File No. S7-04-07 RIN 3235-AJ78

Oversight of Credit Rating Agencies Registered as Nationally Recognized Statistical Rating Organizations
 

AGENCY: Securities and Exchange Commission (Commission).

ACTION: Final rule.

SUMMARY: The Commission is adopting rules to implement provisions of the Credit Rating Agency Reform Act of 2006 (the Rating Agency Act), enacted on September 29, 2006. The Rating Agency 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). The rule and form prescribing the process for a credit rating agency to apply for registration are immediately effective. The remaining rules are effective on June 26, 2007.

EFFECTIVE DATES: June 18, 2007 except that 240.17g-2, 240.17g-3, 240.17g-4, 240.17g-5, and 240.17g-6 are effective on June 26, 2007.

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 D. 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. BACKGROUND

The term nationally recognized statistical rating organization (NRSRO) is used in federal and state statutes and regulations to confer regulatory benefits or prescribe requirements based on credit ratings issued by credit rating agencies identified as NRSROs.¹ The process of identifying NRSROs has historically been undertaken by the Commission staff through the issuance of no-action letters where the staff has determined, among other things, that the credit rating agency is recognized nationally by the predominant users of credit ratings as issuing credible and reliable ratings.² The Rating Agency Act replaces the no-action letter process which has been criticized as lacking transparency with a registration program and Commission oversight of credit rating agencies that choose to be treated as NRSROs.

The Rating Agency Act implements the program for NRSRO registration and oversight by adding definitions to Section 3 of the Securities Exchange Act of 1934 (Exchange Act),³ creating a new Section 15E of the Exchange Act,⁴ and amending Section 17 of the Exchange Act.⁵ Under these new statutory provisions, a credit rating agency seeking to be treated as an NRSRO must apply for, and be granted, registration with the Commission, make public in its application certain information to help persons assess its credibility, and implement procedures to manage the handling of material nonpublic information and conflicts of interest. In addition, the Rating Agency Act provides the Commission with rulemaking authority to prescribe: the form of the application (including requiring the furnishing of additional information); the records an NRSRO must make and retain; the financial reports an NRSRO must furnish to the Commission on a periodic basis; the specific procedures an NRSRO must implement to manage the handling of material nonpublic information; the conflicts of interest an NRSRO must manage or avoid altogether; and the practices that an NRSRO must not engage in if the Commission determines they are unfair, coercive, or abusive.

II. TIMING OF FINAL RULES

On February 2, 2007, the Commission proposed a package of rules pursuant to these grants of rulemaking authority.⁶ The rules published today incorporate many of the proposed provisions but also include significant revisions based on the comments received.⁷ The Commission, in adopting these rules today, intends that Rule 17g-1 (17 CFR 240.17g-1), Form NRSRO, and 17 CFR 249b.300 be issued in final form and be effective on the date of their publication in the Federal Register. The Commission further intends that Rules 17g-2 (17 CFR 240.17g-2), 17g-3 (17 CFR 240.17g-3), 17g-4 (17 CFR 240.17g-4), 17g-5 (17 CFR 240.17g-5), and 17g-6 (17 CFR 240.17g-6) be issued in final form on June 26, 2007 and become effective on that date.

III. EFFECTIVE DATE

Section 553(d) of the Administrative Procedure Act generally provides that, unless an exception applies, a substantive rule may not be made effective less than 30 days after notice of the rule has been published in the Federal Register.⁸ One exception to the 30-day requirement is an agency's finding of good cause for providing a shorter effective date.⁹

The Rating Agency Act provides that the new program for NRSRO registration and oversight shall apply on the earlier of the date on which regulations are issued in final form under Section 15E(n) of the Exchange Act, or 270 days after the enactment of the Rating Agency Act, which will be June 26, 2007.¹⁰ The Rating Agency Act voids existing Commission staff no-action letters on and after the effective date of the new program for NRSRO registration and oversight, but creates a transitional measure allowing credit rating agencies with existing no-action letters to continue to act as NRSROs during Commission consideration of the application, if such entity has furnished an application for registration.¹¹ Consequently, as noted above, the Commission intends that Rule 17g-1 and Form NRSRO be effective immediately upon publication. Further, the Commission intends that the remaining rules, Rule 17g-2 through Rule 17g-6, be effective on June 26, 2007, the statutory deadline.

Immediate effectiveness of Form NRSRO and Rule 17g-1 is necessary to allow credit rating agencies that are currently the subject of staff no-action letters identifying them as NRSROs to have a period of time to submit applications for registration as NRSROs before the provisions of the Rating Agency Act and the recordkeeping, reporting, and conduct rules issued under the Rating Agency Act become effective, and thus before the no-action letters become void. This will avoid a gap in time when no NRSROs exist, which would disrupt the regulatory use of that term in applicable statutes and regulations, resulting in uncertainty in the marketplace for all persons that rely upon credit ratings issued by NRSROs. Further, this result would be inconsistent with Congressional intent in creating the transitional measure. Finally, the accelerated effectiveness for the remaining rules, Rule 17g-2 through Rule 17g-6, is necessary to meet the statutory deadline.

