ABA Letter (indicating that the application of Rule 
15Ga-2 to offshore transactions invokes the same issues identified 
in connection with the extra-territorial application of paragraph 
(a)(3) of Rule 17g-5 and may conflict with foreign securities laws, 
stock exchange rules, and other applicable laws, rules, and 
regulations); DBRS Letter.
    \1421\ See paragraph (e) of Rule 15Ga-2.
    \1422\ As discussed above in section II.G.1. of this release, 
paragraph (a)(3) of Rule 17g-7 provides an exemption from the 
requirement that NRSROs publish a form and any required third-party 
due diligence certifications when taking a rating action if the 
rated obligor or issuer of the rated security is not a U.S. person 
and if the NRSRO has a reasonable basis to conclude that the 
security will be offered and sold upon issuance and that any 
underwriter or arranger linked to the security will effect 
transactions in the security after issuance only in transactions 
outside the United States. See paragraph (a)(3) of Rule 17g-7. While 
one commenter requested that the Commission adopt an exemption for 
foreign transactions in Rule 15Ga-2 similar to that proposed in the 
credit risk retention rules, the Commission believes it is more 
appropriate for this exemption to be aligned with the exemption in 
Rule 17g-7 so that there is a consistent approach to determining 
when the Commission's NRSRO rules apply to offshore transactions. 
See ABA Letter.
    \1423\ 17 CFR 230.902(k).
    \1424\ See paragraph (a)(3) of Rule 17g-7.
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    Several commenters provided views on the proposed timeframe for 
furnishing Form ABS-15G. One commenter noted that the proposed five 
business day timeframe parallels a requirement in the proposed 
revisions to asset-backed securities regulations (``Regulation AB II'') 
\1425\ and suggested that, in the event the timeframe is shortened in 
the adopted Regulation AB II rules, then a corresponding change under 
Rule 15Ga-2 should be made.\1426\ This commenter also suggested that 
Rule 15Ga-2 should not impose a deadline for furnishing Form ABS-15G in 
an unregistered offering that differs from the time an NRSRO is 
required to publish its report under Rule 17g-7.\1427\ Another 
commenter stated that the proposed five business day delay prior to the 
first sale in an offering under Regulation AB II would be unnecessarily 
long in many circumstances.\1428\ Another commenter, however, stated 
that the proposed five business day timeframe prior to a first sale 
would not be sufficient time for an NRSRO to review most issuances of 
asset-backed securities,\1429\ while one commenter supported the 
proposed five business day timeframe.\1430\ After considering the 
comments, the Commission has decided to adopt, as proposed, the 
requirement that an issuer or underwriter must furnish Form ABS-15G at 
least five business days prior to the first sale in the offering.\1431\ 
The Commission believes that the proposed five business day time period 
strikes an appropriate balance between issuers' and underwriters' 
timing concerns and allows users of credit ratings, including 
investors, NRSROs, and other market participants, in combination with 
the disclosure mandated by Rules 17g-7 and 17g-10, adequate time to 
evaluate the extent to which the rating process has incorporated the 
findings and conclusions of third-party due diligence reports obtained 
and disclosed by the issuer and underwriter.\1432\ The Commission 
believes that adopting a deadline to furnish Form ABS-15G that matches 
the deadlines for an NRSRO to publish its reports under Rule 17g-7 or 
Rule 17g-10 would not provide enough certainty about how far in advance 
of sale a user of a credit rating could expect the information, because 
NRSROs are required to make this information available when they take a 
rating action, which could vary among NRSROs and Exchange Act-ABS 
issuances. The Commission also believes that the timeframe for Rule 
15Ga-2 should not be tied to the timeframe under Regulation AB II, as 
they serve different purposes.\1433\ Finally, for the same reasons 
noted above, the Commission does not believe it is appropriate to 
differentiate between registered and unregistered offerings under this 
rule, so the Commission is adopting the five business-day requirement 
regardless of whether the transaction is registered or exempt.
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    \1425\ See Asset-Backed Securities, Securities Act Release No. 
9117 (Apr. 7, 2010), 75 FR 23328 (May 3, 2010) (proposing release); 
Re-Proposal of Shelf Eligibility Conditions for Asset-Backed 
Securities, Securities Act Release No. 9244 (July 26, 2011), 76 FR 
47948 (Aug. 5, 2011).
    \1426\ See ASF Letter (noting that the timeframes for Rule 15Ga-
2 and Regulation AB II should match because they both directly 
relate to the timing of finalizing the composition of the asset 
pool).
    \1427\ See id. As noted above, this commenter also suggested 
that Rule 15Ga-2 should not apply to unregistered offerings.
    \1428\ See FSR Letter (also stating that tying the disclosure of 
third-party due diligence information in the forms to accompany a 
credit rating prior to the first sale in an offering may not be 
practical and may create an impediment to prompt market access for 
many issuers).
    \1429\ See S&P Letter.
    \1430\ See CFA/AFR Letter.
    \1431\ See paragraph (a) of Rule 15Ga-2. One commenter requested 
that the meaning of the term first sale in the offering be clarified 
in the final rule. See ABA Letter. As with other regulations adopted 
by the Commission, the date of first sale in the offering is the 
date at which the purchaser makes an investment decision and commits 
to purchase the securities offered. See, e.g., Electronic Filing and 
Revision of Form D, Securities Act Release No. 8891 (Feb. 6, 2008), 
73 FR 10599 (Feb. 27, 2008). See also instruction to paragraph (a) 
of Rule 15Ga-2.
    \1432\ As stated above, the findings and conclusions that are 
made public under Rule 15Ga-2 include all third-party due diligence 
reports that are obtained by the issuer or underwriter, which is 
more than what an NRSRO may receive under Rule 17g-10 or may use and 
disclose under Rule 17g-7. Users of credit ratings would have five 
business days before the first sale to compare the totality of 
third-party due diligence information with what was provided to, and 
used by, an NRSRO, as disclosed under Rules 17g-7 and 17g-10.
    \1433\ As discussed in this section, the disclosure made under 
Rule 15Ga-2 is for the benefit of the users of credit ratings 
including investors looking to make an investment decision. 
Accordingly, the timing of the publication of third-party due 
diligence report findings and conclusions, which may be available 
far in advance of the first sale in the offering, serves a different 
purpose than delivery of preliminary offering materials under 
Regulation AB II.
---------------------------------------------------------------------------

    The Commission is adopting, as proposed, the requirement that a 
Form ABS-15G furnished by the issuer must be signed by the senior 
officer of the depositor in charge of securitization, and a Form ABS-
15G furnished by the underwriter must be signed by a duly authorized 
officer of the underwriter. The Commission agrees with the commenter 
that suggested \1434\ that a single Form ABS-15G may be furnished when 
the issuer and/or one or more underwriters have obtained the same 
third-party due diligence report and has revised the final rule to 
clarify this point.\1435\ For example, if the issuer and an underwriter 
obtain the same third-party due diligence report related to a 
particular asset-backed security and the issuer timely furnishes a Form 
ABS-15G for that report, the underwriter has no obligation to furnish a 
Form ABS-15G for the same third-party due diligence report. Similarly, 
if a transaction has more than one underwriter, and two or more of 
those underwriters obtain the same third-party due diligence report 
related to a particular asset-backed security, only one of those 
underwriters must timely furnish Form ABS-15G for that report. 
Commenters also requested clarification that a requirement to provide 
the findings and conclusions of third-party due diligence reports would 
apply only to the initial credit rating and not to any subsequent 
upgrades, downgrades, or other rating actions.\1436\ The Commission 
agrees that once the information has been disclosed in connection with 
an initial credit rating, it does not need to be furnished again in 
connection with any subsequent rating actions. Accordingly, as 
clarified

