SEC Proposes Comprehensive Reforms to Bring Increased Transparency to Credit Rating Process

"The events of recent months have had a profound effect on our economy and our markets, and they have galvanized regulators and policymakers not only in this country but around the world to re-examine every aspect of the regulatory framework governing credit rating agencies," said SEC Chairman Christopher Cox. "This package of proposed rules would foster increased transparency, accountability, and competition in the credit rating agency industry for the benefit of investors."

Erik Sirri, Director of the SEC's Division of Trading and Markets, said, "The rules proposed today are designed to improve investor understanding of credit ratings through enhanced disclosure of NRSRO methods and performance data, and to promote investor confidence in credit ratings by minimizing conflicts of interest."

The proposed rulemaking continues the implementation of new regulatory authority that the SEC recently received from Congress to register and oversee nationally recognized statistical rating organizations (NRSROs). Since its authority went into effect in September 2007, the SEC has rigorously applied its new oversight to examine how credit ratings have been created and disseminated. Informed by these ongoing examinations as well as input from international regulatory organizations studying these issues and the Congressional committees responsible for the recent Credit Rating Agency Reform Act, the Commission has proposed this package of rules that would regulate the conflicts of interests, disclosures, internal policies, and business practices of credit rating agencies.

The regulatory program established by Congress through the Credit Rating Agency Reform Act allows the SEC to promulgate rules regarding public disclosure, recordkeeping and financial reporting, and substantive requirements designed to ensure that NRSROs conduct their activities with integrity and impartiality. These additional proposed rules supplement initial rules implemented by the Commission under the Act in June 2007.

The Commission is proposing the rulemaking in three parts, with the first two portions being proposed today and the third portion to be considered on June 25.

The first part of the Commission's rule proposal would:

• Prohibit a credit rating agency from issuing a rating on a structured product unless information on assets underlying the product was available.

• Prohibit credit rating agencies from structuring the same products that they rate.

• Require credit rating agencies to make all of their ratings and subsequent rating actions publicly available. This data would be required to be provided in a way that will facilitate comparisons of each credit rating agency's performance. Doing this would provide a powerful check against providing ratings that are persistently overly optimistic, and further strengthen competition in the ratings industry.

• Attack the practice of buying favorable ratings by prohibiting anyone who participates in determining a credit rating from negotiating the fee that the issuer pays for it.

• Prohibit gifts from those who receive ratings to those who rate them, in any amount over $25.

• Require credit rating agencies to publish performance statistics for 1, 3, and 10 years within each rating category, in a way that facilitates comparison with their competitors in the industry.

• Require disclosure by the rating agencies of the way they rely on the due diligence of others to verify the assets underlying a structured product.

• Require disclosure of how frequently credit ratings are reviewed; whether different models are used for ratings surveillance than for initial ratings; and whether changes made to models are applied retroactively to existing ratings.

• Require credit rating agencies to make an annual report of the number of ratings actions they took in each ratings class, and require the maintenance of an XBRL database of all rating actions on the rating agency's Web site. That would permit easy analysis of both initial ratings and ratings change data.

• Require the public disclosure of the information a credit rating agency uses to determine a rating on a structured product, including information on the underlying assets. That would permit broad market scrutiny, as well as competitive analysis by other rating agencies that are not paid by the issuer to rate the product.

• Require documentation of the rationale for any significant out-of-model adjustments.

The second part of the Commission's proposal would require credit rating agencies to differentiate the ratings they issue on structured products from those they issue on bonds, either through the use of different symbols, such as attaching an identifier to the rating, or by issuing a report disclosing the differences between ratings of structured products and other securities.

The third set of recommendations for the Commission's proposal, to be considered on June 25, are being designed to ensure that the role the SEC has assigned to ratings in its rules is consistent with the objective of having investors make an independent judgment of risks and of making it clear to investors the limits and purposes of credit ratings for structured products.

Public comments on today's proposed amendments and rule must be received by the Commission within 30 days after their publication in the Federal Register.