The primary purpose of the 30-day delayed effectiveness requirement is to give affected parties a reasonable period of time to adjust to the new rules. Here, the existing NRSROs would not be harmed by immediate effectiveness, and would in fact benefit from the opportunity to utilize the transitional measure Congress provided. Further, an entity would not be required to comply with Rule 17g-2 through Rule 17g-6 until its voluntary registration has been approved.

The Commission acted expeditiously in proposing and adopting these rules under a very tight, statutorily-imposed deadline. The Rating Agency Act was enacted on September 29, 2006. Just over four months later, on February 2, 2007, the Commission voted to propose the new rules and form, which were designed to comply with the statutory mandate to establish an entirely new regulatory regime for NRSROs. The Commission voted to adopt these rules and Form NRSRO on May 23, 2007, over a month before the statutory deadline. In doing so, the Commission carefully responded to industry, user, and investor perspectives to ease the transition to a new, Congressionally-created registration and regulatory scheme.

Failure to accelerate effectiveness of Rule 17g-1 through Rule 17g-6 and Form NRSRO could interfere with the goals of the Rating Agency Act. For these reasons, the Commission finds that good cause exists for Rule 17g-1 and Form NRSRO to be immediately effective upon publication, and for Rule 17g-2 through Rule 17g-6 to be effective on June 26, 2007.

IV. REVIEW OF COMMISSION RULES

Section 15E(n)(2) of the Exchange Act requires the Commission to review its existing rules using the term NRSRO within 270 days of its enactment.¹² The statute further provides that the Commission shall amend or revise the rules in accordance with Section 15E(n)(2) of the Exchange Act.¹³ The Commission has reviewed all of its rules using the term NRSRO. The Commission does not believe these rules need to be amended at this time. The term NRSRO in each rule will refer to an NRSRO as that term is defined in the Rating Agency Act when the statutory provisions become effective.¹⁴ For example, Commission Rule 15c3-1 (the broker-dealer net capital rule) uses the term nationally recognized statistical rating organization to prescribe the amount a broker-dealer must haircut proprietary corporate debt securities when computing its regulatory capital.¹⁵ The rule does not otherwise define the term nationally recognized statistical rating organization. Consequently, after the effective date of the NRSRO regulatory program, the term, as used in this rule, will refer to a credit rating agency that is an NRSRO as determined by the provisions of the Rating Agency Act.¹⁶

The Commission notes that several commenters raised potential concerns about how other Commission rules may operate after the NRSRO registration and oversight program takes effect.¹⁷ These commenters suggested that requirements in Rule 2a-7¹⁸under the Investment Company Act of 1940,¹⁹ which regulates the operation of money market funds, may need to be modified depending on the number of credit rating agencies that become registered as NRSROs.²⁰ For example, one commenter noted that Rule 2a-7(c)(6)(i)(A)(2) requires a money market fund to re-assess the minimal credit risk of its portfolio whenever it becomes aware that any unrated or second tier security held by the fund has been given a credit rating by any NRSRO below the NRSROs second highest category.²¹ Another commenter noted that Rule 2a-7 prescribes that money market funds determine whether a security is eligible for purchase based on whether it has received a credit rating in one of the two highest categories from any NRSRO.²² This commenter was concerned that this might lead to money market funds filling portfolios that most NRSROs consider third tier.²³ One of the these commenters also expressed concern that the proposal did not require that an NRSRO have a particular number of credit rating categories or that the categories of one NRSRO might not correspond to those of another NRSRO.²⁴ Based on the uncertainty of how many credit rating agencies ultimately will register as NRSROs, the Commission intends to monitor for now how the NRSRO regulatory program impacts Rule 2a-7 and the Commissions other rules using the term NRSRO. As the program develops, the Commission will evaluate whether modifications to these rules would be appropriate. 