[[Page 55186]]

in the instructions to the final rule, Form ABS-15G does not need to be 
furnished for any subsequent updates to a credit rating issued by an 
NRSRO.
---------------------------------------------------------------------------

    \1434\ See ABA Letter.
    \1435\ See paragraph (b) of Rule 15Ga-2.
    \1436\ See ABA Letter; DBRS Letter.
---------------------------------------------------------------------------

    While one commenter supported the Commission's proposed approach of 
defining the third-party due diligence reports covered by the 
rule,\1437\ a number of other commenters wanted the definitions of 
third-party due diligence report and due diligence services (defined in 
proposed Rule 17g-10,\1438\ which is the basis for the term third-party 
due diligence report in Rule 15Ga-2) to be narrowed in a variety of 
ways. After considering these comments, the Commission is adopting, as 
proposed, the definition of third-party due diligence report to mean 
any report containing findings and conclusions of any due diligence 
services (as defined in Rule 17g-10) performed by a third party.\1439\ 
One commenter suggested that, in the definition of third-party due 
diligence report, the phrase ``final report'' replace the phrase ``any 
report.'' \1440\ The Commission is not, however, replacing the phrase 
``any report'' with the phrase ``final report,'' as suggested by some 
commenters, in part because ``any report'' was specified by Congress in 
the Dodd-Frank Act. Moreover, the Commission believes all third-party 
due diligence reports obtained by the issuer or underwriter, including 
interim reports, related to an offering of asset-backed securities 
should be made publicly available in order for users of credit ratings 
to more thoroughly evaluate the level of due diligence obtained by the 
issuer or underwriter as compared to the due diligence services used by 
an NRSRO rating the Exchange Act-ABS. One commenter requested that the 
Commission revise the phrase ``containing the findings and 
conclusions'' to ``containing a summary of the findings and 
conclusions,'' noting that providing a summary is more appropriate than 
providing the findings and conclusions themselves, and that there is no 
reason why the summary would not be substantially similar in each 
context.\1441\ The Commission is not adopting this alternative for 
several reasons. First, the Commission notes that Congress specified in 
the Dodd-Frank Act that ``the findings and conclusions'' must be made 
publicly available, which the Commission believes would be most 
appropriately interpreted as precluding a summary. Moreover, the 
Commission believes it is important for the third-party due diligence 
provider's findings and conclusions themselves to be made public rather 
than an issuer or underwriter's summary of those findings and 
conclusions because a summary runs the risk of excluding information 
that could be important to a user of credit ratings.\1442\ 
Specifically, the Commission believes that disclosure of the findings 
and conclusions necessarily requires disclosure of the criteria against 
which the loans were evaluated, and how the evaluated loans compared to 
those criteria along with the basis for including any loans not meeting 
those criteria.\1443\ The Commission is also revising the rule to 
clarify that the term issuer is defined in Rule 17g-10.\1444\
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    \1437\ See CFA/AFR Letter (stating that they ``share the view, 
cited by the Commission, that the variation for reviews of different 
types of offerings is likely to be significant and that this area 
therefore is better served by principles-based standards than by 
prescriptive rules''). However, this commenter did object to the 
Commission's decision to withdraw the approach proposed in the 
October 2010 proposal, where issuers and underwriters of registered 
Exchange Act-ABS would have been required to make third-party due 
diligence disclosures in the prospectus. The commenter suggested 
that the revised approach is unnecessarily complex and should be 
simplified.
    \1438\ A summary of comments addressing the definition of due 
diligence services is provided in section II.H.2. of this release.
    \1439\ See paragraph (d) of Rule 15Ga-2; see also paragraph 
(d)(1) of Rule 17g-10 (defining the term due diligence services). 
Although the Commission is not modifying the definition of third-
party due diligence report, it is making some changes to, and 
providing guidance on some aspects of, the definition of due 
diligence services in Rule 17g-10. For example, as discussed below 
in section II.H.2. of this release, the Commission is: (1) Modifying 
the first prong of the definition of due diligence services by 
replacing the phrase ``quality and integrity'' of the data with the 
word ``accuracy;'' (2) providing guidance that the ``catchall'' 
provision of the definition of due diligence services relates to 
reviews of the assets underlying the Exchange Act-ABS (as opposed to 
the reviews of the Exchange Act-ABS itself); and (3) providing 
guidance that it would not object to the inclusion of the 
description of the requirements and limitations resulting from 
relevant professional standards generally described within the 
reports being included in the disclosure.
    \1440\ See Clayton Letter.
    \1441\ See ABA Letter.
    \1442\ As noted above, the Commission believes users of credit 
ratings should be able to compare the totality of third-party due 
diligence information with what was provided to, and used by, an 
NRSRO, as disclosed under Rules 17g-7 and 17g-10.
    \1443\ See instruction to paragraph (a) of Rule 15Ga-2. This is 
the same disclosure standard for findings and conclusions that is 
required under Item 1111(a)(7)(ii) of Regulation AB. See Issuer 
Review of Assets in Offerings of Asset-Backed Securities, 76 FR 
4238.
    \1444\ See paragraph (d) of Rule 15Ga-2 and paragraph (d)(2) of 
Rule 17g-10. As explained above, the proposing release did not 
include a definition of issuer in Rule 15Ga-2 but indicated that the 
term would be interpreted in a manner consistent with the definition 
in Rule 17g-10. For clarity and consistency, the Commission has 
revised the rule text to expressly refer to the definition in Rule 
17g-10.
---------------------------------------------------------------------------

    Several commenters objected to the proposal that an issuer or 
underwriter would not be required to furnish Form ABS-15G if it 
reasonably relies upon the representation from an NRSRO rating the 
transaction that the NRSRO will publicly disclose the required 
information five business days prior to the first sale in the 
offering.\1445\ One commenter supported this part of the proposal, 
noting that it could reduce duplicative disclosures.\1446\ After 
considering these comments, the Commission is not adopting this part of 
the proposal. While the Commission would like to avoid duplicative 
disclosure wherever possible, it has determined that the representation 
may be difficult to implement in practice. NRSROs generally opposed 
this proposal,\1447\ and a number of NRSROs, as well as a trade 
organization with NRSRO members, noted that it is unlikely that any 
NRSRO would make such a representation,\1448\ making it unlikely that 
much duplicative disclosure would actually be avoided. One commenter 
thought that there could be a potential for discrepancies in the 
representations made by NRSROs that operate under the subscriber-pay 
business model and the issuer-pay model. This commenter noted that 
these NRSROs could be in compliance with Rule 17g-7, as proposed to be 
amended, without actually making the findings and conclusions of a 
third-party due diligence report publicly available.\1449\ As explained 
in the proposing release, an NRSRO that operates under the

[[Page 55187]]

subscriber-pay model (rather than the issuer-pay model) and only makes 
the third-party due diligence findings and conclusions available to its 
subscribers would not be able to make a representation to an issuer or 
underwriter that it is making the required information publicly 
available.\1450\ Consequently, this may give issuer-paid NRSROs a 
competitive advantage over subscriber-paid NRSROs. Further, the 
disclosure of the findings and conclusions in the third-party due 
diligence report made by an NRSRO would need to be as comprehensive as 
what is required for issuers and underwriters under Rule 15Ga-2 in 
order to make such a representation. Because Rule 17g-7 only requires 
that an NRSRO disclose a description of the findings and conclusions, 
NRSROs, issuers, and underwriters would have to make judgments as to 
whether the disclosure made in accordance with Rule 17g-7 meets the 
standard for disclosure of the findings and conclusions under Rule 
15Ga-2, as set forth in the instruction to paragraph (a) of Rule 15Ga-
2, before an NRSRO could make, or an issuer or underwriter could rely, 
on such a representation. In addition, if issuers and underwriters were 
allowed to rely on such a representation in order to not furnish Form 
ABS-15G, there would be no central location where users of credit 
ratings could obtain the findings and conclusions of all third-party 
due diligence reports on Exchange Act-ABS. Finally, allowing issuers 
and underwriters to rely on a representation may have resulted in gaps 
in the information that is disclosed on Form ABS-15G.\1451\ These 
results would impair the intended benefits of the rule. Based on the 
totality of comments and the implications of allowing issuers and 
underwriters to rely on a representation from an NRSRO in lieu of 
furnishing Form ABS-15G, the Commission has determined that the 
potential benefit of eliminating redundant disclosure by allowing the 
representation does not justify the uncertainty and costs that it may 
create.
---------------------------------------------------------------------------

