Oversight of Credit Rating Agencies Registered as Nationally Recognized StatisticalAGENCY: Securities and Exchange Commission.ACTION: Proposed rule.Section I-III
SUMMARY: The Commission is proposing for comment rules to implement provisions of the Credit Rating Agency Reform Act of 2006 (the "Act"), enacted on September 29, 2006. The Act defines the term "nationally recognized statistical rating organization," provides authority for the Commission to implement registration, recordkeeping, financial reporting, and oversight rules with respect to registered credit rating agencies, and directs the Commission to issue final implementing rules no later than 270 days after its enactment (or by June 26, 2007). DATES: Comments should be received on or before March 12, 2007. ADDRESSES: Comments may be submitted by any of the following methods: Electronic comments:
Paper comments: • Send paper comments in triplicate to Nancy M. Morris, Secretary, Securities and Exchange Commission, 100 F Street, NE, Washington, DC 20549-1090. All submissions should refer to File Number S7-04-07. This file number should be included on the subject line if e-mail is used. To help us process and review your comments more efficiently, please use only one method. The Commission will post all comments on the Commission’s Internet Web site (http://www.sec.gov/rules/proposed.shtml). Comments are also available for public inspection and copying in the Commission’s Public Reference Room, 100 F Street, NE, Washington, DC 20549. All comments received will be posted without change; we do not edit personal identifying information from submissions. You should submit only information that you wish to make publicly available. FOR FURTHER INFORMATION CONTACT: Michael A. Macchiaroli, Associate Director, at (202) 551-5525; Thomas K. McGowan, Assistant Director, at (202) 5515521; Randall W. Roy, Branch Chief, at (202) 551-5522; Rose Russo Wells, Attorney, at (202) 551-5527; Sheila Swartz, Attorney, at (202) 551-5545, Division of Market Regulation, Securities and Exchange Commission, 100 F Street, NE, Washington, DC 20549-6628. SUPPLEMENTARY INFORMATION: I. BACKGROUNDThe credit rating business has expanded significantly over the last 100 years. Credit rating agencies now issue credit ratings for debt securities of public companies, sovereign governments, and municipalities, and for structured products such as asset backed securities. They also issue ratings on money market instruments such as commercial paper and with respect to obligors (that is, a credit assessment of an entity as opposed to the entity’s securities). Obligor ratings are issued on, among other entities, public companies, sovereign governments, and non-public companies such as banks and insurance companies. The scope of the credit rating business reflects the importance of credit ratings to securities market participants and other creditors. Investors use credit ratings to make investment decisions. Large public institutions, such as pension funds, also use credit ratings to prescribe the types of securities the institution is permitted to hold. Creditors, such as commercial and investment banks, use credit ratings to manage credit risk and govern transactional agreements. For example, credit agreements frequently contain trigger provisions requiring more collateral if the creditor’s credit rating drops. In addition, regulatory bodies have come to rely on credit ratings. In 1975, the Commission adopted the term "nationally recognized statistical rating organization" or "NRSRO" as part of amendments to its broker-dealer net capital rule1 under the Securities Exchange Act of 1934 ("Exchange Act").2 The net capital rule requires a broker-dealer to maintain a level of net capital generally defined as net worth plus subordinated debt less illiquid assets and less percentage deductions on proprietary securities.3 The net capital rule prescribes specific percentage deductions for various classes of securities based on the liquidity and volatility of the type of security.4 These deductions, known as "haircuts," are intended to provide a financial buffer against risks arising from the broker-dealer’s business activities, including potential losses arising from market fluctuations in the prices of, or lack of liquidity in, the securities. The Commission’s incorporation of the term "nationally recognized statistical rating organization" into the net capital rule provided a means to distinguish between different classes of debt securities for the purpose of prescribing applicable haircuts.5 Thus, the net capital rule permits a broker-dealer to apply lower haircuts to certain types of debt securities that are rated in one of the four highest categories (known as the "investment grade" categories) by at least two NRSROs.6 Although the Commission used the term "nationally recognized statistical rating organization" in the net capital rule, it did not provide a definition. The Commission staff has identified NRSROs through no-action letters.7 In response to a request for a no-action letter from a credit rating agency, the Commission staff would review information and documents submitted by the credit rating agency concerning its financial and managerial resources, methodologies for determining ratings, policies for managing activities that could impact the impartiality of the credit ratings, and recognition in the marketplace. Based on this review, the Commission staff would determine whether the credit rating agency had the financial and managerial resources and appropriate policies and procedures to consistently issue credible and reliable credit ratings. The Commission staff also would determine whether the predominant users of credit ratings considered the credit rating agency to be credible and reliable. If these assessments were both positive, the Commission staff, after seeking the advice of the Commission, would issue a no-action letter informing broker-dealers that they could treat the credit rating agency as an NRSRO for purposes of the net capital rule.8 Since 1975, the Commission staff has identified nine credit rating agencies as NRSROs. However, as a result of consolidation, only five credit rating agencies currently are identified as NRSROs – Moody’s Investors Service, Inc., Fitch, Inc., the Standard and Poor’s Division of the McGraw-Hill Companies Inc., A.M. Best Company, Inc., and Dominion Bond Rating Service Limited.9 Over time, the Commission has imported the NRSRO concept into a number of other rules.10 For example, definitions in Commission Rule 2a-7 under the Investment Company Act of 1940 include the term NRSRO to prescribe the type of securities a money market fund can hold.11 In addition, regulations adopted by the Commission under the Securities Act of 1933 permit offerings of certain nonconvertible debt, preferred, and asset-backed securities that are rated investment grade by at least one NRSRO to be registered on Form S-3 – the Commission’s "short-form" registration statement – without the issuer satisfying a minimum public float test.12 The term "NRSRO" also has been incorporated into a wide range of federal legislation.13 For example, when Congress defined the term "mortgage related security" in Section 3(a)(41) of the Exchange Act as part of the Secondary Mortgage Market Enhancement Act of 1984,14 it required, among other things, that such securities be rated in one of the two highest rating categories by at least one NRSRO.15 Further, a number of other federal, state, and foreign laws and regulations have incorporated the term "NRSRO." For example, the U.S. Department of Education uses ratings from NRSROs to set standards of financial responsibility for institutions seeking to participate in student financial assistance programs under Title IV of the Higher Education Act of 1965, as amended.16 Several state insurance codes rely, directly or indirectly, on NRSRO ratings in determining appropriate investments for insurance companies.17 Canada and El Salvador also have employed the concept.18 II. THE CREDIT RATING AGENCY REFORM ACT OF 2006The Act19 seeks to address two important issues that have arisen with respect to credit rating agencies.20 First, the practice of identifying NRSROs through staff no-action letters has been criticized as a process that lacks transparency and creates a barrier to entry for credit rating agencies seeking wider recognition and market share.21 Second, the importance of credit ratings to the financial markets has raised the question of whether greater supervision of credit rating agencies is warranted.22 The failures of Enron and WorldCom – which led to new laws and regulations governing a host of market participants including public companies, securities analysts, and accountants23 – increased concerns that credit rating agencies were operating outside the scope of any meaningful regulatory supervision.24 Over the years, the Commission has made attempts to address these issues25 and has participated in international initiatives to address similar issues.26 However, the Commission’s efforts have been hindered by limitations to its authority.27 Congress ultimately found that legislation was necessary and enacted the Act to provide for voluntary registration and oversight of NRSROs.28 In overview, the Act adds definitions to Section 3 of the Exchange Act,29 creates a new Section 15E of the Exchange Act,30 and amends Section 17 of the Exchange Act.31 These new statutory provisions, and the grants of Commission rulemaking authority under these provisions, establish a registration and regulatory program for credit rating agencies opting to have their credit ratings qualify for purposes of laws and rules using the term "nationally recognized statistical rating organization." These credit rating agencies would be required to register with the Commission, make public certain information to help persons assess their credibility, make and retain certain records, furnish the Commission with certain financial reports, implement policies to manage the handling of material non-public information and conflicts of interest, and abide by certain prohibitions against unfair, coercive, or abusive practices. The Commission notes that international standards, such as those promulgated by the Technical Committee of the International Organization of Securities Commissions ("IOSCO"), are generally consistent with the Act and the rules the Commission is proposing.32 The statutory provisions of the Act prohibit reliance on Commission staff no-action letters identifying NRSROs.33 These statutory provisions become effective on the earlier of June 26, 2007 (270 days after the date of enactment of the Act) or the date the Commission issues final rules under the Act.34 However, as a transitional measure, no-action letters issued before the effective date may continue to be relied upon by regulatory users of credit ratings after the effective date if the credit rating agency identified in the letter has a pending application for registration before the Commission.35 In this case, the letter becomes void after the Commission has acted on the application.36 III. DESCRIPTION OF THE PROPOSED RULESA. Overview The Act mandates that the rules adopted to implement its provisions be "narrowly tailored" to meet the Act’s requirements.37 Moreover, it provides that the rules adopted by the Commission may not "regulate the substance of credit ratings or the procedures or methodologies by which an NRSRO determines credit ratings."38 Under the proposed rules,39 in conjunction with the statutory provisions of the Act, a credit rating agency seeking to register as an NRSRO would need to apply to the Commission using Form NRSRO.40 The information furnished to the Commission in the form would fall broadly into two categories. First, the form would elicit information the credit rating agency would need to make public upon registration and thereafter update to keep the information current.41 As the Senate Report noted, making this information public would "facilitate informed decisions by giving investors the ratings quality of different firms."42 The second category of information would be submitted on a confidential basis to the extent permitted by law and the credit rating agency would not need to make it public or update it on the form (but would have to keep it current through proposed financial reporting requirements).43 After registration, the credit rating agency (now an NRSRO under the Act) would need to promptly update the information on its Form NRSRO to the extent