SEC Adopts Credit Rating Agency Reforms | Practical Law

SEC Adopts Credit Rating Agency Reforms | Practical Law

On August 27, 2014, the SEC adopted stringent conduct rules for credit rating agencies, as mandated under Section 943 of the Dodd-Frank Act. However, the rules do not alter the structure of the current issuer-pay system, which many believe presents an inherent conflict of interest in the ratings process.

SEC Adopts Credit Rating Agency Reforms

Practical Law Legal Update 6-579-6005 (Approx. 4 pages)

SEC Adopts Credit Rating Agency Reforms

by Practical Law Finance
Published on 28 Aug 2014 • USA (National/Federal)
On August 27, 2014, the SEC adopted stringent conduct rules for credit rating agencies, as mandated under Section 943 of the Dodd-Frank Act. However, the rules do not alter the structure of the current issuer-pay system, which many believe presents an inherent conflict of interest in the ratings process.
On August 27, 2014, the SEC adopted final rules on credit rating agency reform under Section 943 of the Dodd-Frank Act, which apply to all credit rating agencies registered with the SEC as nationally recognized statistical rating organizations (NRSROs). While the reforms impose stringent conduct requirements on NRSROs operating in the US, they do not change the traditional framework under which issuers pay rating agencies for credit ratings on their securities, which many believe creates a conflict of interest in the ratings process.
The final rules make amendments and add certain new subsections to Rule 17g under the Exchange Act (as well as Rule 15-Ga), which are designed to:
  • Enhance the transparency of credit rating agencies.
  • Increase the accountability of credit rating agencies.
  • Protect investors and markets against a repeat of the conduct and practices that led to the financial crisis.
  • Strengthen the overall quality of credit ratings.
Noteworthy aspects of the rules include the following:
  • Rating agency chief executives will be required to certify as to the integrity of the agency's ratings process and internal controls. They must also certify that other business activities do not influence ratings.
  • NRSROs will be required to review ratings overseen by analysts who then move to a position with an issuer or investment bank. This rule is designed to require review of ratings that may have been influenced by an analyst seeking a job with an issuer.
  • Rating agencies must carefully document the processes by which their ratings models are crafted and tested.
  • Analysts working on a rating for a particular issuer are prohibited from involvement with sales and marketing efforts to obtain more business from the same issuer.
  • The rules omit major changes to the traditional framework under which issuers pay rating agencies for credit ratings on their securities, which many believe creates an inherent conflict of interest in the ratings process.
The new rules include many changes to rating agency practices that aim to make the credit ratings process more reliable, including:
  • An extensive list of factors that a NRSRO should consider when establishing, maintaining, enforcing and documenting an internal control structure.
  • A requirement that NRSROs must annually report on the effectiveness of their internal control structure.
  • Amendments to the Exchange Act that provide for the issuance of rules prohibiting NRSRO sales and marketing considerations from influencing the production of credit ratings.
  • Requirements on policies and procedures for conducting look-back reviews.
  • Requirements for public disclosure of NRSRO credit rating performance statistics.
  • Amendments to rating agency credit rating methodologies.
  • Requirements that NRSROs accompany credit ratings with certain forms and third-party due diligence certifications.
  • Rules designed to ensure that NRSRO credit analysts meet certain minimum standards of training, experience and competence.
  • Universal NRSRO rating symbols (the major NRSROs currently use differing systems, so there is no standardization).
  • Requirements that the ABS issuer or underwriter disclose the ABS third-party due diligence report.
  • Requirement for a certification by the ABS third-party due diligence provider.
Some of the rules will become effective on November 14, 2014. Other amendments regarding annual reports on internal controls and the production and disclosure of performance statistics will become effective on January 1, 2015. The provisions regarding the following matters are effective on June 15, 2015 in order to provide time for NRSROs, issuers, underwriters and providers of third-party due diligence services to prepare for the changes that result from the new requirements:
  • Sales and marketing conflict.
  • Look-back reviews.
  • Disclosure of rating histories.
  • Rating methodologies.
  • Form and certifications to accompany credit ratings.
  • Issuer and underwriter disclosures of third-party due diligence findings.
  • Certification of third-party due diligence findings.
  • NRSRO standards of training, experience and competence.
  • Universal ratings symbols.
The SEC also released a summary and press release in connection with the final rules.
Special thanks to Reuters Breakingviews and Daniel Indiviglio for certain information provided in this Update.