[Federal Register: April 25, 2005 (Volume 70, Number 78)] [Proposed Rules] [Page 21305-21323] From the Federal Register Online via GPO Access [wais.access.gpo.gov] [DOCID:fr25ap05-21] [[Page 21305]] ----------------------------------------------------------------------- Part IV Securities and Exchange Commission ----------------------------------------------------------------------- 17 CFR Part 240 Definition of Nationally Recognized Statistical Rating Organization; Proposed Rule [[Page 21306]] ----------------------------------------------------------------------- SECURITIES AND EXCHANGE COMMISSION 17 CFR Part 240 [Release Nos. 33-8570; 34-51572; IC-26834; File No. S7-04-05] RIN 3235-AH28 Definition of Nationally Recognized Statistical Rating Organization AGENCY: Securities and Exchange Commission (``Commission''). ACTION: Proposed rule. ----------------------------------------------------------------------- SUMMARY: The Commission is publishing for comment a proposed new rule under the Securities Exchange Act of 1934 (``Exchange Act''), which would define the term ``nationally recognized statistical rating organization'' (``NRSRO''). The proposed definition contains three components that must each be met in order for a credit rating agency to be an NRSRO. The Commission is also providing interpretations of the proposed definition of the term ``NRSRO.'' Defining the term ``NRSRO'' and providing interpretations of the definition would increase transparency with regard to the NRSRO concept. DATES: Comments should be received on or before June 9, 2005. ADDRESSES: Comments may be submitted by any of the following methods: Electronic Comments Use the Commission's Internet comment form (http://www.sec.gov/rules/proposed.shtml. ); or Send an e-mail to rule-comments@sec.gov. Please include File Number S7-04-05 on the subject line; or Use the Federal eRulemaking Portal (http://www.regulations.gov ). Follow the instructions for submitting comments. Paper Comments Send paper comments in triplicate to Jonathan G. Katz, Secretary, Securities and Exchange Commission, 450 Fifth Street, NW, Washington, DC 20549-0609. All submissions should refer to File Number S7-04-05. This file number should be included on the subject line if e-mail is used. To help us process and review your comments more efficiently, please use only one method. The Commission will post all comments on the Commission's Internet Web site (http://www.sec.gov/rules/proposed.shtml ). Comments are also available for public inspection and copying in the Commission's Public Reference Room, 450 Fifth Street, NW, Washington, DC 20549. All comments received will be posted without change; we do not edit personal identifying information from submissions. You should submit only information that you wish to make available publicly. FOR FURTHER INFORMATION CONTACT: Michael A. Macchiaroli, Associate Director, at (202) 942-0132; Thomas K. McGowan, Assistant Director, at (202) 942-4886; Randall W. Roy, Branch Chief, at (202) 942-0798; Mark M. Attar, Special Counsel, at (202) 942-0766; or Rachael Grad, Attorney, at (202) 942-0183, Division of Market Regulation, Securities and Exchange Commission, 450 Fifth Street, NW., Washington, DC 20549- 1001. SUPPLEMENTARY INFORMATION: Table of Contents I. Introduction II. The Development of the NRSRO Concept A. Background B. History of the NRSRO Concept C. Commission Reviews of Credit Rating Agencies 1. 1994 Concept Release 2. 1997 Rule Proposal 3. Recent Reviews of Credit Rating Agencies a. NRSRO Examinations b. Credit Rating Agency Hearings c. Report under the Sarbanes-Oxley Act of 2002 d. The 2003 NRSRO Concept Release D. International Initiatives III. Discussion A. Background B. Proposed Definition of the Term ``NRSRO'' 1. The First Component a. Publicly Available Credit Ratings b. Issue-Specific Credit Opinions c. Current Credit Opinions 2. The Second Component a. General Acceptance in the Financial Markets b. Limited Coverage NRSROs 3. The Third Component a. Analyst Experience and Training b. Number of Ratings per Analyst c. Information Sources Used in the Ratings Process d. Contacts with Management e. Organizational Structure f. Conflicts of Interest g. Misuse of Information h. Financial Resources i. Standardized Rating Symbols C. Statistical Models D. Provisional NRSRO Status E. Staff No-Action Process IV. General Request for Comment V. Paperwork Reduction Act VI. Consideration of the Costs and Benefits of the Proposed Rule A. Benefits B. Costs VII. Consideration on Burden and Promotion of Efficiency, Competition, and Capital Formation VIII. Consideration of Impact on the Economy IX. Regulatory Flexibility Act X. Statutory Authority I. Introduction In June 2003, the Commission issued a concept release (the ``2003 Concept Release'') soliciting public comment on various issues regarding credit rating agencies, including whether credit ratings should continue to be used for regulatory purposes under the federal securities laws, and, if so, the process of determining whose credit ratings should be used and the level of oversight to apply to such credit rating agencies.\1\ To address certain issues raised in response to the 2003 Concept Release, particularly with regard to the clarity of whether a credit rating agency is an NRSRO, the Commission is proposing to define the term ``NRSRO'' in new Exchange Act Rule 3b-10, and to provide interpretations of that definition. The Commission notes that this proposal is intended only to address the meaning of the term ``NRSRO'' as it is used by the Commission; it does not attempt to address many of the broader issues raised in response to the 2003 Concept Release. --------------------------------------------------------------------------- \1\ Securities Act Release No. 33-8236), 68 FR 35258 (June 12, 2003). The 2003 Concept Release was intended to assist the Commission in addresing issues identified in its January 24, 2003 report on credit rating agencies, which was required by Congress under Section 702 of the Arbanes-Oxley Act of 2002. See report on the Role and Function of Credit Rating AGencies in the operation of the Securities Markets, As Required by Seciton 7029b) of the Sarbanes-Oxley Act of 2002, U.S. Securities and Exchange Commission, January 2003. --------------------------------------------------------------------------- II. The Development of the NRSRO Concept A. Background Since 1975, the Commission has relied in several significant regulatory areas on credit ratings by rating agencies that the markets have recognized as credible. These ``nationally recognized statistical rating organizations,'' or ``NRSROs,'' have typically sought a level of comfort regarding their status as NRSROs through the no-action letter process.