At yesterday's open meeting, the Securities and Exchange Commission voted unanimously to adopt a series of proposals that impose new disclosure and conflict of interest requirements on nationally recognized statistical rating organizations (NRSROs), eliminate references to credit ratings by NRSROs from certain SEC rules and forms, and re-open the comment period regarding the proposed elimination of additional NRSRO references from SEC rules and forms. The Commissioners also unanimously approved a proposal that would prohibit the practice of flashing marketable orders under Rule 602 of Regulation NMS.
In 2006, Congress passed the Credit Rating Agency Reform Act (“Reform Act”), which granted the SEC broad authority over rating agency registration. Since 2006, the SEC has adopted numerous rule makings that have implementing enhanced registration and oversight for NRSROs. As this week marks the one year anniversary of the fall of Lehman Brothers, the Commissioners acknowledged that credit rating agencies have played an instrumental role in the financial crisis, and that continued efforts to enhance disclosure of this industry must be adopted. Chairman Shapiro in this regard, noted in her opening remarks that collectively the changes and concepts to be considered seek to “improve the quality of ratings by requiring greater disclosure, fostering competition, helping to address conflicts of interest, shedding light on rating shopping and promoting accountability.”
The following six items relating to NRSROs, first proposed last December, were adopted:
- Rules requiring the disclosure of more information relating to credit rating histories, and rules seeking to enable competing credit rating agencies to offer unsolicited ratings for structured finance products, by granting them broad access to certain underlying data for structured products.
- Rules requiring annual compliance reports and enhanced disclosure of potential sources of revenue-related conflicts.
- Rules requiring enhanced disclosure of information regarding scope of credit rating covers and any material limitations on such and information regarding the issuance of “preliminary ratings” from other credit rating agencies.
- Amendments removing certain references to credit ratings by NRSROs from certain SEC rules and forms, and reopening the public comment period to permit further comment on SEC proposals to eliminate other NRSRO credit rating references from other SEC rules and forms.
- Soliciting public comment whether to amend current SEC rules to eliminate a current provision that exempts NRSROs from being treated as experts when their ratings are used in connection with a registered offering, subjecting NRSROs to potential Section 11 liability when their ratings are used that way.
The SEC also unanimously approved a proposed rule amendment to Rule 602 of Regulation NMS that would eliminate an exception for the use of flash orders. Rule 602 of Regulation NMS in part requires that “[e]ach national securities exchange shall at all times such exchange is open for trading, collect, process and make available to vendors the best bid, the best offer and aggregate quotation sizes for each subject security listed or admitted to unlisted trading privileges which is communicated on any national securities exchange by any responsible broker or dealer.” However, Rule 602(a)(1)(i)(A) contains a limited exception for “[a]ny bid or offer executed immediately after communication and any bid or offer communicated by a responsible broker or dealer other than an exchange market maker which is cancelled or withdrawn if not executed immediate after communication.” Under this exception, certain market participants may view an order before others publicly display their quotes. While flash orders may provide some tangible benefits to market participants, Chairman Shapiro noted in her remarks at the open meeting that “flash orders have the potential to significantly undermine the incentives to display limit orders and to quote competitively,” and cautioned that they detract from market efficiency by potentially “creat[ing] a two-tiered market by allowing only selected participants to access information about the best available prices for listed securities.” If the proposal is adopted it would effectively prohibit all markets, including equity exchanges, options exchanges, and alternative trading systems (ATSs), from displaying marketable flash orders. The adoption of the rule would also permit the SEC to apply Rule 301(b) of Regulation ATS and Rule 601(d) of Regulation NMS in a consistent manner.