    \1445\ See CRE Letter; DBRS Letter; Moody's Letter; Morningstar 
Letter; S&P Letter.
    \1446\ See Deloitte Letter.
    \1447\ See, e.g., Moody's Letter (strongly opposing the 
exemption because the commenter believes: (1) It is contrary to the 
express intent of Congress to promote greater transparency and 
accountability among Exchange Act-ABS issuers; (2) it is contrary to 
the efforts of Congress, the Commission and others to clarify the 
limited role of credit rating agencies in the financial markets; (3) 
it is unlikely to reduce the potential for multiple, inconsistent 
disclosures about the due diligence services; and (4) it will create 
incentives for issuers and underwriters to select NRSROs who are 
willing to make these representations). See also S&P Letter (stating 
that issuers and underwriters should bear this obligation because 
NRSRO disclosure of the required information could confuse investors 
regarding who is providing the required information).
    \1448\ See CRE Letter (suggesting that the rule allow NRSROs and 
underwriters to rely on disclosure made by issuers); Morningstar 
Letter; S&P Letter.
    \1449\ See ASF Letter. As discussed above in section II.G.1. of 
this release, Rule 17g-7, as proposed to be amended, required, in 
part, that NRSROs must, when taking a rating action, publish and 
make available to the same persons who can receive or access the 
credit rating that is the result or the subject of the rating 
action, a form and any written certification received by the NRSRO 
from a provider of third-party due diligence services under section 
15E(s)(4)(B) of the Exchange Act. The form would include, among 
other things, a description of the findings or conclusions of any 
third-party due diligence services used by the NRSRO.
    \1450\ See Nationally Recognized Statistical Rating 
Organizations, 76 FR at 33468, n.534.
    \1451\ See, e.g., Moody's Letter; S&P Letter.
---------------------------------------------------------------------------

    As stated above, the Commission continues to believe that there is 
no need to separately require that disclosure provided in connection 
with Rule 15Ga-2 about any third-party due diligence report be provided 
in the prospectus for a registered offering.\1452\ The Commission 
considered one commenter's suggestion that a separate database be 
created where all third-party due diligence report findings and 
conclusions could be centralized.\1453\ The Commission, however, 
believes that the EDGAR system is the more appropriate place for 
issuers and underwriters to make this information publicly available. 
When information is electronically filed with the Commission on the 
EDGAR system, investors, market participants, and Commission staff can 
access the information from a single, permanent, and centralized 
location. Creating a new system may be duplicative and may result in 
additional costs for issuers and underwriters beyond those that would 
be incurred by using the EDGAR system without providing a significant 
improvement in making the information available to users of credit 
ratings. The additional costs incurred by issuers and underwriters of 
registered Exchange Act-ABS offerings by having to furnish Form ABS-15G 
on the EDGAR system should be incremental,\1454\ as they are already 
required to file other forms and documents on EDGAR. Issuers and 
underwriters of unregistered Exchange Act-ABS offerings, however, may 
incur higher costs compared to those conducting registered offerings if 
they need to adjust their systems or engage outside counsel to prepare 
and furnish Form ABS-15G on EDGAR.\1455\
---------------------------------------------------------------------------

    \1452\ Whether the findings and conclusions of a third-party are 
part of the Rule 193 review and, therefore, included in the 
prospectus disclosure is dictated by the requirements of Rule 193 
and Item 1111 of Regulation AB. See 17 CFR 230.193; 17 CFR 229.1111.
    \1453\ See CFA/AFR Letter.
    \1454\ See section IV.D.10. of this release (discussing the PRA 
burden resulting from this requirement).
    \1455\ The Commission notes, however, that issuers and 
underwriters of unregistered Exchange Act-ABS offerings who already 
file Form ABS-15G on EDGAR in accordance with Rule 15Ga-1 should not 
incur these additional costs.
---------------------------------------------------------------------------

    Commenters noted that issuers of registered offerings may 
incorporate third-party reviews into their registration statement 
disclosure in order to comply with the review of the underlying assets 
required by Rule 193. One of these commenters suggested that when 
disclosures under both Rule 193 and Rule 15Ga-2 might otherwise be 
required, the Rule 193 disclosures should suffice for both 
purposes.\1456\ Another commenter encouraged the Commission to enhance 
the efficiency of this new regulatory framework by including an 
exception that where disclosures about third-party due diligence 
services comply with Rule 193, those same services would not be subject 
to Rule 15Ga-2.\1457\ After considering these comments, the Commission 
has revised Rule 15Ga-2 to reflect that if the disclosure required by 
Rule 15Ga-2 has been made in the prospectus (including an attribution 
to the third party that provided the due diligence report),\1458\ and 
the prospectus is publicly available at the time Form ABS-15G is 
furnished by the issuer or underwriter, the issuer or underwriter may 
refer to that section of the prospectus in Form ABS-15G rather than 
providing the findings and conclusions directly in Form ABS-15G.\1459\ 
This does not, however, exempt an issuer or underwriter from the 
requirements of Rule 15Ga-2, including its duty to furnish Form ABS-
15G. The Commission continues to believe that, in addition to 
disclosures made by the NRSROs, Form ABS-15G is the most appropriate 
place to find information about a particular type of report that is 
relevant to the determination of a credit rating by an NRSRO.
---------------------------------------------------------------------------

    \1456\ See CRE Letter.
    \1457\ See Deloitte Letter (noting that when issuers hire third 
parties to conduct the Rule 193 due diligence review, the 
disclosures required under Rule 193 will be substantially similar to 
the disclosures made about the same findings and conclusions in the 
context of the rules adopted under section 932).
    \1458\ The Commission does not intend for all third parties from 
whom the issuer obtains a third-party due diligence report, as 
defined in Rule 15Ga-2, to be named in the registration statement 
and consent to being named as an expert solely because an issuer 
furnishes Form ABS-15G. If the issuer's prospectus disclosure 
attributes the findings and conclusions of the Rule 193 review to 
the third party from whom it obtains a third-party due diligence 
report, however, the third-party would be required to be named in 
the registration statement and consent to being named as an expert 
in accordance with Rule 436 under the Securities Act. See Issuer 
Review of Assets in Offerings of Asset-Backed Securities, 76 FR 
4231.
    \1459\ See paragraph (c) of Rule 15Ga-2.
---------------------------------------------------------------------------

    Two comments submitted in response to the proposing release related 
to the impact on municipal issuers and underwriters. One commenter 
cautioned the Commission against imposing the new Exchange Act-ABS 
disclosure requirements on the municipal securities market until the 
completion of the reports on municipal securities mandated by the Dodd-
Frank Act.\1460\ The Commission notes that the reports required by 
sections 976 and 977 of the Dodd-Frank Act have been completed by the 
GAO and have not resulted in any legislative changes to disclosure 
requirements applicable to municipal issuers at this time.\1461\ This 
commenter