\2\ To date, nine firms have been identified as NRSROs by the Commission staff. However, during the 1990s, several credit rating agencies consolidated so that there are currently five such NRSROs: A.M. Best Company, Inc. (``A.M. Best''), Dominion Bond Rating Service Limited (``DBRS''); Fitch, [[Page 21307]] Inc. (``Fitch''); Moody's Investors Service Inc. (``Moody's''); and the Standard & Poor's Division of the McGraw Hill Companies, Inc. (``S&P''). --------------------------------------------------------------------------- \2\ See, e.g., Letter from Annette L. Nazareth, Director, Division of Market Regulation, Commission, to Mari-Anne Pisarri, Pickard and Djinis LLP (February 24, 2003). For a more detailed description of the no-action letter process, see also Section III.E. --------------------------------------------------------------------------- Although the Commission originated the use of the term ``NRSRO'' for use in its rules and regulations, ratings by NRSROs today are used as benchmarks in federal and state legislation, rules issued by financial and other regulators, foreign regulatory schemes, and private financial contracts. Many of these uses specifically refer to the term ``NRSRO'' as used in the Commission's rules and regulations. However, the Commission has never defined the term ``NRSRO.'' B. History of the NRSRO Concept The term ``NRSRO'' was originally adopted by the Commission in 1975 solely for use in determining capital charges on different grades of debt securities under Exchange Act Rule 15c3-1, the Commission's ``net capital rule.'' \3\ The use of this term enabled the Commission to distinguish between investment grade and non-investment grade paper in a reasonably objective fashion. The net capital rule requires broker- dealers, when computing net capital, to deduct from their net worth certain percentages of the market value of their proprietary securities positions. These deductions, often referred to as ``haircuts,'' are intended to provide a margin of safety against losses that might be incurred by broker-dealers as a result of market fluctuations in the prices of, or lack of liquidity in, their proprietary positions. The Commission determined that it was appropriate to apply a lower haircut to securities held by a broker-dealer that were rated ``investment grade'' by a credit rating agency of national repute, because those securities typically were more liquid and less volatile in price than securities that were not so highly rated.\4\ --------------------------------------------------------------------------- \3\ See Adoption of Amendments to Rule 15c3-1 and Adoption of Alternative Net Capital Requirement for Certain Brokers and Dealers, Release No. 34-11497 (June 26, 1975), 40 FR 29795 (July 16, 1975). \4\ See, e.g., 17 CFR 240.15c3-1(c)(2)(vi)(E), (F), and (H). --------------------------------------------------------------------------- Over time, as marketplace and regulatory reliance on credit ratings increased, the Commission's use of the NRSRO concept as a proxy for regulatory determinations of liquidity and creditworthiness became more widespread.\5\ Several rules and regulations issued by the Commission pursuant to the Securities Act of 1933,\6\ the Exchange Act,\7\ and the Investment Company Act of 1940,\8\ utilize the term ``NRSRO'' and cross-reference to the net capital rule. For example, Rule 2a-7 under the Investment Company Act of 1940 limits money market funds to investing in only high quality short-term instruments, and NRSRO ratings can be used as benchmarks for establishing minimum quality investment standards. Under Rule 2a-7, a money market fund is limited to investing in securities rated by an NRSRO in the two highest ratings categories for short-term debt (or unrated securities of similar quality), and there are limitations on the amount of securities the fund can hold that are not rated in the highest rating category (or are not unrated securities of similar quality).\9\ In addition, in regulations adopted by the Commission under the Securities Act of 1933, offerings of certain nonconvertible debt, preferred securities, and asset-backed securities that are rated investment grade by at least one NRSRO can be registered on Form S-3--the Commission's ``short-form'' registration statement--without the issuer satisfying a minimum public float test.\10\ --------------------------------------------------------------------------- \5\ The NRSRO concept is currently used in the following 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- 3a(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 (1)(3), 270.2a- 7(a)(10), 270.3a-7(a)(2), 270.5b-3(c), and 270.10f-3(a)(3). \6\ See Regulation S-B (17 CFR 228.10) and Regulation S-K (17 CFR 229.10); Rule 134 (17 CFR 230.134); Rule 436 (17 CFR 230.436); Form S-3 (17 CFR 239.13); Form F-2 (17 CFR 239.32); and Form F-3 (17 CFR 239.33). \7\ See Rule 3a1-1 (17 CFR 240.3a1-1); Rule 10b-10 (17 CFR 240.10b-10); Rules 101 and 102 of Regulation M (17 CFR 242.101 and 242.102, respectively); and Rule 300 of Regulation ATS (17 CFR 242.300). \8\ See Rule 2a-7 (17 CFR 270.2a-7); Rule 3a-7 (17 CFR 270.3a- 7); Rule 5b-3 (17 CFR 270.5b-3); and Rule 10f-3 (17 CFR 270.10f-3). \9\ Under Rule 2a-7 (17 CFR 270.2-7), NRSRO ratings are minimum requirements; fund advisers must also make an independent determination that the security presents ``minimal credit risks.'' \10\ Form S-3 (17 CFR 239.13). --------------------------------------------------------------------------- In addition, Congress has incorporated the term ``NRSRO'' into a wide range of legislation.\11\ For example, when Congress defined the term ``mortgage related security'' in Section 3(a)(41) of the Exchange Act,\12\ as part of the Secondary Mortgage Market Enhancement Act of 1984,\13\ it required, among other things, that such securities be rated in one of the two highest rating categories by at least one NRSRO. --------------------------------------------------------------------------- \11\ See, e.g., 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''); and 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. 