On February 2, 2009 the Securities and Exchange Commission published the text of its new rules for credit rating agencies registered as nationally recognized statistical rating organizations (NRSROs). These rules were adopted at the SEC’s December 3, 2008 open meeting. The new rules are generally scheduled to go into effect on April 10, 2009. The SEC also re-proposed additional rules for NRSROs. Comments on the re-proposed rules are due March 26, 2009.
The rules adopted by the SEC in final form include bans on certain conduct which should be of interest to companies with current credit ratings issued by Standard & Poor’s Ratings Services, Moody’s Investors Service, Fitch Ratings, or another credit rating agency registered as an NRSRO. Since the consequences of violating one of the new bans are severe – requiring the credit rating agency to withdraw its rating – companies should carefully review their policies and procedures for interacting with credit rating agencies.
The new bans include:
• Ban on Recommendations. Under the new rules, a credit rating agency may not issue or maintain a credit rating on an obligor or security where the credit rating agency, or an affiliate, made “recommendations” to the obligor or the issuer, underwriter or sponsor of the security about the corporate or legal structure, assets, liabilities or activities of the obligor or issuer.
Despite concerns raised that a ban on recommendations could unnecessarily chill communications between rated issuers and credit rating agencies, the line between permissible and prohibited communications remains blurred. Attempting to distinguish between a permissible communication and a prohibited recommendation, the SEC stated, for example, that it “does not view an explanation by an NRSRO of the assumptions and rationales it uses to arrive at ratings decisions and how they apply to a given rating transaction as a recommendation.” On the other hand, “if the feedback process turns into recommendations by the NRSRO about changes to the structure, assets, liabilities or activities of the obligor or security that the person seeking the rating potentially could make to obtain a desired credit rating, the NRSRO would be in violation of the new rule.”
Companies and credit rating agencies both will need to exercise care to ensure that their discussions do not cross the line to soliciting or providing an impermissible recommendation.
• Ban on Fee Discussions. A credit rating agency may not issue or maintain a credit rating where the fee paid for the rating was negotiated, discussed or arranged by rating agency personnel with responsibility for participating in determining credit ratings or for developing or approving procedures or methodologies used for determining credit ratings.
Companies should take care not to discuss fee arrangements with rating agency personnel responsible for developing and maintaining their ratings.
• Ban on Gifts. A credit rating agency may not issue or maintain a credit rating where a credit analyst who participated in determining or monitoring the credit rating, or a person responsible for approving the credit rating, received gifts, including entertainment, from the obligor being rated or from the issuer, underwriter or sponsor of the securities being rated. Excluded from this ban are minor incidentals such as light refreshments provided in business meetings, with a value of $25 or less.
Companies should take care not to provide meals, gifts or entertainment to rating agency personnel responsible for developing and maintaining their ratings.
Other elements of the final rules will be of primary interest to credit rating agencies registered as NRSROs. These include:
• Material Deviations from Model-Implied Ratings. The credit rating agency must make a record of the rationale for any “material difference” between the credit rating implied by a quantitative model and the final credit rating issued for a structured finance product, if the quantitative model was a “substantial component” in the process of determining the credit rating.
• Internet Disclosure of a 10% Random Sample of Ratings Histories. The credit rating agency must make a record for each outstanding credit rating showing all rating actions and the date of such actions from the initial credit rating to the current credit rating, identified by the name of the rated security or obligor and, if applicable, the CUSIP of the rated security or the Central Index Key (CIK) number of the rated obligor. For issuer-paid ratings, the credit rating agency must make a random 10% sample of ratings histories for each class of ratings available in XBRL format on its public website (subject to a six-month lag).
• Complaints About Analysts. The credit rating agency must retain any written communications received from outside the credit rating agency that contain complaints about the performance of a credit analyst in initiating, determining, maintaining, monitoring, changing or withdrawing a credit rating.
• Report of the Number of Rating Actions. On an annual basis, the credit rating agency must furnish to the SEC a report of the number of credit rating actions (upgrades, downgrades, placements on credit watch and withdrawals) taken during the year in each class of credit rating for which the credit rating agency is registered with the SEC.
• Performance Measurement Statistics. The credit rating agency must disclose in its Form NRSRO separate sets of performance measurement statistics (showing ratings transition and default rates) broken out over 1, 3 and 10-year periods for each class of credit rating for which the credit rating agency is registered with the SEC.
• Enhanced Disclosure of Rating Methodologies. The credit rating agency must disclose in its Form NRSRO additional information about its rating methodologies, including information regarding:
- how information about verification performed on assets underlying structured finance products is relied on in determining credit ratings,
- how assessments of the quality of originators of assets underlying structured finance products factor into the determination of credit ratings and
- whether changes made to models and criteria for determining initial ratings are applied retroactively to existing ratings, and whether changes made to models and criteria for performing ratings surveillance are incorporated into the models and criteria for determining initial ratings.
The SEC also re-proposed rules originally proposed in June 2008. These include:
• Internet Disclosure of All Issuer-Paid Ratings Histories. In addition to requiring the credit rating agency to publish a 10% sample of its issuer-paid ratings histories (described above), the SEC proposed to require the credit rating agency to publish ratings histories for 100% of its current issuer-paid ratings on its website in XBRL format. The SEC requested comment on all aspects of this proposal, including whether the proposal should be extended to cover subscriber-paid ratings.
• Disclosure of Data Underlying Structured Finance Product Ratings. The SEC substantially rewrote its June 2008 proposal that would have required the credit rating agency hired to rate a structured finance product to disclose to all other credit rating agencies the data provided by the product’s arranger. As re-proposed, the hired credit rating agency can shift the disclosure burden to the arranger, although the hired credit rating agency would be required to maintain a password-protected website, available to other NRSROs, so that the other NRSROs would know what products the hired credit rating agency is in the process of rating. The other NRSROs would then be able to obtain the underlying data from a password-protected website maintained by the arranger. The SEC requested comment on all aspects of this proposal.