[[Page 55188]]

recommended that the Commission exempt municipal securities from the 
proposed disclosure requirements to avoid creating confusion for 
investors and issuers in case different classes of municipal securities 
are subject to different requirements in the future.\1462\ Another 
commenter supported the proposal to allow municipal securitizers or 
underwriters of municipal Exchange Act-ABS to provide the required 
information on EMMA.\1463\
---------------------------------------------------------------------------

    \1460\ See ICI Letter.
    \1461\ See http://www.gao.gov/assets/590/587714.pdf. The 
Commission also issued a comprehensive report on the municipal 
securities market in July 2012. See Commission Report on the 
Municipal Securities Market, available at http://www.sec.gov/news/studies/2012/munireport073112.pdf (``2012 Report on the Municipal 
Securities Market'').
    \1462\ See ICI Letter.
    \1463\ See DBRS Letter.
---------------------------------------------------------------------------

    The Commission also has considered the comments objecting to 
requiring municipal issuers and underwriters to comply with Rule 15Ga-
2, which were submitted in response to the October 2010 proposal.\1464\ 
A number of these commenters expressed the view that sections 15B(d)(1) 
and 15B(d)(2) of the Exchange Act, known collectively as the ``Tower 
Amendment,'' \1465\ expressly prohibit the Commission and the Municipal 
Securities Rulemaking Board (``MSRB'') from requiring an issuer of 
municipal securities to make any specific disclosure filing with the 
Commission or MSRB prior to the sale of these securities to 
investors.\1466\ After considering these comments, the Commission has 
determined that issuers and underwriters of municipal Exchange Act-ABS 
should be excluded from the requirements of Rule 15Ga-2. The Commission 
notes that, in reaching this determination, it does not find it 
necessary to determine whether the Tower Amendment applies in this 
situation and no inference should be drawn from this determination 
regarding the Commission's analysis of the Tower Amendment. In light of 
the fact that municipal issuers and underwriters will remain subject to 
the statutory requirement in section 15E(s)(4)(A) of the Exchange Act 
to make the findings and conclusions of any third-party due diligence 
reports publicly available, and given the Commission's historical 
approach of not requiring municipal issuers to file disclosures with 
the Commission in connection with the issuance of securities, the 
Commission is persuaded that, as a policy matter, it is unnecessary to 
apply Rule 15Ga-2 to municipal issuers and underwriters.\1467\
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    \1464\ Issuer Review of Assets in Offerings of Asset-Backed 
Securities, 75 FR 64182.
    \1465\ 15 USC 78o-4. See also 2012 Report on the Municipal 
Securities Market, at 27-28.
    \1466\ See, e.g., letter from Group of 14 Municipal 
Organizations dated Nov. 15, 2010, National Association of Bond 
Lawyers dated Nov. 19, 2010; letter from National Association of 
Local Housing Finance Agencies dated Nov. 15, 2010; letter from 
Treasurer of the State of Connecticut dated Nov. 15, 2010; letter 
from National Council of State Housing Agencies dated Nov. 15, 2010; 
and letter from Robert W. Scott dated Nov. 19, 2010 (each letter 
submitted in response to the October 2010 proposal).
    \1467\ Municipal securitizers continue to be subject to Rule 
15Ga-1. As the Commission noted at the time Rule 15Ga-1 was adopted, 
section 943 of the Dodd-Frank Act, pursuant to which Rule 15Ga-1 was 
adopted, is a stand-alone statutory provision that does not 
expressly provide the Commission with authority to provide 
exemptions for particular classes of securitizers, including 
municipal securitizers. See Disclosure for Asset-Backed Securities 
Required by Section 943 of the Dodd-Frank Wall Street Reform and 
Consumer Protection Act, 76 FR at 4493.
---------------------------------------------------------------------------

    Under the exclusion, the requirements of Rule 15Ga-2 will not apply 
to issuers and underwriters of an offering of Exchange Act-ABS if: (1) 
The issuer of the rated security is a municipal issuer; and (2) the 
offering is not required to be registered under the Securities Act. A 
municipal issuer is defined as an issuer (as that term is defined in 
paragraph (d)(2) of Rule 17g-10) that is any State or Territory of the 
United States, the District of Columbia, any political subdivision of 
any State, Territory, or the District of Columbia, or any public 
instrumentality of one or more States, Territories, or the District of 
Columbia. The exclusion further provides, as discussed below, that 
issuers and underwriters of municipal Exchange Act-ABS remain subject 
to the requirements of section 15E(s)(4)(A) of the Exchange Act.\1468\
---------------------------------------------------------------------------

    \1468\ See paragraph (f) of Rule 15Ga-2.
---------------------------------------------------------------------------

    Although the Commission is excluding issuers and underwriters of 
municipal Exchange Act-ABS from the application of Rule 15Ga-2, the 
Commission continues to believe that section 15E(s)(4)(A) of the 
Exchange Act should be interpreted to apply to such entities. By its 
terms, section 15E(s)(4)(A) applies to issuers and underwriters of 
``any asset-backed security,'' and the Commission believes the intended 
benefits of greater transparency with respect to the credit rating 
process apply equally to credit ratings of municipal Exchange Act-
ABS.\1469\ The Commission also notes that section 15E(s)(4)(A) requires 
issuers and underwriters to make the specified information publicly 
available and does not mandate filing with the Commission, which was 
the specific concern the Tower Amendment sought to address. 
Consequently, although municipal issuers and underwriters will not be 
required to furnish Form ABS-15G pursuant to Rule 15Ga-2, they are 
subject to the statutory requirement under section 15E(s)(4)(A) to make 
publicly available the findings and conclusions of any third-party due 
diligence report they obtain. Municipal issuers and underwriters may 
make such information available through any means reasonably accessible 
to the public, including, for example, by posting the information on an 
issuer or underwriter sponsored Internet Web site, by voluntarily 
furnishing Form ABS-15G on EDGAR, or by voluntarily submitting a Form 
ABS-15G on EMMA.
---------------------------------------------------------------------------

    \1469\ As discussed above, the Commission believes that section 
15E(s)(4)(A) of the Exchange Act should be interpreted to apply to 
issuers and underwriters of both registered and unregistered 
offerings of Exchange Act-ABS.
---------------------------------------------------------------------------

    Since the Commission is excluding issuers and underwriters of 
municipal Exchange Act-ABS from the application of Rule 15Ga-2, it is 
not adopting the proposed revisions to Rule 314, which would have 
permitted municipal issuers of Exchange Act-ABS, or underwriters in the 
offering, to provide the information required by Form ABS-15G on EMMA, 
as proposed. Notwithstanding the foregoing, as noted above, an issuer 
or underwriter of municipal Exchange Act-ABS could choose to satisfy 
its obligation to make publicly available the findings and conclusions 
of any third-party due diligence report obtained by the issuer or 
underwriter, as required by section 15E(s)(4)(A) of the Exchange Act, 
by voluntarily submitting a Form ABS-15G on EMMA.\1470\
---------------------------------------------------------------------------

    \1470\ The Commission adopted Rule 314 to permit municipal 
securitizers to satisfy the obligation to furnish the information 
required by Rule 15Ga-1 by filing the information on EMMA. See 
Disclosure for Asset-Backed Securities Required by Section 943 of 
the Dodd-Frank Wall Street Reform and Consumer Protection Act, 76 FR 
4489. Accordingly, EMMA will be prepared to accept Form ABS-15G in 
connection with this requirement.
---------------------------------------------------------------------------