106-102 (1999); Transportation Equity Act for the 21st Century, Pub. L. 105-178 (1998); Reigle Community Development and Regulatory Improvement Act of 1994, Pub. L. 103-325 (1994); Department of Commerce, Justice, and State, The Judiciary, and Related Agencies Appropriations Act, FY2001, Pub. L. 106-553 (2000); Higher Education Amendments of 1992, Pub. L. 102-325 (1992); Housing and Community Development Act of 1992, Pub. L. 102-550 (1992); Federal Deposit Insurance Corporation Improvement Act of 1991, Pub. L. 102-242 (1991); and Financial Institutions Reform, Recovery, and Enforcement Act of 1989, Pub. L. 101-72 (1989). \12\ 15 U.S.C. 78c(a)(41). \13\ Pub. L. 98-440, 101, 98 Stat. 1689 (1984). --------------------------------------------------------------------------- Finally, a number of other federal, state, and foreign laws and regulations today use the term ``NRSRO.'' For example, the U.S. Department of Education uses ratings from NRSROs to set standards of financial responsibility for institutions that wish to participate in student financial assistance programs under Title IV of the Higher Education Act of 1965, as amended.\14\ In addition, several state insurance codes rely on NRSRO ratings in determining appropriate investments for insurance companies.\15\ The term ``NRSRO'' also has been used in foreign jurisdictions.\16\ --------------------------------------------------------------------------- \14\ 20 U.S.C. 1070 et seq. and 42 U.S.C. 2751 et seq., 34 CFR 668.15(b)(7)(ii) and (8)(ii). \15\ For example, the California Insurance Code relies on NRSRO ratings in allowing California-incorporated insurers to invest excess funds in certain types of investments. See Cal. Ins. Code 1192.10. \16\ See, e.g., National Instrument 71-101, The Multijurisdicitional Disclosure System (Oct. 1, 1998) (Can.). --------------------------------------------------------------------------- In 1975, when NRSRO ratings first were incorporated in the net capital rule, the Commission staff determined that the ratings of S&P, Moody's, and Fitch were used nationally, and that the staff would raise no questions if these firms were utilized as NRSROs for purposes of the net capital rule.\17\ Since 1975, the Commission staff has issued NRSRO no-action letters \18\ to six additional credit rating agencies: (1) Duff and Phelps, Inc.; \19\ (2) McCarthy, Crisanti & Maffei, Inc.; \20\ (3) IBCA Limited and its subsidiary, IBCA, Inc.; \21\ [[Page 21308]] (4) Thomson BankWatch, Inc.; \22\ (5) DBRS; \23\ and (6) A.M. Best.\24\ With the exception of A.M. Best and DBRS, each of these additional firms has since merged with or been acquired by other NRSROs, resulting in five NRSROs at present. --------------------------------------------------------------------------- \17\ See, e.g., Letter from Gregory C. Yadley, Staff Attorney, Division of Market Regulation, Commission, to Ralph L. Gosselin, Treasurer, Coughlin & Co., Inc. (November 24, 1975). \18\ For a discussion of the no-action letter process, see Section III.E. \19\ See Letter from Nelson S. Kibler, Assistant Director, Division of Market Regulation, Commission, to John T. Anderson, Esquire, Lord, Bissell & Brook, on behalf of Duff & Phelps, Inc. (February 24, 1982). \20\ See Letter from Michael A. Macchiaroli, Assistant Director, Division of Market Regulation, Commission, to Paul McCarthy, President, McCarthy, Crisanti & Maffei, Inc. (September 13, 1983). \21\ See Letter from Michael A. Macchiaroli, Assistant Director, Division of Market Regulation, Commission, to Robin Monro-Davies, President, IBCA Limited (November 27, 1990) and 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). \22\ See Letter from Michael A. Macchiaroli, Assistant Director, Division of Market Regulation, Commission, to Gregory A. Root, President, Thomson BankWatch, Inc. (August 6, 1991) and Letter from Michael A. Macchiaroli, Associate Director, Division of Market Regulation, Commission, to Lee Pickard, Pickard and Djinis LLP (January 25, 1999). \23\ See supra note 2. \24\ See Letter from Mark M. Attar, Special Counsel, Division of Market Regulation, Commission, to Arthur Snyder, President, A.M. Best (March 3, 2005). --------------------------------------------------------------------------- The Commission has not adopted a definition of the term ``NRSRO.'' However, through experience from the no-action process, the Commission staff has developed a number of criteria that it considers when reviewing NRSRO no-action requests. As a result, under current practice, the Commission staff reviews a credit rating agency's operations, position in the marketplace, and other specific factors to determine whether to grant a no-action letter. In determining whether to issue an NRSRO no-action letter, the Commission staff has considered the single most important factor to be whether the credit rating agency is ``nationally recognized'' in the United States as an issuer of credible and reliable ratings by the predominant users of securities ratings. The notion of ``national recognition'' was designed to help ensure that credit ratings used for regulatory purposes under Commission rules are credible and can reasonably be relied upon by the marketplace. Also reviewed in connection with the no-action letter process is a credit rating agency's operational capability and ratings process. Included within this assessment are: (1) The organizational structure of the credit rating agency; (2) the credit rating agency's financial resources; (3) the size and quality of the credit rating agency's staff; (4) the credit rating agency's independence from the companies it rates; (5) the credit rating agency's rating procedures; and (6) whether the credit rating agency has internal procedures to prevent the misuse of nonpublic information and whether those procedures are followed. C. Commission Reviews of Credit Rating Agencies 1. 1994 Concept Release Over the years, the Commission has reviewed a number of issues regarding credit rating agencies, including their regulatory oversight. In 1994, the Commission issued a concept release soliciting public comment on the Commission's use of NRSRO ratings (the ``1994 Concept Release'').