an item or exhibit becomes materially inaccurate, with certain exceptions.44 In addition, on a calendar year basis, the credit rating agency would need to furnish the Commission with an annual certification on Form NRSRO that the information and documents in the form continues to be accurate and listing any material changes that occurred during the year.45 The most recently furnished Form NRSRO (initial, amended, or annual certification) and public exhibits would be the operative registration application and would need to be made public by the NRSRO (with exceptions for certain confidential information). After registration, the NRSRO would be subject to several substantive rules. First, the NRSRO would be subject to a recordkeeping rule, under which the NRSRO would be required to make and retain certain records relating to the business of issuing credit ratings.46 These records would assist the Commission, through its examination process, in monitoring whether the NRSRO complies with the requirements of the Act. Other required records would assist the Commission in monitoring whether the NRSRO follows its established policies and procedures. On an annual fiscal year basis, an NRSRO would be required to furnish the Commission with audited financial statements.47 This requirement is designed to assist the Commission in monitoring whether the credit rating agency continues to maintain adequate financial resources to consistently produce credit ratings with integrity. The financial reports also would include a schedule of the NRSRO’s largest customers. This would assist the Commission in monitoring for potential conflicts of interest arising from dealings with the NRSRO’s largest customers. Finally, all NRSROs would be subject to requirements designed to protect their impartiality with respect to issuing credit ratings. First, they would be required to establish, maintain, and enforce specific written policies designed to prevent the misuse of material non-public information.48 Second, they would be subject to requirements to avoid, manage, and disclose conflicts of interest.49 Third, NRSROs would be prohibited from engaging in certain unfair, coercive, or abusive practices.50 B. Proposed Rule 17g-1 – Registration RequirementsThe provisions of proposed Rule 17g-1 would implement rulemaking authority under the Act with respect to how a credit rating agency must apply to be registered as an NRSRO, make the non-confidential information in its application public, apply to add an additional category of credit ratings to its registration, update its application, furnish the annual certification, and withdraw its registration. 1. Entities Eligible to Apply for RegistrationThe Act, by adding definitions to Section 3 of the Exchange Act,51 identifies the types of entities that may apply for registration with the Commission as an NRSRO.52 First, it defines a "nationally recognized statistical rating organization" as a credit rating agency that: (A) has been in business as a credit rating agency for at least the three consecutive years immediately preceding the date of its application for registration under section 15E [of the Exchange Act]; (B) issues credit ratings certified by qualified institutional buyers, in accordance with section 15E(a)(1)(B)(ix) [of the Exchange Act], with respect to (i) financial institutions, brokers, or dealers; (ii) insurance companies; (iii) corporate issuers; (iv) issuers of asset-backed securities (as that term is defined in [17 CFR 229.1101(c)]); (v) issuers of government securities, municipal securities, or securities issued by a foreign government; or (vi)a combination of one or more categories of obligors described in any of clauses (i) through (v); and (C) is registered under section 15E [of the Exchange Act].53 Section 3 of the Exchange Act also defines the term "credit rating agency" as any person: (A) engaged in the business of issuing credit ratings on the Internet or through another readily accessible means, for free or for a reasonable fee, but does not include a commercial credit reporting company; (B) employing either a quantitative or qualitative model, or both, to determine credit ratings; and (C) receiving fees from either issuers, investors, or other market participants, or a combination thereof.54 Finally, Section 3 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."55 Taken together, these three definitions limit the type of entity eligible to be registered with the Commission as an NRSRO. First, the entity must meet the definition of "credit rating agency" in Section 3 of the Exchange Act, which means, among other things, it must issue "credit ratings" as that term is defined in the act. Thus, an entity that issues "credit ratings" but does not receive compensation from issuers, investors, or other market participants would not be eligible for registration as an NRSRO because it would not meet the third prong of the definition of "credit rating agency."56 Similarly, an entity would not be eligible for registration based solely on the fact that it has issued recommendations with respect to equity securities (for example, buy, sell, or hold) or ratings with respect to the quality of a company’s management. In either case, the entity would not have been issuing "credit ratings" as the term is defined because the recommendations and ratings are not assessments of the creditworthiness of an obligor or of specific securities or money market instruments.57 Another component of the first prong in the definition of "credit rating agency" is that the entity must be engaged in the business of issuing credit ratings on the Internet or through another readily accessible means, for free or for a reasonable fee.58 The statute does not define "reasonable fee." As a preliminary matter, the Commission believes that the fees contemplated by the definition are those charged by a credit rating agency, if any, for a customer to access or receive the credit ratings of the credit rating agency. The fees a credit rating agency charges for other services are not part of the definition, since regulatory users of credit ratings would not need access to these other services to comply with statutes and regulations using the term "NRSRO." These other fees would include fees charged to issuers, obligors, or underwriters to determine or maintain a credit rating, fees charged to subscribers for credit analysis reports, and fees charged for consulting or other services. Additionally, the Commission preliminarily believes that the determination of whether a fee for accessing or obtaining credit ratings is reasonable would depend on the facts and circumstances. The Commission requests comment on the issue of determination of the reasonableness of fees charged by NRSROs for accessing or obtaining their credit ratings; in particular, the Commission requests comment on this issue in the context of users of credit ratings for regulatory purposes. Finally, if an entity meets the definition of "credit rating agency," the entity must have been in the business of issuing credit ratings for the three years immediately preceding the date of its application for registration to be eligible to apply to register with the Commission as an NRSRO. 2. Description of Proposed Registration Rule (Rule 17g-1)A credit rating agency that elects to be treated as an NRSRO must apply to the Commission to be registered as an NRSRO. Section 15E(a)(1)(A) of the Exchange Act provides that a credit rating agency applying for registration must furnish the Commission with an application in a form prescribed by Commission rule.59 In addition, Section 15E(a)(1)(B) of the Exchange Act prescribes certain minimum information the credit rating agency must provide in the application.60 This includes information regarding the categories of credit ratings set forth in the definition of "NRSRO" in Section 3(a)(62)(B) of the Exchange Act with respect to which the credit rating agency "intends to apply for registration."61 Paragraph (a) of proposed Rule 17g-1 would implement these provisions by providing that a credit rating agency applying to be registered with the Commission as an NRSRO would be required to furnish the Commission with an application on Form NRSRO. As discussed below, a credit rating agency would be able to apply to be registered for less than all five of the categories of credit ratings identified in Section 3(a)(62)(B) of the Exchange Act.62 For example, the credit rating agency might not meet the definitional thresholds discussed above with respect to a particular category of credit rating because it has not issued credit ratings in that category for the three years preceding the date of its application.63 Paragraph (b)(1) of proposed Rule 17g-1 provides that an application would be considered furnished to the Commission on the date that the Commission receives a complete and properly executed Form NRSRO that follows all applicable instructions for the form.64 The requirement that an application must be accurate and complete comports with the requirements imposed on other classes of registrants under the Exchange Act.65 In addition, Section15E(a)(2)(A) of the Exchange Act requires the Commission to grant the application for registration or commence proceedings on whether to deny it within 90 days from the date the application is furnished to the Commission or a longer period if the applicant consents.66 Moreover, if proceedings are commenced, Section 15E(a)(2)(B) of the Exchange Act67 requires the Commission to conclude them within 120 days of the date the application was furnished to the Commission.68 As a result, the Commission must have a complete application before the 90-day and 120-day periods begin to run. Paragraph (b)(1) of proposed Rule 17g-1 also provides that information submitted with the application on a confidential basis would be accorded confidential treatment to the extent permitted by law. As discussed in detail below, the information proposed to be required in Form NRSRO includes information which an NRSRO would need to make public after registration and information that is submitted on a confidential basis to the extent permitted by law. Some of the confidential information is required by Section 15E(a)(1)(B) of the Exchange Act.69 The Commission also would require certain additional information under authority conferred by Section 15E(a)(1)(B)(x) of the Exchange Act.70 The Commission believes that it would be appropriate to provide confidential treatment to some of this information as well. Because the statute does not specifically grant confidential treatment to the additional information, the Commission would provide it through paragraph (b)(1) of proposed Rule 17g-1 to the extent permitted by law. Paragraph (b)(2) of proposed Rule 17g-1 would provide a mechanism for a credit rating agency to withdraw its application before the Commission takes final action on it.71 Specifically, it would require the credit rating agency to furnish the Commission with a written notice of withdrawal executed by a duly authorized person. The proposed requirement for execution by a duly authorized person is designed to ensure that the withdrawal notice reflects the intent of the credit rating agency. Paragraph (c) of proposed Rule 17g-1 would provide that if information on the application becomes materially inaccurate before the Commission has granted or denied the application, the credit rating agency must promptly notify the Commission and amend the application with accurate and complete information by submitting an amended initial application on proposed Form NRSRO.72 Because preparing and furnishing an amended form may take time, this proposed notification provision is designed to alert the Commission as soon as possible that the application before it is materially inaccurate or incomplete. The intent is to avoid situations where the Commission continues to review an application that is no longer materially accurate. Section 15E(a)(3) of the Exchange Act provides that the Commission, by rule, shall require an NRSRO, after registration, to make the information submitted in its completed application and any amendments publicly available on its Web site or through another comparable, readily accessible means.73 It also permits the Commission to determine by rule the information that shall be made publicly available.74 Paragraph (d) of proposed Rule 17g-1 would require that the information be made publicly available within five business days of the NRSRO being registered or furnishing an amendment or