¹ See, e.g., federal statutes: 15 U.S.C. 78c(a)(41) (defining the term mortgage related security); 15 U.S.C. 78c(a)(53)(A) (defining the term small business related security); 15 U.S.C. 80a-6(a)(5)(A)(iv)(I) (exempting certain companies from the provisions of the Investment Company Act of 1940); Gramm-Leach-Bliley Act, Pub. L. No. 106-102 (1999); Transportation Equity Act for the 21^st Century, Pub. L. No. 105-178 (1998); Reigle Community Development and Regulatory Improvement Act of 1994, Pub. L. No. 103-325 (1994); Department of Commerce, Justice, and State, The Judiciary, and Related Agencies Appropriations Act, FY2001, Pub. L. No. 106-553 (2000); Higher Education Amendments of 1992, Pub. L. No. 102-325 (1992); Housing and Community Development Act of 1992, Pub. L. No. 102-550 (1992); Federal Deposit Insurance Corporation Improvement Act of 1991, Pub. L. No. 102-242 (1991); and Financial Institutions Reform, Recovery, and Enforcement Act of 1989, Pub. L. No. 101-72 (1989); Commission rules: 17 CFR 228.10(e), 229.10(c), 230.134(a)(14), 230.436(g), 239.13, 239.32, 239.33, 240.3a1-1(b)(3), 240.10b-10(a)(8), 240.15c3-1(c)(2)(vi)(E), (F), and (H), 240.15c3-1a(b)(1)(i)(C), 240.15c3-1f(d), 240.15c3-3a, Item 14, Note G, 242.101(c)(2), 242.102(d), 242.300(k)(3) and (l)(3), 270.2a-7(a)(10), 270.3a-7(a)(2),
270.5b-3(c), and 270.10f-3(a)(3); and state rule: Cal. Ins. Code 1192.10.

² See letter from Nelson S. Kibler, Assistant Director, Division of Market Regulation, Commission, to John T. Anderson, Esquire, of Lord, Bissell & Brook, on behalf of Duff & Phelps, Inc. (February 24, 1982); letter from Michael A. Macchiaroli, Assistant Director, Division of Market Regulation, Commission, to Paul McCarthy, President, McCarthy, Crisanti & Maffei, Inc. (September 13, 1983); letter from Michael A. Macchiaroli, Assistant Director, Division of Market Regulation, Commission, to Robin Monro-Davies, President, IBCA Limited (November 27, 1990); letter from Michael A. Macchiaroli, Assistant Director, Division of Market Regulation, Commission, to David L. Lloyd, Jr., Dewey Ballentine, Bushby, Palmer & Wood (October 1, 1990); letter from Michael A. Macchiaroli, Assistant Director, Division of Market Regulation, Commission, to Gregory A. Root, President, Thomson BankWatch, Inc. (August 6, 1991); letter from Michael A. Macchiaroli Assistant Director, Division of Market Regulation, Commission, to Lee Pickard, Pickard and Djinis LLP (January 25, 1999); letter from Annette L. Nazareth, Director, Division of Market Regulation, Commission, to Mari-Anne Pisarri, Pickard and Djinis LLP (February 24, 2003); letter from Mark M. Attar, Special Counsel, Division of Market Regulation, Commission, to Arthur Snyder, President, A.M. Best Company, Inc. (March 3, 2005); letter from Erik R. Sirri, Director, Division of Market Regulation, Commission, to Neal E. Sullivan, Bingham McCutchen LLP (May 21, 2007); letter from Erik R. Sirri, Director, Division of Market Regulation, Commission, to Yoshihiro Saito, Perkins Coie LLP (May 23, 2007).

³ 15 U.S.C. 78c.

⁴ 15 U.S.C. 78o-7.

^{5 15 U.S.C. 78q.}

⁶ See Exchange Act Release No. 55231 (February 2, 2007), 72 FR 6378 (February 9, 2007) (Proposing Release).

⁷ These comments are available on the Commissions Internet Web site, located at http://www.sec.gov/comments/s7-04-07/s70407.shtml, and in the Commissions Public Reference Room in its Washington, DC headquarters.

⁸ 5 U.S.C. 553(d).

⁹ Id.

¹⁰ 15 U.S.C. 78o-7(p).

¹¹ 15 U.S.C. 78o-7(l).

¹² 15 U.S.C. 78o-7(n)(2).

¹³ Id.

¹⁴ See Sections 3(a)(62) and 15E(l)(2) of the Exchange Act (15 U.S.C. 78c(a)(62) and 15 U.S.C. 78o-7(l)(2)).

¹⁵ See 17 CFR 240.15c3-1(c)(2)(vi)(F).

¹⁶ See Sections 3(a)(62) and 15E(l)(2) of the Exchange Act (15 U.S.C. 78c(a)(62) and 15 U.S.C. 78o-7(l)(2)).

¹⁷ See letter dated March 12, 2007 from Elizabeth Krentzman, General Counsel, Investment Company Institute (ICI Letter); letter dated March 12, 2007 from Stephen A. Keen, Attorney, on behalf of Federated Investors, Inc. (FI Letter); letter dated April 4, 2007 from Charles S. Morrison, Senior Vice President and Money Market Group Leader, Fidelity Management and Research Company (FMRC Letter).

¹⁸ 17 CFR 270.2a-7.

¹⁹ 15 U.S.C. 80a-1 et seq.

²⁰ See ICI Letter; FI Letter; FMRC Letter.

²¹ See FI Letter.

²² See FMRC Letter.

²³ Id.

²⁴ See FI Letter.