\25\ Due to the expanded role played by credit ratings in Commission rules and regulations, a number of domestic and foreign credit rating agencies at that time had sought NRSRO no-action letters. Also, concerns had been expressed that Commission rules and regulations did not define the term ``NRSRO,'' and that there was no formal mechanism for monitoring the activities of NRSROs. As a result, the Commission solicited public comment on the appropriate role of credit ratings in the federal securities laws, and the need to establish formal procedures for identifying NRSROs and monitoring their activities. Most commenters supported the continued use of the NRSRO concept and recommended that the Commission adopt a formalized process for identifying NRSROs.\26\ --------------------------------------------------------------------------- \25\ See Nationally Recognized Statistical Rating Organizations, Release No. 34-34616 (August 31, 1994), 59 FR 46314 (September 7, 1994). \26\ See, e.g., Letter from Walter J. Schroeder, President, DBRS, to Jonathan G. Katz, Secretary, Commission (December 20, 1994). --------------------------------------------------------------------------- 2. 1997 Rule Proposal As a response to the 1994 Concept Release, the Commission, in 1997, proposed to amend the net capital rule to define the term ``NRSRO.'' \27\ The proposed amendments set forth criteria to be considered by the Commission in recognizing credit rating agencies as NRSROs, and would have established an NRSRO application process for credit rating agencies. --------------------------------------------------------------------------- \27\ See Capital Requirements for Brokers or Dealers Under the Securities Exchange Act of 1934, Release No. 34-39457 (December 17, 1997), 62 FR 68018 (December 30, 1997). --------------------------------------------------------------------------- Although commenters generally supported the Commission's attempt to define the requirements necessary for a credit rating agency to be identified as an NRSRO, the Commission did not act upon the 1997 rule proposal described above as a result of, among other things, the initiation of broad-based Commission and Congressional reviews of credit rating agencies. 3. Recent Reviews of Credit Rating Agencies More recently, the Commission has pursued several approaches to conduct a thorough and meaningful study of the use of credit ratings in the federal securities laws, the process of determining which credit ratings should be used for regulatory purposes, and the level of oversight to apply to credit rating agencies. Commission efforts included discussions with credit rating agencies and market participants, including buy-side firms,\28\ formal examinations of each of the NRSROs, and public hearings that offered a broad cross-section of market participants the opportunity to communicate their views on credit rating agencies and their role in the capital markets. --------------------------------------------------------------------------- \28\ Retail investor participation in the debt markets often takes place indirectly through buy-side firms, such as investment companies. --------------------------------------------------------------------------- a. NRSRO Examinations On March 19, 2002, the Commission issued an Order directing investigation, pursuant to Section 21(a) of the Exchange Act, into the role of credit rating agencies in the U.S. securities markets.\29\ The purpose of the Order was to ascertain facts, conditions, practices, and other matters relating to the role of credit rating agencies in the U.S. securities markets, and to aid the Commission in assessing whether to continue to use credit ratings in its rules and regulations under the federal securities laws and, if so, the categories of acceptable credit ratings and the appropriate level of regulatory oversight. --------------------------------------------------------------------------- \29\ See Order In the Matter of the Role of Rating Agencies in the U.S. Securities Markets Directing Investigation Pursuant to Section 21(a) of the Securities Exchange Act of 1934, and Designating Officers for Such Designation (March 19, 2002). --------------------------------------------------------------------------- The Commission's examination of the NRSROs revealed several concerns, including those relating to: (i) Potential conflicts of interest caused by payment by issuers to NRSROs for their ratings; (ii) exacerbation of those conflicts of interest due to the marketing by the NRSROs of ancillary services to issuers, such as pre-rating assessments and corporate consulting; (iii) the potential for the NRSROs, given their substantial power in the marketplace, to improperly pressure issuers to pay for ratings; (iv) the potential for the NRSROs, given their substantial power in the marketplace, to improperly pressure issuers to purchase ancillary services; (v) the effectiveness of the NRSROs' existing policies and procedures designed to protect confidential information; and (vi) difficulties in the Commission's examinations of NRSROs from, among other things, the lack of recordkeeping requirements tailored to NRSRO activities, the NRSROs' assertions that the document retention and production requirements of the Investment Advisers Act of 1940 are inapplicable to the credit rating business, and their claims that the First Amendment shields the NRSROs from producing certain documents to the Commission. [[Page 21309]] b. Credit Rating Agency Hearings The Commission's broad-based study of credit rating agencies included public hearings held on November 15 and 21, 2002, that addressed credit rating agencies operating in U.S. securities markets.\30\ Panel participants represented various views, including those of credit rating agencies, broker-dealers, buy-side firms, issuers, and the academic community. --------------------------------------------------------------------------- \30\ The Current Role and Function of Credit Rating Agencies in the Operation of the Securities Markets, Hearings Before the U.S. Securities and Exchange Commission (November 15 and 21, 2002) (``SEC Hearing on Credit Rating Agencies''). Full hearing transcripts are available on the Commission's Web site at http://www.sec.gov/spotlight/ratingagency.htm [hereinafter ``SEC Hearing Transcript'']. --------------------------------------------------------------------------- Topics addressed during the hearings included the current role and functioning of credit rating agencies, information flow in the credit rating process, concerns regarding credit rating agencies (e.g., potential conflicts-of-interest), and the regulatory treatment of credit rating agencies (including concerns regarding potential barriers to entry). Most hearing participants favored the regulatory use of credit ratings issued by NRSROs as a simple, efficient benchmark of credit quality, and suggested that regulatory standards for NRSROs were necessary for this concept to have meaning and reliability.