annual certification. The five business-day period is intended to provide the NRSRO with sufficient time to make the information public while also designed to ensure that users of credit ratings would have access to information within a reasonably short timeframe. Under the proposed rule, certain additional information submitted pursuant to Commission rulemaking authority also would not need to be made publicly available after registration.75 In addition, an applicant could seek confidential treatment for information in the application under existing law and rules governing confidential treatment.76 The Commission would accord this information confidential treatment to the extent permitted by law. While Section 15E(a)(3) of the Exchange Act77 does not require an applicant to make the public information in its application publicly available until after registration, this information typically would be made available by the Commission to members of the public before the application is acted on by the Commission. As noted above, an applicant could seek confidential treatment for information in the application under existing laws and rules governing confidential treatment.78 This would be consistent with how the Commission treats applications of other entities. As noted, a credit rating agency may apply to be registered for fewer than all five categories of credit ratings described in Section 3(a)(62)(B) of the Exchange Act.79 Paragraph (e) of proposed Rule 17g-1 would create a mechanism for an NRSRO registered for fewer than the five categories to apply to be registered with respect to an additional category.80 The proposed rule provides that the NRSRO would need to furnish an amended Form NRSRO and indicate where appropriate on the form the additional category for which it is applying to be registered.81 The proposed rule also provides that the application to register for an additional category would be subject to the requirements in proposed Rule 17g-1 and Section 15E of the Exchange Act82 applicable to an initial application. For example, the provisions of paragraph (b)(1) of proposed Rule 17g-1 regarding when an application is deemed to have been furnished to the Commission would apply, as would the provisions of paragraph (c) with respect to amending the application prior to registration being granted. The time periods for the Commission to act on the application set forth in Sections 15E(a)(2)(A) and (B) of the Exchange Act also would apply to the amended form.83 Section 15E(b)(1) of the Exchange Act requires an NRSRO to promptly amend its application for registration if, after registration, any information or document provided as part of the application becomes materially inaccurate.84 The statute further provides that the information on credit ratings performance statistics (discussed more fully below) need only be updated on an annual basis and that the QIB certifications need not be updated.85 Paragraph (f) of proposed Rule 17g-1 provides that an NRSRO would need to meet the statutory requirement to amend an application if information becomes materially inaccurate by promptly furnishing the amendment to the Commission on Form NRSRO.86 The Act does not define the term "promptly." The Commission believes the amendment should be furnished as soon as reasonably practicable after the NRSRO determines the information has become materially inaccurate. In most cases, the Commission believes that completing Form NRSRO, attaching any amended information and documents, and submitting the amendment package to the Commission should not take more than two days. Section 15E(b)(2) of the Exchange Act requires an NRSRO to furnish the Commission with an amendment to its registration not later than 90 days after the end of each calendar year in a form prescribed by Commission rule.87 This section further provides that the amendment must (1) certify that the information and documents provided in the application for registration (except the QIB certifications) continue to be accurate and (2) list any material change to the information and documents during the previous calendar year.88 Paragraph (g) of proposed Rule 17g-1 would implement these statutory provisions by requiring an NRSRO to furnish the amendment on Form NRSRO. Finally, Section 15E(e)(1) of the Exchange Act provides that an NRSRO may withdraw from registration, subject to terms and conditions the Commission may establish as necessary in the public interest or for the protection of investors, by furnishing the Commission with a written notice of withdrawal.89 Paragraph (h) of proposed Rule 17g-1 would provide that the notice must be executed by a person duly authorized by the NRSRO. The proposed requirement for execution by a duly authorized person is designed to ensure that the registration withdrawal notice reflects the intent of the credit rating agency. Section 15E(e)(1) of the Exchange Act also provides the Commission with the authority to establish additional terms and conditions with respect to the withdrawal of a credit rating agency’s NRSRO registration as necessary in the public interest or for the protection of investors.90 Such conditions potentially could include a requirement that the NRSRO provide public notice that its credit ratings will cease to be eligible for regulatory use. The Commission generally requests comment on all aspects of this proposed rule. The Commission also seeks comment on whether the five-day time limit for making the non-confidential information in the application publicly available should be longer or shorter. For example, the Commission seeks comment on whether five days is a sufficient amount of time to make an initial application public, given the volume of information that may need to be posted on a Web site or made public through another comparable means. Additionally, the Commission requests comment on ways other than the Internet that the information could be made public that would be comparable to posting the information on a Web site, particularly in terms of ensuring that users of credit ratings would have a comparable ease of access to the information. Further, the Commission seeks comment on whether it should define the term "promptly" in Section 15E(b)(1) of the Exchange Act91 to mean a specific time period such as two, five, or ten business days or some other period. C. Proposed Form NRSRO1. Overview of How the Form Would be UsedThe Commission is proposing a new form, "Form NRSRO," the "Application for Registration as a Nationally Recognized Statistical Rating Organization." The form is designed to serve four functions: to apply for initial registration, to amend the scope of registration, to amend public information required by the form, and to make an annual certification. Instructions for the form describe how an applicant, and after registration, an NRSRO, should complete the form in each of these circumstances. The Commission construes the Act’s requirement that implementing rules be "narrowly tailored" to also apply to proposed Form NRSRO.92 The Commission believes that having just one form (and one set of instructions) would reduce the burden on applicants, NRSROs, and Commission staff. For example, it would reduce the complexity of having different forms for the application, amendments, and annual certification. Using one form also would allow NRSROs to more quickly become familiar with the form and its instructions, which would reduce the potential for making mistakes in completing the form. It also would assist users of credit ratings in understanding the form and public exhibits and where to look on the form for specific information. A credit rating agency applying for registration as an NRSRO would need to complete the form by providing the required information in all the items (except Item 7)93 and attaching all exhibits. The credit rating agency also would need to attach a minimum of 10 certifications from QIBs (with at least two addressing each category for which registration is sought), and a non-resident credit rating agency would need to attach the undertaking required under proposed Rule 17g-2 (discussed below). The Commission would use the information provided on the form to make the threshold determination whether the applicant is a "credit rating agency" as defined in Section 3(a)(61) of the Exchange Act and would meet the definition of "NRSRO" in Section 3(a)(62) of the Exchange Act.94 The Commission also would use the information on the form to determine whether the applicant meets the statutory requirements for registration.95 Specifically, the Commission would use the information to determine whether the applicant has adequate financial and managerial resources to consistently produce credit ratings with integrity and to comply with its established policies and methodologies (e.g., policies for determining credit ratings, managing material non-public information and conflicts of interest, and complying with applicable laws and regulations).96 The Commission also would use the information to determine whether the credit rating agency, if granted registration, would not be subject to having its registration suspended or revoked under Section 15E(d) of the Exchange Act.97 After registration, an NRSRO would use Form NRSRO if it sought to apply for registration with respect to an additional category of credit ratings. In this case, the NRSRO would not need to update the non-public exhibits, and it also would not need to update the public exhibits to the extent that information or documents previously provided remained materially accurate. However, the fact that the NRSRO was seeking to expand the scope of its registration to an additional category of credit ratings likely would mean certain information provided in the public exhibits would no longer be materially accurate. For example, the NRSRO may have established new or additional methodologies to determine credit ratings in the category for which it was seeking registration. These would need to be provided as an update to Exhibit 2.98 Finally, the NRSRO would need to provide two QIB certifications for each category of credit rating for which it is applying to be registered.99 An NRSRO also would use Form NRSRO to amend the information on the form and in the public exhibits after registration.100 The need to amend the form would arise whenever there was a material change to information in one of the items on the form (except for Items 6 and 7)101 or to information or a document provided in a public exhibit. For example, if the NRSRO materially changed its procedures for preventing the misuse of material non-public information, the NRSRO would be required to furnish the Commission with an amendment on Form NRSRO and include the new procedures as an update to Exhibit 3.102 It would not need to update the other public exhibits if the information in them remained materially accurate. Finally, an NRSRO would use Form NRSRO to furnish the annual certification required by Section 15E(b)(2) of the Exchange Act.103 This section requires the NRSRO to certify on an annual calendar-year basis that the information and documents provided in its application continue to be materially accurate (other than the QIB certifications).104 It also requires the NRSRO to identify any material change to the information or documents that occurred during the previous calendar year.105 In addition, Section 15E(b)(1) of the Exchange Act provides that the performance statistics about the NRSRO’s credit ratings need only be updated on a yearly basis with the annual certification.106 The proposed Form NRSRO is designed to meet these statutory requirements. First, the certification on the facing page would include the representations needed for the annual certification; namely, that the NRSRO’s application on Form NRSRO, as amended, continues to be accurate.107 Second, Exhibit 1 would require information on credit rating performance statistics. The instructions would require this information to be provided in the initial application and, thereafter, updated with the annual certification (as opposed to the other public exhibits that would need to be updated promptly whenever they become materially inaccurate). The instructions also would require the NRSRO to include with the annual certification a list of each material change made during the previous calendar year.108 2. Items on the FormCheckboxes indicating nature of submission. The first entry an applicant or NRSRO would make on Form NRSRO would be to indicate, by checking the appropriate