SEC Proposes Changes to Rules for Credit Ratings Agencies

By Cydney Posner

This morning, the SEC voted to propose new rules and amendments to implement provisions of Dodd-Frank applicable to credit rating agencies registered as nationally recognized statistical rating organizations (NRSROs), providers of third-party due diligence services for asset-backed securities, and issuers and underwriters of asset-backed securities. The DFA expands the authority of the SEC with regard to NRSROs because Congress astutely suspected that something might be amiss when CDOs related to a bunch of subprime mortgages, half of which were in default, received AAA credit ratings. Following are some of the provisions of the SEC's proposal:

• Require NRSROs to provide annual reports describing their internal control structures for determining ratings and assessing the effectiveness of those structures;
• Address potential conflicts of interest when sales personnel also participate in determining credit ratings by prohibiting the NRSRO from issuing or maintaining a rating in that circumstance;
• Require policies and procedures to address the situation where an analyst who participated in a credit rating for an entity is subsequently employed by that rated entity, including a "look-back" review, application of a credit watch and potential reassessment of the entity's rating;
• Establish standards for training and competence of analysts, including periodic testing and a requirement for participation in each rating of an analyst with at least three years of experience;
• Require policies and procedures for the methodologies of determining ratings, including Board approval of the methodologies, consistent application of the methodologies and publication of notice of significant changes and identified errors in those methodologies;
• Require standardization of the calculation and presentation of aggregated information about ratings changes over time;
• Require disclosure of quantitative and qualitative information regarding ratings, including limitations, assumptions and performance statistics for each outstanding rating to allow investors to compare performance across the industry; and
• Require that due diligence providers for asset-backed securities provide a written certification to any NRSRO that rates the securities.

Here is a link to the press release: http://www.sec.gov/news/press/2011/2011-113.htm.  The 518-page proposal is also available.

As is her wont, Commissioner Casey expressed her concern that these proposals just might be excessive and too intrusive into the substance of the rating function itself, particularly the look-back provisions and standardization. She also took issue with the cost-benefit analysis applied here and in other DFA regulation. In particular, she was concerned that the analyses do not consider the full impact of proposed regulations because they look only at those aspects of the regulations that are the result of the SEC's exercise of its discretionary authority, not those dictated by legislation.

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