\31\ --------------------------------------------------------------------------- \31\ See, e.g., SEC Hearing Transcript, supra note 30 (November 15, 2002) (testimony of Gregory A. Root, Executive Vice President, DBRS). --------------------------------------------------------------------------- Many participants expressed concern about the existing NRSRO no- action letter process.\32\ Suggestions to improve the process included (i) that the Commission should specify the information credit rating agencies should provide when requesting NRSRO no-action letters; and (ii) that the Commission review the staff's work in evaluating satisfaction of the NRSRO criteria.\33\ Some suggested that NRSRO no- action requests be completed in a more timely fashion and some noted that the Commission might promote competition in the credit rating industry by explicitly permitting credit rating agencies that specialize in particular sectors to receive NRSRO no-action letters.\34\ --------------------------------------------------------------------------- \32\ See, e.g., Written Statement of Paul Saltzman, Executive Vice President and General Counsel, The Bond Market Association), SEC Hearing on Credit Rating Agencies, supra note 30 (November 21, 2002). \33\ Id. \34\ See, e.g., Written Statement of Yasuhiro Harada, Senior Executive Managing Director, Rating and Investment Information, Inc., SEC Hearing on Credit Rating Agencies, supra note 30 (November 21, 2002). --------------------------------------------------------------------------- Some ratings users and issuers suggested that the Commission consider more substantive regulation of credit rating agencies (e.g., to address potential conflicts of interest), and engage in more active oversight of them (e.g., monitoring compliance with the NRSRO criteria).\35\ --------------------------------------------------------------------------- \35\ See, e.g., Written Statement of Amy Lancellotta, Senior Counsel, Investment Company Institute, SEC Hearing on Credit Rating Agencies, supra note 30 (November 21, 2002). --------------------------------------------------------------------------- Concerns were raised by hearing participants regarding the special access of subscribers to credit rating agency personnel, particularly given the exclusion from Regulation FD available for disclosures to credit rating agencies.\36\ While the larger credit rating agencies make ratings and the basic rating rationale available simultaneously to subscribers and non-subscribers, subscribers may also have direct access to credit rating agency analysts.\37\ Because of this direct access, there is a greater risk that nonpublic material information may be communicated to subscribers. --------------------------------------------------------------------------- \36\ See, e.g., SEC Hearing Transcript, supra note 30 (November 15, 2002) (testimony of Malcolm S. Macdonald, Vice President-- Finance and Treasurer, Ford Motor Company). See also Selective Disclosure and Insider Trading, Release No. 34-43154 (August 15, 2000), 65 FR 51716 (August 24, 2000). Generally, Regulation FD prohibits an issuer of securities, or persons acting on behalf of the issuer, from communicating material nonpublic information to certain enumerated persons--in general, securities market professionals or others who may use the information for trading-- unless the information is publicly disclosed. When Regulation FD was adopted, the Commission exempted credit rating agencies--not just NRSROs--from Regulation FD, on the condition that the material nonpublic information is communicated to a credit rating agency solely for the purpose of developing a credit rating and that the rating is publicly available. In addition to the specific rating agency exemption in Regulation FD, credit rating agencies may be able to avail themselves of the exemption for ``persons who expressly agree to maintain the disclosed information in confidence.'' 17 CFR 243.100(b)(2)(ii). \37\ Id. --------------------------------------------------------------------------- c. Report Under the Sarbanes-Oxley Act of 2002 Coincident with these Commission initiatives, Congress in Section 702 of the Sarbanes-Oxley Act of 2002, required that the Commission conduct a study of credit rating agencies and submit a report on that study to the President and Congress (the ``Report''). The Commission submitted the Report to the President and Congress on January 24, 2003.\38\ The Report addressed, among other things, each of the topics identified for Commission study in Section 702, including the role of credit rating agencies and their importance to the securities markets, impediments faced by credit rating agencies in performing that role, measures to improve information flow to the market from credit rating agencies, barriers to entry into the credit rating business, and conflicts of interest faced by credit rating agencies.\39\ --------------------------------------------------------------------------- \38\ See supra note 1. \39\ Sarbanes-Oxley Act of 2002, Pub. L. 107-204, Section 702(b), 116 Stat. 745 (2002). --------------------------------------------------------------------------- d. The 2003 NRSRO Concept Release To further assist the Commission in addressing issues identified in the Report, the Commission published the 2003 Concept Release on June 4, 2003, seeking comment on a number of issues relating to credit rating agencies. These issues included whether credit ratings should continue to be used for regulatory purposes under the federal securities laws, and, if so, the process of determining whose credit ratings should be used, and the level of oversight to apply to such credit rating agencies. Issues discussed during the Commission's two days of public hearings on credit rating agencies were also addressed in the 2003 Concept Release. Most of the 46 commenters responding to the 2003 Concept Release supported retention of the NRSRO concept. They generally represented that, among other things, eliminating the NRSRO concept would be disruptive to the capital markets,\40\ and would be costly and complicated to replace.