2. New Rule 17g-10
    As stated above, section 15E(s)(4)(A) of the Exchange Act requires 
the issuer or underwriter of any asset-backed security to make publicly 
available the findings and conclusions of any third-party due diligence 
report obtained by the issuer or underwriter.\1471\ Section 
15E(s)(4)(B) of the Exchange Act requires that in any case in which 
third-party due diligence services are employed by an NRSRO, issuer, or 
underwriter, the person providing the due diligence services shall 
provide, to any NRSRO that produces a credit rating to which such 
services relate, written certification, in a format as provided in 
section 15E(s)(4)(C).\1472\ Section 15E(s)(4)(C) of the Exchange Act 
provides that the Commission shall establish the appropriate format and 
content for the written certifications required under section 
15E(s)(4)(B) to ensure that providers of due diligence services have 
conducted a thorough

[[Page 55189]]

review of data, documentation, and other relevant information necessary 
for an NRSRO to provide an accurate rating.\1473\ The Commission 
proposed to implement these sections through Rule 17g-10 and Form ABS 
Due Diligence-15E.\1474\ As proposed, Rule 17g-10 would require a 
provider of third-party due diligence services to provide the written 
certification required by section 15E(s)(4)(B) of Exchange Act on Form 
ABS Due Diligence-15E.
---------------------------------------------------------------------------

    \1471\ See 15 U.S.C. 78o-7(s)(4)(A).
    \1472\ See 15 U.S.C. 78o-7(s)(4)(B).
    \1473\ See 15 U.S.C. 78o-7(s)(4)(C).
    \1474\ See Nationally Recognized Statistical Rating 
Organizations, 76 FR 33471-33476. Form ABS Due Diligence-15E is 
discussed below in section II.H.3. of this release.
---------------------------------------------------------------------------

    The Commission is adopting Rule 17g-10 with modifications from the 
proposal in response to comments.\1475\ As discussed below, the 
modifications add a ``safe harbor'' for the third-party due diligence 
provider in order to satisfy its obligations under section 15E(s)(4)(B) 
of the Exchange Act, clarify the proposed definition of due diligence 
services, and make certain technical modifications.\1476\
---------------------------------------------------------------------------

    \1475\ See Rule 17g-10.
    \1476\ See id.
---------------------------------------------------------------------------

    As proposed, paragraph (a) of Rule 17g-10 provided that the written 
certification that a person employed to provide third-party due 
diligence services is required to provide to an NRSRO pursuant to 
section 15E(s)(4)(B) of the Exchange Act must be made on Form ABS Due 
Diligence-15E.\1477\ The Commission did not receive comments on 
paragraph (a) as proposed and is adopting the paragraph with one 
technical modification.\1478\ As adopted, the paragraph provides that 
the written certification that a person employed to provide third-party 
due diligence services is required to provide to an NRSRO pursuant to 
section 15E(s)(4)(B) must be on Form ABS Due Diligence-15E.\1479\
---------------------------------------------------------------------------

    \1477\ See paragraph (a) of Rule 17g-10, as proposed; Nationally 
Recognized Statistical Rating Organizations, 76 FR at 33544.
    \1478\ See paragraph (a) of Rule 17g-10. The modification 
corrects an incorrect reference to Form ABS Due Diligence-15E in the 
proposal by replacing the phrase ``(Sec.  240b.400 of this 
chapter)'' with the phrase ``(Sec.  249b.500 of this chapter)''.
    \1479\ See paragraph (a) of Rule 17g-10. Form ABS Due Diligence-
15E is discussed below in section II.H.3. of this release.
---------------------------------------------------------------------------

    Paragraph (b) of Rule 17g-10, as proposed, provided that the 
written certification must be signed by an individual who is duly 
authorized by the person providing the third-party due diligence 
services to make such a certification.\1480\ The proposed requirement 
was designed to ensure that the person executing the certification on 
behalf of the provider of third-party due diligence services has 
responsibilities that will make the person aware of the basis of the 
information being provided in the form.\1481\ The Commission did not 
receive comments on paragraph (b) and is adopting the paragraph as 
proposed.\1482\
---------------------------------------------------------------------------

    \1480\ See paragraph (b) of Rule 17g-10, as proposed; Nationally 
Recognized Statistical Rating Organizations, 76 FR at 33544.
    \1481\ See Nationally Recognized Statistical Rating 
Organizations, 76 FR at 33471.
    \1482\ See paragraph (b) of Rule 17g-10.
---------------------------------------------------------------------------

    As discussed above, the Commission did not receive comments 
specifically addressing paragraphs (a) and (b) of Rule 17g-10, as 
proposed.\1483\ However, the Commission did receive comments raising 
concerns about how a third-party due diligence provider can meet the 
requirement in section 15E(s)(4)(B) of the Exchange Act, which--as 
discussed above--provides that in any case in which third-party due 
diligence services are employed by an NRSRO, issuer, or underwriter, 
the person providing the due diligence services shall provide, to any 
NRSRO that produces a rating to which such services relate, written 
certification in a format as provided in section 15E(s)(4)(C) of the 
Exchange Act.\1484\
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    \1483\ As discussed below in section II.H.3. of this release, 
the Commission did receive comments in response to the proposed 
format of the Form ABS Due Diligence-15E. Those comments and the 
Commission's response to the commenters are discussed in section 
II.H.3. of this release.
    \1484\ See 15 U.S.C. 78o-7(s)(4)(B).
---------------------------------------------------------------------------

    Commenters stated that the third-party due diligence provider or 
NRSRO may not know the identities of the NRSROs producing credit 
ratings to which the due diligence services relate.\1485\ One of these 
commenters stated that the proposed requirements ``unfairly place a 
heavy burden on the third-party due diligence provider to determine 
which NRSRO is rating the transaction'' because this information ``lies 
with the issuer.'' \1486\
---------------------------------------------------------------------------

    \1485\ See Clayton Letter; Deloitte Letter; S&P Letter.
    \1486\ See Clayton Letter.
---------------------------------------------------------------------------

    The Commission anticipated this concern and, consequently, in the 
proposing release the Commission asked a number of questions regarding 
how a third-party due diligence provider could comply with section 
15E(s)(4)(B) of Exchange Act and whether the Commission should take 
steps to implement the statutory requirement.\1487\ One of the 
potential approaches identified by the Commission in the proposing 
release was to use the Web site referred to in paragraph (a)(3)(iii) of 
Rule 17g-5 maintained by issuers, sponsors, or underwriters of 
structured finance products (``Rule 17g-5 Web site''), as the mechanism 
for providing the written certification to all NRSROs producing a 
credit rating to which the due diligence services relate.\1488\
---------------------------------------------------------------------------

    \1487\ See Nationally Recognized Statistical Rating 
Organizations, 76 FR at 33466.
    \1488\ See id. See also 17 CFR 240.17g-5(a)(3). Among other 
things, paragraph (a)(3) of Rule 17g-5 requires an NRSRO, among 
other things, to maintain on a password-protected Internet Web site 
a list of each structured finance product for which it currently is 
in the process of determining an initial credit rating, and to 
provide free and unlimited access to any NRSRO that, among other 
things, certifies it will access the Web site solely for the purpose 
of determining and monitoring credit ratings. Paragraph (a)(3)(iii) 
of Rule 17g-5 requires an NRSRO to obtain from the issuer, sponsor, 
or underwriter of the structured product a written representation 
that can reasonably be relied upon that the arranger will, among 
other things, maintain on a password-protected Internet Web site the 
information it provides to the NRSRO and will provide access to the 
Web site to an NRSRO that, among other things, certifies it will 
access the Web site solely for the purpose of determining and 
monitoring credit ratings.
---------------------------------------------------------------------------