box, the reason the form is being furnished: initial application, amendment, or annual certification. If an amendment, the NRSRO also would need to briefly describe the amendment on lines under the amendment check box. For example, if an NRSRO was filing the amendment because its address and organizational structure changed, the description of the amendments should be as brief as "Item 1C (address change)" and "Exhibit 4 (new organizational structure)." Item 1 (Identifying information). Item 1 of proposed Form NRSRO would elicit the name and address of the credit rating agency, and the name and address of the contact person for the credit rating agency. The instructions for proposed Form NRSRO would provide that the individual listed as the contact person must be authorized to receive all communications and papers from the Commission and would be responsible for their dissemination within the credit rating agency. Item 2 (Legal status, place of formation, fiscal year end). Item 2 of proposed Form NRSRO would elicit the legal status of the credit rating agency (for example, corporation or partnership), the place and date of formation of the entity, and the fiscal year end of the credit rating agency. The information with respect to the fiscal year end of the applicant or NRSRO is relevant because Form NRSRO would require applicants to submit audited financial statements with the application. Proposed Rule 17g-3 would require NRSROs to annually furnish the Commission with audited financial statements covering the previous fiscal year. Item 3 (Undertaking by non-resident NRSRO). Paragraph (f) of proposed Rule 17g-2 would require an NRSRO that does not reside in the United States to execute a written undertaking, in substantially the form provided in the proposed rule, to promptly provide books and records to the Commission in a form requested by the Commission, including translation into English. The proposed undertaking is designed to provide a means for the Commission to promptly obtain records subject to its examination authority located outside the U.S. without requiring that Commission staff travel to the location. In addition, because some non-resident NRSROs may maintain original records in a language other than English, the proposed undertaking would require a translation if the Commission requested it. Item 3 of proposed Form NRSRO would require a non-resident applicant to attach the required undertaking to its initial application. If the application is granted, the undertaking would be in place when the applicant becomes an NRSRO and is subject to the proposed recordkeeping requirements. The prescribed form of the undertaking would make it applicable only to books and records a credit rating agency is required to make, keep current, retain, or produce to the Commission pursuant to any provision of the Exchange Act109 or any regulation under the Exchange Act.110 An applicant becomes subject to these recordkeeping requirements only after registration is granted and the applicant becomes an NRSRO. Item 4 (Compliance officer). Section 15E(j) of the Exchange Act requires every NRSRO to designate an individual responsible for administering the policies and procedures of the credit rating agency to prevent the misuse of nonpublic information, to manage conflicts of interest, and to ensure compliance with the securities laws and the rules and regulations under those laws.111 Item 4 of proposed Form NRSRO would elicit the name of and contact information for this person. Item 5 (Method of making form and public exhibits readily accessible). Section 15E(a)(3) of the Exchange Act provides that the Commission shall, by rule, require an NRSRO, upon the granting of registration, to make the non-confidential information and documents submitted to the Commission in the initial application, amendments, or annual certifications publicly available on the NRSRO’s Web site or through another comparable, readily accessible means.112 Item 5 of proposed Form NRSRO would elicit information on how the applicant would make the public information readily accessible. Providing this information on proposed Form NRSRO would assist the Commission in verifying that the NRSRO is complying with this requirement and assist the public in locating the information to assess the credibility and integrity of the NRSRO. Item 6 (Categories of credit ratings for which registration is sought and QIB certifications). Item 6 of proposed Form NRSRO would only need to be completed when a credit rating agency was furnishing an initial application to be registered as an NRSRO and when an NRSRO was applying to expand the scope of its registration by adding an additional class of credit ratings. This item would elicit information about the categories of credit ratings for which the applicant was applying for registration. It also would require the applicant to attach the QIB certifications to the application (unless the applicant was exempt from this requirement under Section 15E(a)(1)(D) of the Exchange Act).113 Section 15E(a)(1)(B)(vii) of the Exchange Act requires an applicant for NRSRO registration to provide information with respect to the categories of credit ratings for which it is applying to be registered.114 Item 6 of proposed Form NRSRO would require a credit rating agency applying for registration, and an NRSRO applying to add a category of credit ratings to its registration, to indicate the categories of credit ratings for which registration was being sought. Item 6 also would elicit the approximate number of credit ratings issued in each category as of the date of the application, and the number of consecutive years preceding the date of the application that the credit rating agency has issued credit ratings with respect to each category indicated. This information would be used by the Commission in verifying that the credit rating agency meets the definitional thresholds for registration as NRSRO, including that the entity has been in business as a credit rating agency for the three consecutive years preceding the date of its application.115 Item 6 also would elicit a brief description of how the credit rating agency makes its credit ratings readily accessible. The Commission would use this information to verify that the applicant meets another definitional threshold for registration eligibility; namely, that the applicant issues credit ratings on the Internet or through another readily accessible means, for free or for a reasonable fee.116 The Act does not define "readily accessible" other than to specify that the method must be comparable to the Internet in terms of accessibility.117 Moreover, as discussed above, the Act does not define "reasonable fee." However, the Commission believes the "fee" contemplated by the statute is the fee charged to access or receive the credit ratings of the credit rating agency (i.e., not the fees charged for other services). This information elicited in Item 6 (and after registration in Item 7) would assist the Commission in monitoring the cost to regulatory users of credit ratings of accessing or obtaining NRSRO credit ratings. Finally, Item 6 would require the applicant to provide QIB certifications. Section 15E(a)(1)(B)(ix) of the Exchange Act requires an applicant to submit a minimum of ten QIB certifications with the application.118 Sections 15E(a)(1)(C)(i), (ii), and (iii) further provide, respectively, that: (1) the certifying QIB must not be affiliated with the applicant; (2) the certification may address more than one of the categories of credit ratings for which the applicant is seeking registration; and (3) at least two of the certifications must address each category of credit ratings for which the applicant is seeking registration.119 Section 15E(a)(1)(C)(iv) provides that the QIB must state in the certification that it meets the definition of a "QIB" in Section 3(a)(64) of the Exchange Act120 and that the QIB has used the credit ratings of the applicant for at least three years immediately preceding the date of the application in the subject category or categories of subscribers.121 The Senate Report explained that the term "used" was intended to mean the QIB "seriously considered the ratings in some of [its] investment decisions."122 The proposed instructions to Item 6 would prescribe the form of the QIB certification. For example, consistent with Section 15E(a)(1)(C)(i)(I) of the Exchange Act123 and the Senate Report explaining that section, the QIB certification would be required to include a representation that the QIB "has seriously considered the credit ratings of [the credit rating agency] in the course of making investment decisions for at least the three years immediately preceding the date of this certification, in the following classes of credit ratings."124 The QIB certification also would be required to be executed by a person duly authorized by the QIB to make the certification on behalf of the QIB.125 This is designed to ensure that the certification is that of the QIB and not an employee of the QIB who may have an interest (distinct from that of the QIB) in providing the certification to the applicant. In addition, as a measure designed to ensure the impartiality of the QIB’s assessment, the QIB would need to certify that it had not received compensation for providing the certification. Item 6 of proposed Form NRSRO also would require the applicant to indicate whether it was submitting the QIB certifications and, if so, how many certifications were being submitted or that the applicant was exempt from the requirement to provide the certifications. Under Section 15E(a)(1)(D) of the Exchange Act, a credit rating agency is not required to submit the QIB certifications if it was identified as an NRSRO in a Commission staff no-action letter issued before August 2, 2006.126 The Commission requests comment on whether there should be a requirement for an NRSRO to notify the Commission if a QIB withdraws its certification. Item 7 (Categories of credit ratings covered by current registration). Item 7 would solicit information about the categories of credit ratings for which the NRSRO was currently registered, the approximate number of credit ratings currently outstanding in each category, and the number of years the NRSRO has issued credit ratings in that category. It also would elicit information about how the NRSRO makes its credit ratings readily accessible to users of credit ratings. Because some of the information in Item 7 may change fairly regularly, this Item would need to be updated if it became materially inaccurate only when the NRSRO furnishes the next Form NRSRO either as an amendment or as an annual certification. Thus, if the information in Item 7 became materially inaccurate, it would be updated on an annual basis at a minimum. The information requested in Item 7 would allow users of credit ratings to assess the NRSRO with respect to the number of credit ratings it has issued and the number of years it has issued credit ratings in each category for which it is registered.127 Item 8 (Potential statutory disqualifications). Section 15E(a)(2)(C)(ii)(II) of the Exchange Act128 directs the Commission to deny a credit rating agency’s application for registration as an NRSRO if the Commission finds that the applicant, if granted registration, would be subject to suspension or revocation of its registration under Section 15E(d) of the Exchange Act.129 Section 15E(d) of the Exchange Act130 provides that the Commission, by order, shall censure, place limitations on the activities, functions, or operations of, suspend for a period not exceeding 12 months, or revoke the registration of an NRSRO, if the Commission finds that the NRSRO or a person associated with the NRSRO has committed certain acts described in Sections 15(b)(4)(A), (D), (E), (G), or (H) of the Exchange Act,131 been convicted of certain offenses described in Section 15(b)(4)(B) of the Exchange Act,132 been convicted of certain other offenses, or if a person associated with the NRSRO is subject to a Commission order suspending or barring the person from being associated with an NRSRO. Item 8 of proposed Form NRSRO would ask whether the acts, convictions or orders described in Section 15E(d) of the Exchange Act133 applied to the credit rating agency or any person associated with the credit rating agency. If a question in Item 8 was answered "yes," the credit rating agency would be required to provide additional information on a Disclosure Reporting Page (DRP) NRSRO as set forth in the instructions for Form NRSRO. The Commission would then need to evaluate whether an applicant’s registration could be granted in light of the disclosure. After registration, an NRSRO would need to update the information in Item 8 if there was a change. The Commission would then evaluate whether it would be appropriate to issue an order censuring, placing limitations on the activities, functions, or operations of, suspending for a period not exceeding 12 months, or revoking the registration of the NRSRO as provided for under Section 15E(d) of the Exchange Act.134 Certification. Proposed Form NRSRO would require the signature of an authorized person of the credit rating agency representing that the information and statements contained in the form are current, accurate, and complete or, if the NRSRO is submitting an annual certification, that the application, as amended, is current, accurate, and complete. 