\41\ Only four commenters supported elimination of the concept,\42\ and there was limited discussion of regulatory alternatives.\43\ --------------------------------------------------------------------------- \40\ See, e.g., Letter from Leo C. O'Neill, President, Standard & Poor's, to Jonathan G. Katz, Secretary, Commission (July 28, 2003). \41\ See, e.g., Letter from Gregory V. Serio, Superintendent, New York Insurance Department, Chair, NAIC Rating Agency Working Group, National Association of Insurance Commissioners, to Commission (July 28, 2003). \42\ See, e.g., Letter from Lawrence J. White, Professor of Economics, Stern School of Business, New York University, to Commission (July 25, 2003). \43\ See, e.g., Letter from Frank Partnoy, University of San Diego School of Law, to Jonathan G. Katz, Secretary, Commission (July 28, 2003). --------------------------------------------------------------------------- Most commenters supported improving the clarity of the process for identifying NRSROs to the extent credit ratings continue to be relied upon in Commission rules. Specifically, commenters generally supported the Commission's suggestions to specify more detail in what credit rating agencies need to provide to obtain an NRSRO no-action letter.\44\ Some also generally supported greater transparency regarding the NRSRO concept, for example, by identifying [[Page 21310]] NRSROs through Commission action versus the existing no-action letter process.\45\ --------------------------------------------------------------------------- \44\ See, e.g., Letter from Barbara Roper, Director of Investor Protection, Consumer Federation of America, to Jonathan G. Katz, Secretary, Commission (July 28, 2003). \45\ See, e.g., Letter from Steven C. Nelson, Director of Taxable Money Market Research, Fidelity Investments Money Management, Inc., to Jonathan G. Katz, Secretary, Commission (July 25, 2003). --------------------------------------------------------------------------- A few commenters represented that the current NRSRO criteria, as set forth in the 2003 Concept Release, create barriers to entry for new entrants and that the standards for determining NRSRO status should be lowered.\46\ Others disagreed and represented that the current NRSRO criteria should not be diluted.\47\ Most commenters supported NRSRO criteria designed to limit conflicts of interest in the credit rating business.\48\ There was also general support for recognizing credit rating agencies that confine their activities to a limited sector of the debt market \49\ or a limited geographic area.\50\ --------------------------------------------------------------------------- \46\ See, e.g., Letter from LACE Financial Corp. (July 25, 2003). \47\ See, e.g., Letter from Grace Hinchman, Senior Vice President, Public Affairs, Financial Executives International, to Jonathan G. Katz, Secretary, Commission (July 25, 2003). \48\ See, e.g., Letter from John M. Ramsey, Senior Vice President and Regulatory Counsel, The Bond Market Association, to Jonathan G. Katz, Secretary, Commission (July 28, 2003). \49\ See, e.g., Letter from Jeffrey P. Neubert, President and CEO, The New York Clearing House Association L.L.C., to Jonathan G. Katz, Secretary, Commission (July 31, 2003). \50\ See, e.g., Letter from Naohiko Matsuo, Director for International Financial Markets, Financial Services Agency, Government of Japan, to Jonathan G. Katz, Secretary, Commission (July 25, 2003). --------------------------------------------------------------------------- Most commenters supported the concept of regulatory oversight of NRSROs, at a minimum, to determine whether a credit rating agency continues to meet the NRSRO criteria on an ongoing basis.\51\ Commenters also recommended that NRSROs should be subject to periodic Commission examinations.\52\ --------------------------------------------------------------------------- \51\ See, e.g., Letter from Amy B.R. Lancellotta, Senior Counsel, Investment Company Institute, to Jonathan G. Katz, Secretary, Commission (July 28, 2003). \52\ See, e.g., supra note 41. --------------------------------------------------------------------------- D. International Initiatives In recent years, there have also been several international initiatives involving credit rating agencies. In February 2003, the Technical Committee of the International Organization of Securities Commissions (``IOSCO''),\53\ of which the Commission is a member, created a task force to study issues concerning credit rating agencies, and in September 2003 IOSCO published ``Principles Regarding the Activities of Credit Rating Agencies,'' \54\ a set of high-level objectives for regulators, credit rating agencies, and other market participants. In February 2004, the IOSCO Technical Committee formed a Chairmen's Task Force for the purpose of developing a voluntary code of conduct for credit rating agencies providing guidance on ways credit rating agencies could implement the Principles in practice, leading to the December 2004 publication by IOSCO of a ``Code of Conduct Fundamentals for Credit Rating Agencies.'' \55\ The Code, among other things, addresses how credit rating agencies can protect their analytical independence, eliminate or manage conflicts of interest, and help ensure the confidentiality of nonpublic information shared with them by issuers. --------------------------------------------------------------------------- \53\ IOSCO consists of 175 securities market regulators that have agreed to cooperate in order to promote high standards of regulation and to maintain efficient and sound domestic and international securities markets. \54\ ``IOSCO Statement of Principles Regarding the Activities of Credit Rating Agencies,'' The Technical Committee, IOSCO (September 25, 2003). See also ``Report on the Activities of Credit Rating Agencies,'' The Technical Committee, IOSCO (September 2003). \55\ See ``Code of Conduct Fundamentals for Credit Rating Agencies,'' The Technical Committee of IOSCO (December 2004). --------------------------------------------------------------------------- III. Discussion A. Background The Commission is proposing to define the term ``NRSRO'' in new Exchange Act Rule 3b-10. The proposed definition would be composed of three components, which the Commission preliminarily believes to be the most important criteria in determining whether an entity's ratings should be relied upon for purposes of the securities laws and Commission rules and