Under the SEC’s Release 34-61050, published in December 2009, additional disclosure and conflict of interest requirements were imposed on nationally recognized statistical rating organizations (NRSROs) in the United States. The Release amended Rule 17g-5 of the Securities Exchange Act of 1934 (the Act) in an effort to address concerns of the SEC about the integrity of credit rating procedures and the methodologies of NRSROs. One of the goals is to facilitate unsolicited ratings in respect of a structured finance issuer from an NRSRO not otherwise engaged by such structured finance issuer as a counter-balance to the objectivity challenges that arise for rating agencies that receive fees from originators/sponsors in connection with the delivery of ratings. Where NRSROs that are not engaged by a structured finance issuer have reasonable access to information about a proposed rated issuance they will not be at a disadvantage in generating an unsolicited rating of the subject issuance when compared to the NRSRO that had been engaged by the structured finance issuer for that purpose.
Among other changes, the amended Rule 17g-5 requires that certain arrangers that pay for a credit rating of a structured finance product maintain information on a password-protected web site for the benefit of qualifying NRSROs, whether or not the NRSRO had been hired to determine an initial credit rating or to monitor a credit rating of the structured finance issuer in question and to represent to the hired NRSRO as part of the engagement of such NRSRO that such web site had been established in compliance with the requirements of the SEC Rule. Under Rule 17g-5(a)(3), an NRSRO is prohibited from issuing or maintaining a credit rating when it is subject to certain conflicts of interest (including being hired by an arranger to determine a credit rating for a structured finance product) unless the NRSRO, among other things, (i) maintains on a password-protected web site a list of each structured finance product for which it currently is in the process of determining an initial credit rating in chronological order and identifying the type of structured finance product, the name of the issuer, the date the rating process was initiated and the web site address where the arranger represents that the information provided to the hired NRSRO can be accessed by other NRSROs; and (ii) obtains from the arranger a written representation that can reasonably be relied upon that the arranger will, among other things, disclose on a password-protected web site the information that it provides to the hired NRSRO to determine the initial credit rating (and monitor that credit rating) and provide access to the web site to other NRSROs. The Rule establishes a compliance date of June 2, 2010, subject to the conditional exemption described in the following paragraph.
In an Order dated May 19, 2010 (SEC Release No.34-62120), the SEC has temporarily exempted NRSROs from the requirements of SEC Rule 17-g-5(a)(3) where certain conditions are satisfied. Under the Order, an NRSRO is not required to comply with Rule 17g-5(a)(3) until December 2, 2010 with respect to credit ratings where (1) the issuer of the structured finance product is a non-U.S. person; and (2) the 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, only in transactions outside the U.S. The SEC intends that a “U.S. person” for purposes of the exemptive relief will have the same meaning as under Regulation S of the Securities Act of 1933. Whether an NRSRO has a “reasonable basis” to conclude that a structured finance transaction is not a U.S. transaction will be determined on the facts and would presumably involve conversations between the NRSRO and the arrangers and marketers of the structured finance instrument in question as to the intentions vis-à-vis the marketing, trading and re-sale of such instrument.
As background to the Order, the SEC stated that it had learned from certain foreign securities regulators that many foreign arrangers were not prepared to address the requirements imposed by the amended SEC Rule 17g-5 in terms of establishing the requisite web sites and implementing other systems requirements necessary to make the required disclosures in light of local laws that may impact adherence to the SEC Rule. The corresponding effect of imposing on NRSROs the requirements of Rule 17g-5(a)(3) would have been to require conditions to NRSROs’ issuing or monitoring credit ratings of structured finance products that non-U.S. arrangers were not able to address or accommodate. The SEC relief is designed to address those entities that are not U.S. persons within the meaning of the Act and complete non-U.S. transactions. The SEC will be monitoring the use of the temporary exemption to evaluate whether it is being used for transactions that meet the above-described conditions. The SEC is specifically seeking comments as to the application of Rule 17g-5(a)(3) to non-U.S. transactions.
While NRSROs in the structured finance market have temporary relief in respect of non-U.S. transactions, actions will need to be taken to prepare for compliance with the SEC Rule by structured finance arrangers and NRSROs with Canadian activities prior to the end of the temporary relief period.