3. Exhibits to the FormProposed Form NRSRO would have 13 exhibits. Sections 15E(a)(1)(B)(i), (ii), (iii), (iv), (v), (vi), and (viii) of the Exchange Act require the furnishing of some of this information.135 The Commission is proposing to require the furnishing of the remainder of the information pursuant to its authority under Section 15E(a)(1)(B)(x) of the Exchange Act.136 The proposed exhibits are an important part of the program for NRSRO oversight. Therefore, the information and documents proposed to be provided in the exhibits must be sufficiently detailed to allow the Commission to evaluate and verify the information and, with respect to the public exhibits, assist users of credit ratings in understanding how the NRSRO manages its activities. Exhibits 1 through 9 would be public exhibits that the NRSRO would be required to keep current through furnishing updated information and make readily accessible to the public. The information in these public exhibits would be useful to the users of credit ratings in assessing the ratings quality of the NRSRO and in comparing the NRSRO to other NRSROs. Exhibits 10 through 13 would be accorded confidential treatment by the Commission, to the extent permitted by law, under provisions of Section 15E of the Exchange Act137 in conjunction with proposed Rule 17g-1.138 The information in the public and confidential exhibits would be used by the Commission to make the determination whether the credit rating agency has adequate financial and managerial resources to consistently produce credit ratings with integrity and to materially comply with the methodologies, policies, and procedures it discloses in the public exhibits.139 The information in Exhibits 10 through 13 would not need to be updated by furnishing amendments on proposed Form NRSRO after registration is granted. Instead, this information would be updated through the proposed financial reporting rule (proposed Rule 17g-3). Section 15E(b)(1) of the Exchange Act140 provides that information submitted with an application must be updated promptly when the information becomes materially inaccurate, except information submitted under Sections 15E(a)(1)(B)(i) and (ix) of the Exchange Act (respectively, the performance statistics, which must be updated annually, and the QIB certifications, which need not be updated).141 Thus, under the statute, the information provided in Exhibits 10 through 13 would need to be updated promptly if it became materially inaccurate. However, the Commission is not proposing that an NRSRO update these exhibits by furnishing the information to the Commission in Form NRSRO amendments. Rather, the Commission is proposing that the NRSRO would update this information as part of the financial statements that would be required to be furnished under proposed Rule 17g-3. Exhibit 1 (Public). Section 15E(a)(1)(B)(i) of the Exchange Act requires that an application for registration as an NRSRO contain credit ratings performance measurement statistics over short-term, mid-term, and long-term periods (as applicable).142 This information would be required as Exhibit 1 to proposed Form NRSRO. The Exchange Act does not otherwise define or identify the particular credit rating performance statistics to be provided with the application. The Commission believes credit rating agencies typically generate statistical reports showing historical default and downgrade rates within each credit rating notch or grade.143 Further, the Commission believes these types of statistics are important indicators of the performance of a credit rating agency in terms of its ability to assess the creditworthiness of issuers and obligors and, consequently, would be useful to users of credit ratings in evaluating an NRSRO. In addition to historical default and downgrade rates, the instructions to proposed Form NRSRO also would provide that an applicant or NRSRO include in the exhibit definitions of the credit ratings (i.e., an explanation of each grade or notch) and explanations of the performance measurement statistics, including the metrics used to derive the statistics. The Commission believes that requiring this information would be necessary or appropriate in the public interest or for the protection of investors because it would assist users of credit ratings in understanding how the measurements were derived and in making comparisons with the measurement statistics of other NRSROs.144 The definitions of the notches and grades also would assist the Commission in assessing whether the NRSRO’s ratings, as a practical matter, can be used for certain Commission rules. For example, paragraph(c)(2)(vi)(F) of Commission Rule 15c3-1 specifies lower haircuts for debt securities that are rated in one of the "four highest rating categories" (i.e., notches) of at least two NRSROs.145 The current NRSROs generally have at least eight notches for their debt securities with the top four commonly referred to as "investment grade." If an NRSRO decided to use less than eight notches, the Commission would need to evaluate whether, based on the NRSRO’s definitions, securities that would be included in the top four notches would be suitable for the lower haircuts specified in paragraph(c)(2)(vi)(F) of Rule 15c3-1.146 The Commission generally requests comment on Exhibit 1. The Commission also requests comment on whether the performance measurement statistics should use standardized inputs, time horizons and metrics to allow for greater comparability. Commenters are requested to provide specific details as to how these statistical measures could be standardized. The Commission further requests comment on whether credit rating agencies or other persons currently use other performance measurement statistics or whether other performance measurement statistics would be appropriate as an alternative, or in addition, to historical default and downgrade rates. For example, the Commission requests comment on whether Exhibit 1 should require measurement of the performance of a given credit rating by comparing or mapping it to the market value of the rated security or to extreme declines in the market value of the security after the rating. The Commission additionally requests comment on whether the requirement to include definitions and explanations in Exhibit 1 would achieve its stated purpose. Exhibit 2 (Public). Section 15E(a)(1)(B)(ii) of the Exchange Act requires that an application for registration as an NRSRO contain information regarding the procedures and methodologies used by the credit rating agency to determine credit ratings.147 This information would be required as Exhibit 2 to proposed Form NRSRO. The Exchange Act does not otherwise define or identify the procedures and methodologies that must be provided under this section.148 However, the definition of "credit rating agency" in Section 3(a)(61) of the Exchange Act provides that a "credit rating agency" is an entity that, among other things, "employ[s] either a quantitative or qualitative model, or both, to determine credit ratings."149 The Commission believes that entities meeting the definition of "credit rating agency" in Section 3(a)(61) of the Exchange Act150 generally establish procedures and methodologies for determining credit ratings in the following areas: the determination of whether to initiate a credit rating; the use of public and non-public sources of information to perform credit rating analysis, including information and analysis provided by third-party vendors; the use of quantitative and qualitative models and metrics to determine credit ratings; the interaction with the management of a rated obligor or issuer of rated securities; the establishment of the structure and voting process of committees that review or approve credit ratings; the notification of rated obligors or issuers of rated securities about credit rating decisions and for appeals of final or pending credit rating decisions; monitoring, reviewing, and updating of credit ratings; and the withdrawal, or suspension of the maintenance, of a credit rating. This list identifies areas where a credit rating agency could establish procedures and methodologies for determining credit ratings. The applicability of certain areas to a particular credit rating agency may depend on whether it uses subjective qualitative analysis, purely quantitative models or a combination of both.151 Consequently, an applicant and NRSRO may not establish a procedure or methodology in a given area because doing so would not be relevant to how the credit rating agency determines credit ratings. In addition, credit rating agencies that issue "unsolicited" credit ratings may establish procedures and methodologies in the areas described above that are unique to such ratings. An "unsolicited" credit rating is one the credit rating agency decides to initiate without being requested to do so by an issuer, obligor, underwriter, or other interested party. Credit rating agencies that use a subscription fee based business model may only issue unsolicited ratings because that business model does not rely on fees from issuers, obligors, and underwriters to determine specific credit ratings (issuers, obligors, and underwriters, however, may subscribe to receive the credit ratings of such credit rating agencies). The procedures and methodologies these credit rating agencies employ, in some respects, may be unique to this business model. Credit rating agencies that are paid by issuers, obligors, and underwriters to determine specific credit ratings sometimes also issue unsolicited ratings. As discussed below with regard to proposed Rule 17g-6, this practice has led to concerns that unsolicited ratings may be used to coerce issuers and obligors into ultimately paying the credit rating agency to determine and maintain the credit rating. Consequently, the Commission believes that credit rating agencies that rely on fees from issuers, obligors, and underwriters to determine specific credit ratings, but also issue unsolicited ratings, often have established procedures and methodologies for determining unsolicited credit ratings that are designed to address this concern and the fact that the issuer or obligor may not have participated in the determination of the credit rating (as is frequently the case with a solicited credit rating). The Commission believes that information regarding the procedures and methodologies established by an NRSRO in the areas described above, including those with respect to unsolicited credit ratings, as applicable, would be useful to users of credit ratings. The information would provide an understanding of the nature of the credit rating agency (i.e., a user of quantitative models, qualitative analysis, or a combination of both) and how the credit rating agency produces credit ratings. This would provide a basis for comparing NRSROs. The disclosure also would provide the Commission with an understanding of the managerial and financial resources required to produce the credit ratings. This would assist the Commission in evaluating whether an applicant or NRSRO has adequate financial and managerial resources to consistently produce credit ratings with integrity and to materially comply with its procedures and methodologies.152 The Commission generally requests comment on Exhibit 2, as proposed. The Commission also requests comment on whether the areas identified above are the areas where credit rating agencies establish procedures and methodologies for determining credit ratings. A commenter that believes one or more of the areas identified above is not one where any type of credit rating agency establishes procedures and