regulations. In addition, the Commission is providing interpretations of the proposed definition. Specifically, the Commission is proposing to define the term ``NRSRO'' as an entity (i) that issues publicly available credit ratings that are current assessments of the creditworthiness of obligors with respect to specific securities or money market instruments; (ii) is generally accepted in the financial markets as an issuer of credible and reliable ratings, including ratings for a particular industry or geographic segment, by the predominant users of securities ratings; and (iii) uses systematic procedures designed to ensure credible and reliable ratings, manage potential conflicts of interest, and prevent the misuse of nonpublic information, and has sufficient financial resources to ensure compliance with those procedures. The components of the proposed definition are designed to determine those credit rating agencies whose ratings are sufficiently reliable to be used for a variety of regulatory purposes, such as for purposes of the net capital rule. For example, the principal purposes of the net capital rule are to protect customers and other market participants from broker-dealer failures and to enable those firms that fall below the minimum net capital requirements to liquidate in an orderly fashion without the need for a formal proceeding or financial assistance from the Securities Investor Protection Corporation. The net capital rule requires different minimum levels of capital based upon the nature of the firm's business and whether the broker-dealer handles customer funds or securities. In relying on credit ratings believed to be sufficiently reliable, the Commission is using those ratings as a means to evaluate the liquidity as well as the creditworthiness of certain securities held by a broker-dealer in establishing a sufficient capital cushion. B. Proposed Definition of the Term ``NRSRO'' 1. The First Component The first component of the proposed NRSRO definition would limit the definition to entities that issue publicly available credit ratings that are current assessments of the creditworthiness of obligors with respect to specific securities or money market instruments. a. Publicly Available Credit Ratings In the 2003 Concept Release, the Commission inquired whether it should address concerns that certain credit rating agencies make their ratings available only to paid subscribers and that it would be inappropriate to require users of credit ratings to subscribe for a fee to an NRSRO's services to obtain ratings for regulatory purposes. The majority of commenters agreed that credit rating agencies whose ratings are used for regulatory purposes under the Commission's rules and regulations should agree to make public dissemination of their ratings on a widespread basis at no cost.\56\ --------------------------------------------------------------------------- \56\ See, e.g., Letter from Denise Voigt Crawford, Securities Commissioner, Texas State Securities Board, to Jonathan G. Katz, Secretary, Commission (July 28, 2003). --------------------------------------------------------------------------- Commenters generally represented that the publication of credit ratings (i) enhances the transparency and efficiency of the market, (ii) helps prevent potential selective disclosure of material nonpublic information obtained by a credit rating agency under Regulation FD, and (iii) and allows for [[Page 21311]] ratings comparability.\57\ The commenters also said that a credit rating should not be considered to be ``publicly disseminated'' if access to it is not readily available on a widespread basis.\58\ --------------------------------------------------------------------------- \57\ See, e.g., Letter from Raymond McDaniel, President, Moody's, to Jonathan G. Katz, Secretary, Commission (July 28, 2003). \58\ Id. --------------------------------------------------------------------------- One commenter noted that a credit rating agency should not be required to disclose ratings to the public when there is a specific prior agreement between the credit rating agency and an issuer as to certain prescribed conditions for not publishing the issuer's rating (e.g., in the case of ``private'' ratings, in which a credit rating agency agrees to provide its rating of an issuer only to the issuer).\59\ Another commenter suggested that NRSROs should permit others, such as publishers of financial information, to freely distribute new rating information without limitations.\60\ One commenter also cautioned the Commission against involving itself in the determination of an NRSRO's pricing models.\61\ This commenter represented that NRSROs should be allowed to charge whatever price the market will bear.\62\ Another commenter expressed concern that requiring NRSROs to publish their credit ratings at no cost may result in higher prices for issuers and others who pay for an NRSRO's services.\63\ In response to these comments, the Commission is proposing that, in order to meet the definition of the term ``NRSRO,'' a credit rating agency must issue credit ratings that are publicly available. The Commission is also interpreting ``publicly available,'' as used in the definition, to mean that credit ratings used for regulatory purposes under Commission rules must be disseminated on a widespread basis at no cost. In this context, the rating could be published in a readily accessible manner on the credit rating agency's internet Web site. The Commission believes that it is important for credit ratings used for regulatory purposes to be publicly available, as public availability-- at no cost--should assure wide dissemination of ratings and provide the opportunity for the marketplace to judge the credibility and reliability of an entity's credit ratings. --------------------------------------------------------------------------- \59\ See, e.g., Letter from Yasuhiro Harada, Executive Vice President, Rating and Investment Information, Inc., to Jonathan G. Katz, Secretary, Commission (July 28, 2003). \60\ See, e.g., Letter from David Colling, Product Director, ABS Reports (UK) Limited), to Jonathan G. Katz, Secretary, Commission (July 31, 2003). \61\ See, e.g., Letter from James A. Kaitz, President and CEO, Association for Financial Professionals, to Jonathan G. Katz, Secretary, Commission (July 28, 2003). \62\ Id. \63\ See, e.g., Letter from Richard Raeburn, Chief Executive, and John