    Commenters responded that the Rule 17g-5 Web site would be an 
appropriate mechanism to provide the certification to the NRSROs.\1489\ 
One of these commenters stated that using the Rule 17g-5 Web site would 
be ``the most efficient way'' to provide the certification and that it 
would be a better approach than applying a ``reasonableness test'' in 
terms of assessing whether the third-party due diligence provider 
submitted the certification to all NRSROs that are required to receive 
the certification.\1490\ Another commenter stated that the proposed 
requirements should ``accommodate situations'' in which an NRSRO 
obtains the written certification indirectly from, for example, a Rule 
17g-5 Web site.\1491\ An NRSRO stated that using the Rule 17g-5 Web 
sites as a ``delivery mechanism for the Rule 17g-10 certification'' 
would ensure that ``certifications are supplied to all affected NRSROs 
at roughly the same time.'' \1492\
---------------------------------------------------------------------------

    \1489\ See ASF Letter; Clayton Letter; DBRS Letter.
    \1490\ See Clayton Letter.
    \1491\ See ASF Letter.
    \1492\ See DBRS Letter.
---------------------------------------------------------------------------

    Another alternative suggested by the Commission was to establish a 
centralized database administered by the Commission (such as the 
Commission's EDGAR system) or by market participants to be used for the 
purpose of providing the written certifications in accordance with 
section 15E(s)(4)(B) of the Exchange Act.\1493\ An NRSRO and another 
commenter stated that creating a new centralized database or similar 
alternative for distributing the

[[Page 55190]]

due diligence certification would be costly.\1494\
---------------------------------------------------------------------------

    \1493\ See Nationally Recognized Statistical Rating 
Organizations, 76 FR at 33466.
    \1494\ See Clayton Letter (``[W]e do not believe that it is 
cost-effective for the Commission or the ABS community to have the 
industry adopt a new system for distributing the Form ABS Due 
Diligence-15E information nor do we believe it is cost-effective for 
such parties to have to utilize a for-profit centralized database 
service for such purposes, especially in light of the amount of time 
and resources that have already been directed to the development of 
the Rule 17g-5 system of distribution. And as we described above, 
the Rule 17g-5 system more fairly allocates responsibility for 
dissemination of the information among the issuer, underwriter and 
NRSRO.''); DBRS Letter (``Mandating the creation of a new 
centralized database or any other costly alternative is not 
warranted under the circumstances.'').
---------------------------------------------------------------------------

    Commenters suggested other alternatives.\1495\ One commenter stated 
that the due diligence provider should be required to deliver the 
certification ``promptly upon receipt of a written request from an 
NRSRO'' for use by the NRSRO ``in preparing its published report under 
Rule 17g-7.'' \1496\ Another commenter stated that the party engaging 
the due diligence provider should be required to obtain the 
certification from the service provider and that the service provider 
should ``be able to rely on the engaging party to transmit the form'' 
to the required NRSROs.\1497\
---------------------------------------------------------------------------

    \1495\ See ASF Letter; Deliotte Letter.
    \1496\ See ASF Letter.
    \1497\ See Deloitte Letter.
---------------------------------------------------------------------------

    In the proposing release, the Commission sought comment on how soon 
after it completes its review the provider of third-party due diligence 
services should provide the written certification to all NRSROs 
required to receive the certification, and the Commission provided 
examples of potential timeframes (within twenty-four hours, two 
business days, or ten business days).\1498\ One commenter stated that 
the due diligence provider should be required to deliver the 
certification ``promptly upon receipt of a written request from an 
NRSRO.'' \1499\ Another commenter suggested that the certification be 
provided five business days after the service provider finishes 
reviewing the data in connection with its due diligence report.\1500\ 
One NRSRO stated that the certification should be provided ``within two 
business days following completion of the due diligence review'' and 
added that ``all required NRSROs should be in receipt of the 
certification at the same time.'' \1501\ Another NRSRO stated that the 
certification should be provided ``within one business day after the 
service provider completes its review.'' \1502\
---------------------------------------------------------------------------

    \1498\ See Nationally Recognized Statistical Rating 
Organizations, 76 FR at 33466.
    \1499\ See ASF Letter.
    \1500\ See Clayton Letter.
    \1501\ See S&P Letter.
    \1502\ See DBRS Letter.
---------------------------------------------------------------------------

    The Commission is persuaded that the final rule should provide a 
means for providers of third-party due diligence services to be certain 
that they have met their obligation under section 15E(s)(4)(B) of the 
Exchange Act to provide Form ABS Due Diligence-15E to any NRSRO that 
produces a credit rating to which the due diligence services 
relate.\1503\ The Commission also is persuaded that the most efficient 
means of providing certainty to the providers of third-party due 
diligence services that they have met their obligations under section 
15E(s)(4)(B) is to require the third party to provide Form ABS Due 
Diligence-15E to any NRSRO that specifically requests the form and to 
post the form on the Rule 17g-5 Web site maintained by the issuer, 
sponsor, or underwriter of the Exchange Act-ABS.\1504\
---------------------------------------------------------------------------

    \1503\ See 15 U.S.C. 78o-7(s)(4)(B).
    \1504\ See, e.g., DBRS Letter (``DBRS believes that the most 
efficient and cost-effective approach is to utilize existing 
regulations as much as possible. As it stands today, issuers and 
underwriters who hire an NRSRO to rate a structured finance product 
such as an Exchange Act-ABS are required to make available to other 
NRSROs all information the issuer or underwriter `contracts with a 
third party to provide to' the hired NRSRO. Thus, if the issuer or 
underwriter contracts with a third-party service provider to supply 
a hired NRSRO with a due diligence report, a copy of that report 
would already be made available to other NRSROs pursuant to Rule 
17g-5(a)(3).'').
---------------------------------------------------------------------------

    This will provide access to the form to an NRSRO that is producing 
a credit rating for the Exchange Act-ABS but is unaware that the third 
party is conducting the due diligence services because, for example, 
the NRSRO is using the Rule 17g-5 Web site to determine an unsolicited 
credit rating. In addition, the third party will not be burdened with 
the task of trying to identify every NRSRO that is producing a credit 
rating to which the due diligence services relate. For these reasons, 
the Commission believes it is appropriate to modify Rule 17g-10 from 
the proposal to add a ``safe harbor'' provision that incorporates the 
Rule 17g-5 Web sites.
    Further, as discussed above, commenters suggested relatively short 
timeframes for providing the written certification to the NRSROs 
producing a credit rating to which the due diligence services relate. 
The Commission agrees that the written certification should be provided 
soon after the provider of third-party due diligence services completes 
its review. As discussed below, the certification will provide 
information that can be used by the NRSRO in determining a credit 
rating for the Exchange Act-ABS. Consequently, the Commission believes 
the certification should be provided to the appropriate NRSROs as soon 
as the third party completes the review so that NRSROs can consider it 
in determining a credit rating for the Exchange Act-ABS before the 
security is issued and purchased by investors. However, prescribing a 
specific timeframe (such as within twenty-four hours or two days) may 
result in situations--depending on the circumstances--where the 
certification could have been provided sooner than required (for 
example, within minutes of it being finalized) or where practical 
issues would prevent it from being submitted within the required 
timeframe. Therefore, the Commission believes the ``safe harbor'' for 
the written certification should incorporate a ``promptly'' standard.
    For all the foregoing reasons, the Commission is establishing a 
``safe harbor'' provision in paragraph (c) of Rule 17g-10 pursuant to 
which a person employed to provide third-party due diligence services 
will be deemed to have satisfied its obligations under section 
15E(s)(4)(B) of the Exchange Act if the person promptly delivers an 
executed Form ABS Due Diligence-15E after completion of the due 
diligence services to: (1) An NRSRO that provided a written request for 
the form prior to the completion of the due diligence services stating 
that the services relate to a credit rating the NRSRO is producing; (2) 
an NRSRO that provides a written request for the form after the 
completion of the due diligence services stating that the services 
relate to a credit rating the NRSRO is producing; and (3) the issuer or 
underwriter of the asset-backed security for which the due diligence 
services relate that maintains the Rule 17g-5 Web site with respect to 
the asset-backed security.\1505\ Consequently, the third-party provider 
of due diligence services can fulfill its obligations under the statute 
by responding promptly to specific requests that Form ABS Due 
Diligence-15E be delivered to a particular NRSRO and by promptly 
delivering the form to the issuer or underwriter of the Exchange Act-
ABS that maintains the Rule 17g-5 Web site. This establishes a process 
that can provide certainty to the third party that it has met its 
obligation under section 15E(s)(4)(B) of the Exchange Act.
---------------------------------------------------------------------------