methodologies should identify each area and explain the reason for such conclusion. The Commission also requests comment on whether there are additional areas where credit rating agencies establish procedures and methodologies for determining credit ratings and, if so, requests that commenters identify them. Exhibit 3 (Public). Section 15E(a)(1)(B)(iii) of the Exchange Act153 requires that an application for registration as an NRSRO contain information regarding policies or procedures adopted and implemented by the credit rating agency to prevent the misuse, in violation of Exchange Act154 provisions and rules, of material, non-public information. Exhibit 3 would require an applicant and NRSRO to furnish its policies and procedures to prevent the misuse of material, nonpublic information established under Section 15E(g) of the Exchange Act155 and proposed Rule 17g-4. Section 15E(g)(1) of the Exchange Act156 requires an NRSRO to establish, maintain, and enforce written policies and procedures to prevent the misuse of material, nonpublic information in violation of the Exchange Act.157 Section 15E(g)(2) of the Exchange Act provides that the Commission shall adopt rules requiring an NRSRO to establish specific policies and procedures to prevent the misuse of material, non-public information.158 As discussed below, proposed Rule 17g-4 would implement this statutory provision by requiring an NRSRO’s policies and procedures established pursuant to Section 15E(g)(1) of the Exchange Act159 to include certain specific types of procedures. The Commission generally requests comment on Exhibit 3, as proposed. Exhibit 4 (Public). Section 15E(a)(1)(B)(iv) of the Exchange Act requires that an application for registration as an NRSRO contain information regarding the organizational structure of the applicant.160 This information would be required as Exhibit 4 to proposed Form NRSRO. The Exchange Act does not otherwise define or identify the specific type of organizational information that should be provided under Section 15E(a)(1)(B)(iv) of the Exchange Act.161 The Commission believes that companies typically create, as applicable, an organizational chart showing ultimate and sub-holding companies, subsidiaries, and material affiliates; an organizational chart showing divisions, departments, and business units within the entity; and an organizational chart showing the management structure and senior management reporting lines within the entity. The Commission believes that, if a credit rating agency is part of a holding company structure, users of credit ratings and the Commission would benefit from an organizational chart showing the entity’s ultimate and sub-holding companies, subsidiaries, and material affiliates. This chart would provide an understanding of where potential conflicts of interest relating to the business activities of related companies might arise. Also, the fact that a credit rating agency has a holding company that potentially could provide financial support would be relevant to the Commission’s evaluation of whether an applicant or NRSRO has adequate financial resources as required under the Exchange Act.162 The Commission further believes that, if a credit rating agency engages in business activities in addition to determining credit ratings, users of credit ratings and the Commission would benefit from an organizational chart showing the entity’s divisions, departments, and business units. This chart would provide an understanding of where potential conflicts of interest relating to ancillary business activities might arise. Finally, the Commission believes that users of credit ratings and the Commission would benefit from an organizational chart showing an NRSRO’s management structure and senior management reporting lines. This chart would assist the Commission in evaluating whether an applicant and NRSRO has adequate managerial resources as required under the Exchange Act.163 Users of credit ratings also would be able to use this information to compare the managerial resources of different NRSROs. Additionally, the instructions to proposed Form NRSRO would provide that this managerial chart include the compliance officer designated by the NRSRO pursuant to Section 15E(j) of the Exchange Act.164 The Commission believes that including the compliance officer in the chart would be necessary or appropriate in the public interest or for the protection of investors because it would assist the Commission and users of credit ratings in understanding the degree of the compliance officer’s independence from the business managers.165 The Commission believes users of credit ratings would find the compliance officer’s reporting lines relevant in assessing the integrity of the credit rating process of a particular NRSRO, since the officer is responsible for administering the credit rating agency’s policies and procedures required by Sections 15E(g) and (h) of the Exchange Act166 and for ensuring the NRSRO’s compliance with the securities laws and rules and regulations thereunder.167 In carrying out these responsibilities, a compliance officer would need to review activities overseen by senior business managers. The ability of the compliance officer to objectively review an area could be impacted by whether the officer reported to the senior manager responsible for the area. Thus, the relative independence of the compliance officer would be relevant to assessing the NRSRO’s ability to ensure compliance with its policies and procedures. For these reasons, Exhibit 4 would provide that the information about the organizational structure of the applicant or NRSRO required to be furnished and made public under Section 15E(a)(1)(B)(iv) of the Exchange Act168 consist of charts showing the managerial structure and senior management reporting lines, and, if applicable, the ultimate and sub-holding companies, subsidiaries, and material affiliates of the entity, and the divisions, departments, and business units within the entity. The exhibit also would require that the management chart include the designated compliance officer. The Commission generally requests comment on Exhibit 4, as proposed. The Commission specifically also requests comment on whether including the compliance officer in the chart would achieve the stated purpose of the requirement. The Commission further requests comment on whether other organizational information should be provided, or whether some of the information proposed to be required should be eliminated or modified. Commenters who believe that other information should be provided are asked to describe the information and explain why it would be appropriate under Section 15E of the Exchange Act.169 Exhibit 5 (Public). Section 15E(a)(1)(B)(v) of the Exchange Act requires that an application for registration as an NRSRO contain information regarding whether the applicant has a code of ethics in effect or an explanation of why the applicant has not established a code of ethics.170 Exhibit 5 to proposed Form NRSRO would elicit this information by requiring an applicant and NRSRO to attach its code of ethics or an explanation of why it does not have a code of ethics. The Exchange Act does not otherwise define or identify the "code of ethics" that should be provided under Section 15E(a)(1)(B)(v).171 The Commission believes credit rating agencies should have the flexibility to establish a code of ethics appropriate for their business model and organizational structure and, consequently, is not proposing any specific elements that should be in the code of ethics, if any, furnished in this exhibit. The Commission generally requests comment on Exhibit 5, as proposed. The Commission also requests comment on whether it should propose specific elements to be included in the code of ethics provided in Exhibit 5. Commenters who believe the Commission should propose specific elements are asked to describe them. The Commission further seeks comment on whether it should require in Exhibit 5 that NRSROs disclose whether they comply with international principles and codes of conduct related to credit rating agencies. Exhibit 6 (Public). Section 15E(a)(1)(B)(vi) of the Exchange Act requires that an application for registration as an NRSRO contain information regarding any conflict of interest relating to the issuance of credit ratings by the applicant and NRSRO.172 Exhibit 6 to proposed Form NRSRO would require an applicant and NRSRO to identify, in general terms, the types of conflicts of interest that arise from its business as a credit rating agency. The Exchange Act does not otherwise define or identify the types of conflicts of interest that should be disclosed under Section 15E(a)(1)(B)(vi) of the Exchange Act.173 The Commission believes that credit rating agencies that rely on fees from issuers, obligors and underwriters to determine specific credit ratings are exposed to a unique set of conflicts, as are credit rating agencies that operate under a subscriber fee based business model. Moreover, certain conflicts, such as those arising from owning securities of a rated entity, can arise under either business model. The Commission believes that the types of conflicts of interest arising from the activities of credit rating agencies include, as applicable: receiving compensation from rated obligors, issuers of rated securities and money market instruments, and underwriters of rated securities and money market instruments to determine or maintain a credit rating and for other services; owning securities of, or having any other form of ownership interest in, a rated obligor, issuer of rated securities and money market instruments, or underwriter of rated securities and money market instruments; receiving compensation for any service from subscribers that use credit ratings for regulatory purposes; owning securities of, or having any other form of ownership interest in, a subscriber that uses credit ratings for regulatory purposes; and having another material business relationship (e.g., a loan) or affiliation (e.g., being an officer or director) with a rated obligor, issuer of rated securities and money market instruments, underwriter of a rated securities and money market instruments, or entity that uses credit ratings for regulatory purposes. The Commission believes the above list covers the range of general conflicts of interest that arise from the activities of credit rating agencies.174 However, as noted, based on a particular credit rating agency’s business model, some of these conflicts would not be evident. The Commission further believes that an applicant and NRSRO subject to any of these types of conflicts would need to disclose that fact in a general manner in order to comply with Section 15E(a)(1)(B)(vi) of the Exchange Act.175 Furthermore, the disclosure would assist the Commission in evaluating whether an applicant has sufficient financial and managerial resources to comply with the procedures for managing conflicts of interest required under Section 15E(h) of the Exchange Act,176 given the conflicts of interest identified by the applicant.177 The information also would be useful to users of credit ratings in assessing an NRSRO by, for example, comparing the types of conflicts disclosed by the entity in Exhibit 6 with the procedures for managing conflicts of interest disclosed by the entity in Exhibit 7 (discussed next). As noted above, the disclosure of the type of conflict only would need to be general in nature. For example, an NRSRO that receives compensation from issuers for rating their securities would only need to disclose that fact. It would not need to disclose separately each time it was compensated by an issuer or the identity of each such issuer. The instructions to Form NRSRO also would provide that an applicant and NRSRO include in Exhibit 6 the identity of any affiliated entity that acts as an underwriter or uses credit ratings for regulatory purposes.178 The Commission believes that requiring a credit rating agency to disclose this information would be necessary or appropriate in the public interest or for the protection of investors because it would apprise users of credit ratings to a potential conflict of interest arising from the fact that the affiliate could exercise undue influence on the credit rating agency to issue a credit rating that assists in the marketing of the security or that provides a regulatory benefit.179 Users of credit ratings would able to review the NRSRO’s procedures made public in Exhibit 7 to understand how the credit rating agency addresses