In June 2007, the Securities and Exchange Commission (the “SEC”) released its final rules implementing provisions of the Credit Rating Agency Reform Act of 2006 (the “Act”) pursuant to which a credit rating agency can apply to be registered as a nationally recognized statistical rating organization (an “NRSRO”). This legal advisory notice discusses: (1) the new NRSRO registration process; (2) the maintenance of NRSRO status; and (3) the potential effects of the new registration requirements on investors and other members of the public who utilize credit ratings.
Under the new rules, registration as an NRSRO is voluntary through the filing and regular updating of new Form NRSRO. Before the enactment of the Act and the new rules, the SEC identified NRSROs through staff no-action letters. This process was criticized for lacking transparency and creating a barrier to smaller credit rating agencies seeking wider recognition and greater market share. The Act and its implementing rules were designed to address these shortcomings and to achieve disclosure and regulatory goals.
Publicly Available Information on NRSROs
Under the new rules, rating agencies may register for specific classes of credit ratings using Form NRSRO, which must by updated annually, whenever information becomes materially inaccurate, or when the NRSRO wishes to add a new class of credit ratings to its registration. Once approved, the NRSRO must make all information submitted in its Form NRSRO publicly available on its website or through another comparable means readily accessible to the public.
NRSROs are required to make the following public disclosures:
1. Credit Ratings Performance Statistics. An NRSRO must report performance measurement statistics calculated for short-, mid-, and long-term periods, along with explanations of the statistics and the metrics used to derive them. Currently, the SEC is not prescribing standard metrics.
2. Methodologies for Determining Credit Ratings. An NRSRO must report the model it uses to determine credit ratings. NRSROs may use an objective quantitative model, either alone or in combination with subjective qualitative analysis, to make such determinations. An NRSRO may also establish its own procedures and methodologies to: determine whether and when to initiate, update, review, or withdraw a credit rating; interact with the management of rated obligors or issuers of securities, including notification of ratings decisions and appeals; and establish the structure and voting process for monitoring, reviewing, and approving credit ratings. The SEC requires an NRSRO to disclose a sufficiently detailed description of these procedures and methodologies to the public, and to internally document the procedures actually used.
3. Organizational Information. An NRSRO must create, submit, and make publicly available several organizational charts showing its: subsidiaries and material affiliates; divisions, departments, and business units; and management structure and senior management reporting lines. These charts should provide a broad overview of an NRSRO’s operations and business interests and facilitate the evaluation and understanding of the degree to which an NRSRO’s designated compliance officer – charged with preventing the misuse of nonpublic information, managing conflicts of interest and ensuring compliance with securities laws and regulations – is independent from the NRSRO’s business managers.
4. Code of Ethics. An NRSRO must make available a copy of its code of ethics, or provide an explanation as to why it does not have a code of ethics.
5. Conflicts of Interest. An NRSRO must provide a copy of its written policies and procedures for managing conflicts of interest and must make available a list that identifies and discloses, in general terms, the types of conflicts of interest that arise from its business activities. Examples of potential conflicts of interest practices that an NRSRO must disclose include, but are not limited to:
- Payment by an issuer, underwriter or obligor to the NRSRO for determination of a credit rating;
- Payment by a rated entity for any ancillary service;
- Direct ownership by NRSRO employees of the securities or money market instruments of entities subject to a credit rating determined by the NRSRO; and
- Business relationships of NRSRO employees and rated entities other than in the ordinary course of business.
NRSROs are expressly prohibited from engaging in the following activities due to the risk of undue influence:
- Issuance of a credit rating to an entity that provided 10% or more of its total net revenue in the previous fiscal year;
- Direct ownership of instruments by a credit analyst or supervisor determining or approving an issuer’s credit rating;
- Issuance of a credit rating for an entity controlling, controlled by, or under common control with the NRSRO; and
- Issuance or approval of a credit rating by an analyst or supervisor who is an officer or director of the rated entity.
6. Credit Analyst Information. In order to assist investors in evaluating the qualifications of employees of an NRRO, the SEC requires disclosure of an NRSRO’s total number of credit analysts and credit analyst supervisors, as well as general descriptions of the minimum required qualifications (including education level and work experience) of credit analysts and supervisors.
Disclosures to the SEC
NRSROs must also furnish additional information to the SEC which will be given confidential treatment and will assist the SEC in monitoring the credit rating agency’s continued compliance with all applicable rules and regulations. This information will be used by the SEC to monitor an NRSRO’s largest users of rating services, financial viability of the NRSRO and the NRSRO’s recordkeeping and compliance with internal procedures.
Benefits to Investors
By making registration accessible and manageable for agencies of all sizes, the SEC believes the new rules will encourage increased competition among NRSROs and potentially lower costs to issuers for obtaining credit ratings. The SEC also believes that, as a result of increased oversight and improved integrity of credit ratings issued, the new rules will reduce the risk of an unexpected collapse of a rated issuer or obligor. Finally, the SEC believes that new NRSRO disclosures will allow investors to view and compare NRSRO information and weigh the respective credit ratings of each NRSRO accordingly.
There are seven organizations that are currently designated as NRSROs under the new registration procedures: A.M. Best Company, Inc., DBRS Ltd., Fitch, Inc., Japan Credit Rating Agency, Ltd., Moody's Investors Service, Inc., Rating and Investment Information, Inc., and Standard and Poor's Ratings Services.