    \1505\ See paragraphs (c)(1) through (3) of Rule 17g-10.
---------------------------------------------------------------------------

    The Commission is making a corresponding amendment to Rule 17g-5 
that is designed to provide for the

[[Page 55191]]

prompt posting of Form ABS Due Diligence-15E to the Rule 17g-5 Web site 
so that other NRSROs can have access to it contemporaneously with an 
NRSRO that knew the third party was performing due diligence and 
requested that the form be delivered upon completion of the 
services.\1506\ Specifically, the Commission is adding paragraph 
(a)(3)(iii)(E) to Rule 17g-5 to require that an NRSRO hired to rate a 
structured finance product must obtain an additional representation 
that can reasonably be relied upon from the issuer, sponsor, or 
underwriter of the product: Namely, that the issuer, sponsor, or 
underwriter will post to the Rule 17g-5 Web site, promptly after 
receipt, any executed Form ABS Due Diligence-15E containing information 
about the security delivered by a person employed to provide third-
party due diligence services with respect to the structured finance 
product.\1507\
---------------------------------------------------------------------------

    \1506\ See, e.g., DBRS Letter (``By adding a note to paragraph 
(a)(3)(iii)(C) [of Rule 17g-5], the Commission could confirm that 
where an issuer or underwriter contracts for the delivery of a due 
diligence report to the hired NRSRO, the posted information must 
include the related Rule 17g-10 certification.'').
    \1507\ See paragraph (a)(3)(iii)(E) of Rule 17g-5. The 
Commission also is amending paragraphs (a)(3)(i) and (a)(3)(iii)(A) 
of Rule 17g-5 to add references to new paragraph (a)(3)(iii)(E).
---------------------------------------------------------------------------

    Paragraph (c) of Rule 17g-10, as proposed, contained definitions of 
due diligence services, issuer, originator, and securitizer for 
purposes of section 15E(s)(4)(B) of the Exchange Act and Rule 17g-10. 
As proposed, paragraph (c)(1) defined the term due diligence 
services.\1508\ Under the proposed definition, an entity would be 
deemed to have provided due diligence services if it engaged in a 
review of the assets underlying an Exchange Act-ABS for the purpose of 
making findings with respect to any one of the five types of activities 
identified in proposed paragraphs (c)(1)(i) through (v) of Rule 17g-
10.\1509\
---------------------------------------------------------------------------

    \1508\ See paragraph (c)(1) of Rule 17g-10, as proposed; 
Nationally Recognized Statistical Rating Organizations, 76 FR at 
33544.
    \1509\ See paragraphs (c)(1)(i) through (v) of Rule 17g-10, as 
proposed; Nationally Recognized Statistical Rating Organizations, 76 
FR at 33472, 33544.
---------------------------------------------------------------------------

    Paragraph (c)(1)(i) of Rule 17g-10, as proposed, would identify the 
first category of due diligence services as a review of the assets 
underlying an Exchange Act-ABS 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 
originator of the assets.\1510\ Paragraph (c)(1)(ii), as proposed, 
would identify the second category of due diligence services as a 
review of the assets underlying an Exchange Act-ABS for the purpose of 
making findings with respect to whether the origination of the assets 
conformed to stated underwriting or credit extension guidelines, 
standards, criteria, or other requirements.\1511\ Paragraph 
(c)(1)(iii), as proposed, would identify the third category of due 
diligence services as a review of the assets underlying an Exchange 
Act-ABS for the purpose of making findings with respect to the value of 
collateral securing such assets.\1512\ Paragraph (c)(1)(iv), as 
proposed, would identify the fourth category of due diligence services 
as a review of the assets underlying an Exchange Act-ABS for the 
purpose of making findings with respect to whether the originator of 
the assets complied with federal, state, or local laws or 
regulations.\1513\
---------------------------------------------------------------------------

    \1510\ See paragraph (c)(1)(i) of Rule 17g-10, as proposed; 
Nationally Recognized Statistical Rating Organizations, 76 FR at 
33544.
    \1511\ See paragraph (c)(1)(ii) of Rule 17g-10, as proposed; 
Nationally Recognized Statistical Rating Organizations, 76 FR at 
33544.
    \1512\ See paragraph (c)(1)(iii) of Rule 17g-10, as proposed; 
Nationally Recognized Statistical Rating Organizations, 76 FR at 
33544.
    \1513\ See paragraph (c)(1)(iv) of Rule 17g-10, as proposed; 
Nationally Recognized Statistical Rating Organizations, 76 FR at 
33544.
---------------------------------------------------------------------------

    Paragraph (c)(1)(v) of Rule 17g-10, as proposed, would identify the 
fifth category of due diligence services--the catchall--as a review of 
the assets underlying an Exchange Act-ABS for the purpose of making 
findings with respect to any other factor or characteristic of such 
assets that would be material to the likelihood that the issuer of the 
Exchange Act-ABS will pay interest and principal according to its terms 
and conditions.\1514\ The proposed catchall was intended to apply to 
due diligence services used for pools of other asset classes (for 
example, commercial loans, corporate loans, student loans, or credit 
card receivables) to the extent that providers of third-party due 
diligence services currently provide or in the future begin providing 
due diligence services with respect to other asset classes and those 
services, because of the different nature of the assets, do not fall 
into one of the other four categories.\1515\
---------------------------------------------------------------------------

    \1514\ See paragraph (c)(1)(v) of Rule 17g-10, as proposed; 
Nationally Recognized Statistical Rating Organizations, 76 FR at 
33544.
    \1515\ See Nationally Recognized Statistical Rating 
Organizations, 76 FR at 33472. In the proposing release, the 
Commission stated that the first four prongs of the definition of 
due diligence services addressed reviews that persons commonly 
understood as due diligence providers conducted with respect to 
RMBS. Id.
---------------------------------------------------------------------------

    Paragraph (c)(2), as proposed, defined the term issuer as including 
a sponsor, as defined in 17 CFR 229.1011, or depositor, as defined in 
17 CFR 229.1011, that participates in the issuance of an Exchange Act-
ABS.\1516\ Paragraphs (c)(3) and (c)(4), as proposed, provided that the 
terms originator and securitizer, respectively, have the same meanings 
as in section 15G of the Exchange Act.\1517\ Defining these two terms 
was intended to provide greater clarity as to the proposed meaning of 
due diligence services.\1518\
---------------------------------------------------------------------------

    \1516\ See paragraph (c)(2) of Rule 17g-10, as proposed; 
Nationally Recognized Statistical Rating Organizations, 76 FR at 
33544. As explained in the proposing release, the Commission 
interprets the term issuer to refer to the depositor of an asset-
backed security. See id. at 33467, n.532, 33473, n.594. This 
treatment is consistent with the Commission's historical regulatory 
approach to that term, including the Securities Act and the rules 
promulgated under the Securities Act and the Exchange Act. See, 
e.g., 17 CFR 230.191; 17 CFR 240.3b-19.
    \1517\ See paragraphs (c)(3) through (4) of Rule 17g-10, as 
proposed; Nationally Recognized Statistical Rating Organizations, 76 
FR at 33544. Section 15G(a)(4) of the Exchange Act defines the term 
originator to mean ``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.'' See 15 U.S.C. 78o-9(a)(4). Section 
15G(a)(3) of the Exchange Act defines the term securitizer to mean: 
``(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.'' See 15 U.S.C. 78o-
9(a)(3).
    \1518\ See Nationally Recognized Statistical Rating 
Organizations, 76 FR at 33473.
---------------------------------------------------------------------------