these potential conflicts. The Commission generally requests comment on Exhibit 6, as proposed. The Commission also requests comment on whether there are conflicts of interest that should be disclosed in addition to those identified above, or whether some of the information proposed to be required should be eliminated or modified. Commenters who believe that other conflicts exist should describe how they arise from the business of credit rating agencies. The Commission further requests specific comment on whether requiring the identification of affiliates that are underwriters and regulatory users of credit ratings would achieve the stated purpose of the requirement. Exhibit 7 (Public). Section 15E(h) of the Exchange Act requires an NRSRO to establish, maintain, and enforce written policies and procedures to address and manage conflicts of interest.180 These policies and procedures would be required as Exhibit 7 to proposed Form NRSRO. The Commission believes that requiring these policies and procedures would be necessary or appropriate in the public interest or for the protection of investors.181 First, their disclosure would assist the Commission in monitoring whether an NRSRO is complying with Section 15E(h) of the Exchange Act.182 Second, the disclosure would assist the Commission in evaluating whether an applicant or NRSRO has sufficient financial and managerial resources to manage the conflicts of interest disclosed by the credit rating agency in Exhibit 6. Third, the disclosure would allow users of credit ratings to compare an NRSRO’s policies and procedures for managing conflicts of interest with the types of conflicts disclosed in Exhibit 7. The Commission requests general comment on Exhibit 7, as proposed, including on whether including this information would achieve the stated purpose of the requirement. Exhibits 8 (Public). The ability of a credit rating agency to assess the credit worthiness of an issuer and obligor depends on the competence of the personnel responsible for determining the entity’s credit ratings ("credit analysts"). This is true regardless of whether the credit rating agency uses quantitative models or qualitative analysis or a combination of both. A credit rating agency that solely uses quantitative models would be relying on credit analysts to understand the model inputs and metrics and back test the model’s results to judge whether the model is producing credible credit ratings. A credit rating agency that uses qualitative analysis would be relying on credit analysts to understand and interpret relevant information about an obligor or issuer and use the information to render a credible assessment of the issuer or obligor’s creditworthiness. The Commission believes that requiring an applicant and NRSRO to disclose information about the responsibilities, experience and employment history of its credit analysts and supervisors would be necessary or appropriate in the public interest or for the protection of investors.183 First, it would assist users of credit ratings in assessing the competence of an NRSRO’s credit analysts and, thereby, provide a means for users to compare NRSROs. Second, this information would assist the Commission in evaluating whether the applicant has adequate managerial resources to consistently produce credit ratings with integrity and to materially comply with its procedures and methodologies.184 The Commission requests comment on Exhibit 8, as proposed. Comment is specifically sought on whether the information would be helpful to users of credit ratings in comparing the NRSRO to other NRSROs. The Commission also requests comment on whether other information should be provided, or whether some of the information proposed to be required should be eliminated or modified. For example, comment is sought on whether Exhibit 8 should be limited to eliciting information about the supervisors of the credit analysts. Commenters who believe other information should be provided should describe the information and explain why it would be appropriate. Exhibit 9 (Public). As discussed above, Section 15E(j) of the Exchange Act requires every NRSRO to designate an individual responsible for administering the policies and procedures of the credit rating agency to prevent the misuse of nonpublic information, to manage conflicts of interest, and to ensure compliance with the securities laws and the rules and regulations under those laws.185 The ability of the compliance officer to carry out these statutorily mandated responsibilities would depend, in part, on the officer’s experience and qualifications. Additionally, based on the size of the credit rating agency, it may depend also on the experience and qualifications of persons who assist the designated compliance officer in these responsibilities. The Commission believes that requiring information about the experience and employment history of the designated compliance officer and persons assisting the officer would be necessary or appropriate in the public interest or for the protection of investors. It would assist the Commission in evaluating whether the applicant has adequate managerial resources to consistently produce credit ratings with integrity and to materially comply with its procedures and methodologies.186 It also would be useful to users of credit ratings because it would provide information regarding the resources an NRSRO devotes to ensuring, among other things, that credit ratings are determined in accordance with the procedures and methodologies the NRSRO makes public in Exhibit 1. The Commission requests comment on Exhibit 9, as proposed. The Commission also requests comment on whether other information should be provided, or whether some of the information proposed to be required should be eliminated or modified. Commenters should describe the additional information and why it would be appropriate.Exhibit 10 (Confidential). Section 15E(a)(1)(B)(viii) of the Exchange Act requires that an application for registration as an NRSRO include, on a confidential basis, a list of the 20 largest issuers and subscribers that use the credit rating services provided by the credit rating agency by amount of net revenue received by the credit rating agency in the fiscal year immediately preceding the date of submission of the application.187 This information would be required as Exhibit 10 to proposed Form NRSRO. An NRSRO would not be required to make this information public (to the extent permitted by law) or update the exhibit after registration. However, an NRSRO would be required to update this information in the audited financial statements provided to the Commission under proposed Rule 17g-3. The statute refers to the "20 largest issuers and subscribers." The instructions to Exhibit 10 would provide that an applicant add certain large obligors (i.e., persons who are rated as an entity as opposed to having their securities rated) and underwriters to the list. Specifically, these types of customers would need to be added to the list if they are determined to have provided at least as much net revenue as the 20th largest issuer or subscriber. Consequently, a credit rating agency would be required to identify the 20 largest issuers and subscribers as required by Section 15E(a)(1)(B)(viii) of the Exchange Act188 and add any obligor and underwriter customers that met the above criteria. The Commission believes that adding large obligor and underwriter customers to the list of the 20 largest issuer and subscriber customers would be necessary or appropriate in the public interest or for the protection of investors.189 The Commission views the list as a means to identify customers that could potentially have undue influence on an NRSRO given the amount of revenue the customer provides the NRSRO. Obligors and securities underwriters would have as much of an interest in potentially influencing a credit rating as issuers and subscribers. Section 15E(a)(1)(B)(viii) of the Exchange Act limits the customers required to be included in the list to users of the "credit rating services" of the applicant and NRSRO.190 The Exchange Act191 does not define the term "credit rating services." The Commission would interpret this term to mean any of the following: rating an obligor (regardless of whether the obligor or any other person paid for the credit rating); rating an issuer’s securities or money market instruments (regardless of whether the issuer, underwriter, or any other person paid for the credit rating); and providing credit ratings to a subscriber. The intent of this interpretation is to include – along with customers that pay for credit ratings and subscriptions – customers that are rated, or whose securities or money market instruments are rated, but that did not pay for the credit rating. Even though these customers may not have paid for the credit rating, they potentially could have undue influence on the credit rating agency if they provide substantial net revenue for other services or products. Section 15E(a)(1)(B)(viii) of the Exchange Act provides that the determination of the 20 largest issuers and subscribers is to be based on "net revenue" received from the issuer or subscriber.192 The Exchange Act193 does not define the term "net revenue." The Commission proposes to interpret the term "net revenue" for the purposes of Section 15E(a)(1)(B)(viii) of the Exchange Act194 to mean all fees, sales proceeds, commissions, and other revenue received by the applicant and its affiliates for any type of service or product, regardless of whether related to credit ratings, and net of any fees, sales proceeds, rebates, commissions, and other monies paid to the customer by the credit rating agency and its affiliates. The risk is that a large customer may be in a position to influence the determination of the credit rating. Limiting the interpretation of net revenue to revenues relating to "credit rating services" may not capture the largest customers of the NRSRO or its affiliates as these customers may use credit rating services of the NRSRO and other services of the NRSRO and its affiliates. The instructions for proposed Form NRSRO would implement this proposed interpretation by providing that the calculation of net revenue should include all revenue received from the customer. The Commission requests comment on Exhibit 10, as proposed. The Commission specifically requests comment on its proposal to include large obligor and underwriter customers in the list. The Commission further requests comment on the proposed interpretations of "credit rating services" and "net revenue." Specifically, the Commission requests comment on how these interpretations affect the determination of large customers. If a commenter believes they are not practicable, the commenter should provide alternative interpretations and explain how they would achieve the goal of identifying large customers that could potentially exercise undue influence on the NRSRO. Exhibit 11 (Confidential). Exhibit 11 would require the applicant to furnish audited financial statements for the past three fiscal or calendar years immediately preceding the date of the application. An NRSRO would not need to make the information in Exhibit 11 public (to the extent permitted by law) or update the exhibit after registration. An NRSRO would, however, be required to provide audited financial statements to the Commission annually under proposed Rule 17g-3. The Commission believes this financial information would be necessary or appropriate in the public interest or for the protection of investors because it would assist the Commission in making the finding required by Section 15E(a)(2)(C) of the Exchange Act.195 This section directs the Commission to grant a credit rating agency’s application for registration as an NRSRO unless, among other things, the Commission finds that the applicant does not have adequate financial and managerial resources to consistently issue ratings with integrity and to materially comply with its procedures and methodologies furnished in the public exhibits and with the requirements in Sections 15E(g), (h), (i) and (j) of the Exchange Act.196 The financial statements would provide the Commission with information as to the applicant’s net worth and income, which would assist it in determining whether the applicant has sufficient financial resources. Financial statements for three years would provide information that would assist the Commission in verifying that the applicant has been in the business of issuing credit ratings for the