    The definitions of due diligence services, issuer, originator, and 
securitizer in Rule 17g-10, as adopted, are contained in paragraph (d) 
(rather than paragraph (c), as proposed) because of the addition of the 
new ``safe harbor'' provision in paragraph (c) as discussed 
above.\1519\ The definitions are being adopted substantially as 
proposed with modifications, in part, in response to comments.\1520\
---------------------------------------------------------------------------

    \1519\ See paragraphs (d)(1) through (4) of Rule 17g-10.
    \1520\ See paragraphs (d)(1) through (4) of Rule 17g-10. In 
addition to the modifications discussed below, the final rule is 
modified from the proposal in the following ways. First, the 
citation to the definition of asset-backed security in the Exchange 
Act is corrected in the prefatory text of paragraph (d) and in 
paragraphs (d)(1) and (3). Second, the word ``such'' in third prong 
of the definition of due diligence services (paragraph (d)(1)(iii)) 
has been replaced with the word ``the''. Third, references in the 
definition of issuer in paragraph (d)(2) have been corrected by 
replacing in two places the phrase ``Sec.  229.1011'' with the 
phrase ``Sec.  229.1101''. These modifications are not intended to 
substantively change the meaning of the terms as compared to the 
proposed definitions.
---------------------------------------------------------------------------

    Commenters focused on the definition of due diligence services 
because the requirement to provide the written certification under 
section 15E(s)(4)(B) of the Exchange Act is triggered when a third 
party is employed to provide these services with respect to an

[[Page 55192]]

Exchange Act-ABS.\1521\ A commenter that provides due diligence 
services recommended modifying the first prong of the definition by 
replacing the phrase ``quality and integrity'' of the data with the 
word ``accuracy'' because that would ``more accurately reflects the 
role of the due diligence provider and the nature of its objective 
review.'' \1522\ The Commission believes that this change will more 
accurately describe the nature of the work undertaken by a provider of 
third-party due diligence services, as suggested by the commenter. 
Consequently, the Commission is making the modification.\1523\
---------------------------------------------------------------------------

    \1521\ See 15 U.S.C. 78o-7(s)(4)(B).
    \1522\ See Clayton Letter.
    \1523\ See paragraph (d)(1)(i) of Rule 17g-10. The commenter 
also recommended this modification be made to Item 4 of Form ABS Due 
Diligence-15E, which used similar text to describe due diligence 
services. See Clayton Letter. As discussed below in section II.H.3. 
of this release, the Commission is making a corresponding 
modification to Item 4.
---------------------------------------------------------------------------

    Commenters were concerned that the definition of due diligence 
services could be interpreted to include services that have not 
traditionally been viewed as third-party due diligence services. In 
this regard, several commenters focused on the fifth prong of the 
definition: The catchall.\1524\ As proposed, this prong included within 
the definition a review of the assets underlying an Exchange Act-ABS 
for the purpose of making findings with respect to any other factor or 
characteristic of such assets that would be material to the likelihood 
that the issuer of the Exchange Act-ABS will pay interest and principal 
according to its terms and conditions.\1525\ Some commenters 
recommended eliminating this catchall provision.\1526\ Two commenters 
recommended it be narrowed.\1527\ One of these commenters stated that 
the provision should only include ``factors or characteristics that 
were material to determining the credit rating.'' \1528\ The other 
commenter stated that the provision should be limited to ``factors that 
materially impact the likelihood that the assets themselves would pay 
interest and principal according to their terms and conditions.'' 
\1529\
---------------------------------------------------------------------------

    \1524\ See CRE Letter; Deloitte Letter; Morningstar Letter; S&P 
Letter.
    \1525\ See paragraph (c)(1)(v) of Rule 17g-10, as proposed; 
Nationally Recognized Statistical Rating Organizations, 76 FR at 
33544.
    \1526\ See CRE Letter; Deloitte Letter; Morningstar Letter; S&P 
Letter.
    \1527\ See Morningstar Letter; Deloitte Letter.
    \1528\ See Morningstar Letter.
    \1529\ See Deloitte Letter.
---------------------------------------------------------------------------

    The Commission is not persuaded that the catchall provision should 
be eliminated. As the Commission explained in the proposing release, 
the first four prongs of the definition were based on the Commission's 
understanding of the types of reviews undertaken with respect to the 
pools of mortgage loans underlying issuances of RMBS because due 
diligence services traditionally have been performed with respect to 
RMBS.\1530\ The first four prongs also may cover due diligence services 
performed with respect to other types of Exchange Act-ABS. However, 
there also may be reviews now or in the future that are more tailored 
to the different nature of the assets underlying these other types of 
Exchange Act-ABS. The proposed catchall was designed to apply to due 
diligence services provided with respect to the assets (for example, 
commercial loans, corporate loans, student loans, or credit card 
receivables) underlying other types of Exchange Act-ABS to the extent 
not covered by the first four prongs of the definition. For these 
reasons, the Commission believes it is appropriate to retain the 
catchall prong of the definition and, therefore, is adopting it as 
proposed.\1531\
---------------------------------------------------------------------------

    \1530\ See Nationally Recognized Statistical Rating 
Organizations, 76 FR at 33472.
    \1531\ See paragraph (d)(1)(v) of Rule 17g-10.
---------------------------------------------------------------------------

    One commenter stated that, if the catchall provision is not 
eliminated, ``the final rule should limit the provision's application 
to other factors that materially impact the likelihood that [the 
underlying] assets themselves would pay interest and principal 
according to their terms and conditions'' so that the ``focus of the 
diligence services will be on the assets themselves, not the issuer's 
ability to pay as is set forth in the proposed definition.'' \1532\ The 
Commission agrees that due diligence services typically focus on the 
assets underlying an Exchange Act-ABS. Indeed, the prefatory text of 
paragraph (d)(1) of Rule 17g-10 provides that the term due diligence 
services means a review of the assets underlying an Exchange Act-ABS 
for the purpose of making findings with respect to certain 
matters.\1533\ Moreover, the catchall provision includes within the 
definition of due diligence services a review of any other factor or 
characteristic of the assets underlying an Exchange Act-ABS that would 
be material to the likelihood that the issuer will pay interest and 
principal in accordance with applicable terms and conditions.\1534\ 
Consequently, in response to the commenter, the Commission confirms 
that a review must be of the assets underlying the Exchange Act-ABS in 
order to fall within the definition of due diligence services. However, 
the performance of the underlying assets (for example, their ability to 
pay principal and interest) ultimately will impact whether the Exchange 
Act-ABS itself will be able to pay interest and principal because the 
payments received on the underlying assets are passed through to the 
holders of the Exchange Act-ABS. Moreover, a review of the underlying 
assets that is relevant to whether the Exchange Act-ABS will pay 
interest and principal according to its terms is the type of 
information that would be useful to an NRSRO that is assessing the 
creditworthiness of Exchange Act-ABS. The catchall provision is 
designed to account for such reviews to the extent they are not 
addressed in the other prongs of the definition of due diligence 
services.\1535\
---------------------------------------------------------------------------

    \1532\ See Deloitte Letter.
    \1533\ See prefatory text of paragraph (d)(1) of Rule 17g-10