three years immediately preceding the date of its application for registration. An applicant must have been in the business of issuing credit ratings for the three years preceding the application to be eligible for registration with the Commission as an NRSRO.197 The information also would alert the Commission to a significant downward trend in the applicant’s financial condition, which could be relevant to whether it has adequate financial resources. The proposed requirement that the financial statements be audited would provide the Commission with an independent verification of the information in the statements. However, the Commission anticipates that some applicants may not have been audited in the past. In this case, the applicant would only need to provide an audited financial statement for the fiscal year immediately preceding the date of the application. The other years could be covered by unaudited statements. The applicant would need to attach to the unaudited financial statements a statement by a duly authorized person of the applicant that the financial statements present fairly, in all respects, the financial condition, results of operations, and the cash flows of the applicant. This would provide a level of assurance that the information in the financial statements had been reviewed and verified by the applicant. In addition, the Commission also anticipates that some applicants would be subsidiaries of holding companies. In this case, the applicant would be able to provide consolidated and consolidating financial statements of the parent company. This would diminish the burden on applicants that have a holding company audit but not an audit of the subsidiary credit rating agency. Consolidated and consolidating financial statements would provide sufficient information about the subsidiary credit rating agency for the Commission to evaluate whether its financial resources meet the requirements of Section 15E(a)(2)(C)(ii)(I) of the Exchange Act.198 The Commission requests comment on whether the furnishing of audited financial statements would achieve the stated purposes of the requirement. Exhibit 12 (Confidential). Exhibit 12 would require an applicant to provide information as to the amount of revenue generated from various credit rating services and a separate computation of total revenue from all other services. The information would be for the most recently completed fiscal or calendar year and would not have to be audited. An NRSRO would not need to make the information in Exhibit 12 public (to the extent permitted by law) or update the exhibit after registration. An NRSRO would, however, be required to update this information with the annual audited financial statements provided to the Commission under proposed Rule 17g-3. As described in the instructions for proposed Form NRSRO, the specific revenue items would be, as applicable:
The Commission believes this revenue information would be necessary or appropriate in the public interest or for the protection of investors because it would assist the Commission in making the finding with respect to adequate financial resources required by Section 15E(a)(2)(C) of the Exchange Act.199 This information would augment the financial statements that would be required under proposed Exhibit 11 in that it would provide detail as to the revenues generated by different types of services. The Commission requests comment on whether the furnishing of this revenue information would achieve the stated purposes of the requirement, or whether any additions, deletions or modifications should be made. The Commission also requests comment on any difficulties a credit rating agency may confront in determining its revenues from these various sources. If a commenter believes it would not be practicable to do so, the commenter should explain why. Exhibit 13 (Confidential). Exhibit 13 would require an applicant to provide the amount of total aggregate annual compensation paid to its credit analysts and the median compensation. The information would be for the most recently completed fiscal or calendar year and would not have to be audited. An NRSRO would not need to make the information in Exhibit 13 public (to the extent permitted by law) or update the exhibit after registration. An NRSRO would, however, be required to update this information with the annual audited financial statements provided to the Commission under proposed Rule 17g-3. The Commission believes this compensation information would be necessary or appropriate in the public interest or for the protection of investors because it would assist the Commission in making the finding with respect to adequate financial resources required by Section 15E(a)(2)(C) of the Exchange Act.200 Similar to the revenue information, this information would augment the financial statements that would be required under Exhibit 11 because it provides detail on the expenses necessary to retain the credit rating agency’s credit analysts. The Commission requests comment on Exhibit 13, as proposed. The Commission also requests comment on any difficulties a credit rating agency would have in determining these compensation amounts. If a commenter believes it would not be practicable to do so, the commenter should explain why. Request for comment. In addition to the specific requests for comment above, the Commission requests comment on all aspects of proposed Form NRSRO and the proposed instructions to the form, including whether the proposals could be more narrowly tailored and still meet the stated goals. Further, the Commission solicits comment about whether other requirements should be added, or whether items and exhibits proposed should be eliminated or modified. Commenters are asked to explain their conclusions. D. Proposed Rule 17g-2 – RecordkeepingThe Act amends Section 17(a)(1) of the Exchange Act to add NRSROs to the list of entities required 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.201 The inclusion of NRSROs on the list also provides the Commission with authority under Section 17(b)(1) of the Exchange Act to examine all the records of an NRSRO.202 Proposed Rule 17g-2, "Records to be made and retained by nationally recognized statistical rating organizations," would implement the Commission’s recordkeeping rulemaking authority under Section 17(a) of the Exchange Act.203 The proposed rule would require an NRSRO to make and retain certain records relating to its business and to retain certain other business records, if such records are made. The rule also would prescribe the time periods and manner in which all these records must be retained. With respect to other regulated entities, the Commission has made clear that books and records rules are "integral to the Commissions investor protection function because the preserved records are the primary means of monitoring compliance with applicable securities laws."204 Proposed Rule 17g-2 is designed to ensure that an NRSRO makes and retains records that would assist the Commission in monitoring, through its examination authority, whether an NRSRO was complying with the provisions of Section 15E of the Exchange Act205 and the rules thereunder. For example, examiners would use the records to monitor whether an NRSRO was following its disclosed procedures and methodologies for determining credit ratings, its disclosed policies and procedures for preventing the misuse of material non-public information, and managing conflicts of interest, and whether it was complying with proposed Rules 17g-4, 17g-5 and 17g-6 discussed below. 1. Paragraph (a): Records to be Made and RetainedParagraph (a) of proposed Rule 17g-2 would require an NRSRO to make and retain certain books and records. Under the proposed rule, the records required in paragraph (a) must be complete and current. Consequently, it would be a violation of the proposed rule to falsify a record or fail to update a record when the information on the record becomes stale or incomplete. The Commission believes the records required to be made and retained under paragraph (a) of proposed Rule 17g-2 would be necessary or appropriate in the public interest, for the protection of investors, or otherwise in furtherance of the Exchange Act because, as described below, they would assist the Commission in monitoring whether an NRSRO was complying with Section 15E of the Exchange Act and the rules thereunder.206 The Commission does not intend that these provisions of proposed Rule 17g-2 require a specific form of record. An NRSRO would have the flexibility to implement a recordkeeping system that captured the following information in a manner that conformed to the NRSRO’s internal processes. Paragraph (a)(1). Paragraph (a)(1) of proposed Rule 17g-2 would require an NRSRO to make records of original entry into the rating organization’s accounting system, and records reflecting entries to and balances in all general ledger accounts of the rating organization for each fiscal year. These are fundamental business records and necessary for the preparation of the audited financial statements and schedules that would need to be prepared under proposed Rule 17g-3. Paragraph (a)(2). Paragraph (a)(2) of proposed Rule 17g-2 would require an NRSRO to make and retain the following records with respect to each of the NRSRO’s current credit ratings, as applicable: the identity of any credit analyst(s) that determined the credit rating; the identity of the person(s) who approved the credit rating before it was issued; the procedures and methodologies used to determine the credit rating; the method by which the credit rating was made readily accessible; whether the credit rating was solicited or unsolicited; and the date the credit rating action was taken. As noted above, the NRSRO would not be required to make a single record containing all this information for each current credit rating. Rather, the NRSRO would have the flexibility to implement a recordkeeping system that captured this information in different records in a manner that conformed to the NRSRO’s internal processes. The information in these records about the identity of the credit analysts, the persons who approved the credit rating, the methodology used to determine the credit rating, and whether the credit rating was solicited or unsolicited, collectively would assist the Commission in monitoring whether the NRSRO was following its procedures and methodologies for determining credit ratings. The information about the identity of the credit analysts, and the persons who approved the credit rating, also would assist the Commission in monitoring whether the NRSRO was complying with procedures designed to prevent the misuse of material nonpublic information. Paragraph (a)(3). Paragraph (a)(3) of proposed Rule 17g-2 would require a record identifying each person that solicits the NRSRO to determine or maintain a credit rating (e.g., an obligor, issuer, or underwriter) and the credit ratings determined for the person. This information would assist the Commission in monitoring whether the NRSRO was complying with procedures for addressing and managing conflicts of interest as well as complying with the requirements in proposed Rule 17g-5 prohibiting certain conflicts of interest. Paragraph (a)(4). Paragraph (a)(4) of proposed Rule 17g-2 would require a record for each person that subscribes to receive the credit ratings of the NRSRO. Similar to the records that would be required under paragraph (a)(3), this information would assist the Commission in monitoring whether the NRSRO was complying with procedures for addressing and managing conflicts of interest as well as complying with the requirements in proposed Rule 17g-5 prohibiting certain conflicts of interest. Paragraph (a)(5). Paragraph (a)(5) of proposed Rule 17g-2 would require a record describing each type of service and product offered by the NRSRO. This record would provide the Commission with details of the ancillary business activities of the credit rating agency and, therefore, would be useful in identifying potential conflicts of interest that arise from such activities. Commission examiners would then be able to review whether the NRSRO had implemented procedures to manage these potential conflicts. Request for comment. The Commission requests comment on whether the records that would be required to be made and retained under paragraph (a) of proposed Rule 17g-2 would achieve the stated purposes of the requirements. Commenters should explain a | ||||||
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