Grout, Technical Director, The Association of Corporate Treasurers, United Kingdom, to Jonathan G. Katz, Secretary, Commission (August 8, 2003). --------------------------------------------------------------------------- This approach is consistent with the views of most commenters that it would be inappropriate to require users of credit ratings to subscribe for a fee to an NRSRO's services to obtain credit ratings for regulatory purposes. The Commission notes that in proposing to define the term ``NRSRO'' as an entity that makes its credit ratings publicly available, the public availability reference only would apply to the credit rating itself (i.e., the rating symbol), and not to other information otherwise developed by the credit rating agency (e.g., the credit rating agency's rating rationale). This approach should not result in NRSROs charging higher fees for their services because it would not require a credit rating agency to make available at no cost the analysis underlying its rating.\64\ The Commission notes that this approach is also consistent with the current practices of many credit rating agencies, including each of the current NRSROs, that already publish their credit ratings on a widespread basis at no cost. --------------------------------------------------------------------------- \64\ In connection with the Commission's review of issues concerning credit rating agencies, commenters have consistently represented that they typically subscribe to a rating agency's services primarily to understand the analysis underlying the rating agency's ratings--not solely for the credit rating itself. For example, during the Commission's 2002 credit rating agency hearings, representatives of users of credit ratings (e.g., from mutual fund companies and broker-dealers) indicated that they review research that is done by credit rating agencies to assess credit risk for the securities they purchase within their portfolios. See, e.g., SEC Hearing Transcript, supra note 30 (November 15, 2002) (testimony of Deborah A. Cunningham, Senior Vice President and Senior Portfolio Manager, Federated Investors, Inc., and testimony of Cynthia L. Strauss, Director of Taxable Bond Research, Fidelity Investments Money Management, Inc.). --------------------------------------------------------------------------- Questions: How should it be determined whether an NRSRO is making its credit ratings readily available on a widespread basis? Should our rule specify the manner and methods that must be used to distribute ratings? Should internet posting itself be sufficient? b. Issue-Specific Credit Opinions The Commission is aware that credit rating agencies often issue different types of credit ratings that can reflect, among other things, the creditworthiness of specific securities or obligations, or the general creditworthiness of specific entities. Because the Commission's regulatory use of the term ``NRSRO'' primarily relates to credit ratings on specific securities or obligations, the Commission, in its proposed definition of the term ``NRSRO,'' is limiting the availability of the NRSRO concept to entities that issue such ratings. The Commission is proposing to clarify this element of the proposed NRSRO definition because credit rating agencies that do not issue credit ratings on specific securities, but instead issue credit ratings on the general creditworthiness of specific entities, have requested NRSRO no-action relief. The risk of loss on different debt instruments of the same issuer can vary considerably depending on the terms written into a security's legal documentation. Therefore, applying a single ``issuer'' rating to all of an issuer's outstanding debt instruments could be misleading, in the context of the regulatory use of NRSRO ratings, and have adverse regulatory implications. Questions: Should a credit rating agency that does not rate specific securities or money market instruments be included in the definition of NRSRO? If so, under what circumstances? c. Current Credit Opinions The proposed definition also attempts to ensure that only ``current'' credit ratings--meaning that such ratings are actively monitored and updated appropriately on a continuous basis--be used for regulatory purposes under the federal securities laws. The Commission believes that credit ratings used for regulatory purposes should be actively monitored on a continuous basis and confirmed, upgraded, or downgraded, if and when necessary. The Commission's reliance on credit ratings from a credit rating agency that are not current, and thus, may not even reflect the credit rating agency's own view as to the creditworthiness of a security, could interfere with the intended regulatory uses of the NRSRO rating. The first component of the proposed definition would require a credit rating agency to issue credit ratings that are ``current assessments'' of the creditworthiness of specific securities or money market instruments. This component may help to ensure that persons relying on a rating for regulatory purposes in Commission rules and regulations can have confidence, at any given time, that the rating reflects the credit rating agency's current view. Under the proposed definition, the Commission would interpret ``current assessments'' to mean that a credit rating agency's published credit ratings reflect its opinion as to the creditworthiness of a security or money [[Page 21312]] market instrument as of the time the rating was issued and until the rating is changed or withdrawn. Under this interpretation, a credit rating agency could meet the ``current assessments'' element of the proposed definition if it has and follows procedures designed to ensure that its ratings are reviewed and, if necessary, updated on the occurrence of material events, including significant sector or issue- specific events. By including in the NRSRO definition that a credit rating agency's ratings need to be ``current assessments,'' the Commission is responding to comments received in response to the 2003 Concept Release that a requirement that NRSRO ratings be kept ``current'' is desirable.\65\ --------------------------------------------------------------------------- \65\ See, e.g., supra note 63. --------------------------------------------------------------------------- Further, although the Commission is proposing to define the term ``NRSRO'' to require an NRSRO's ratings to be current, the Commission is not proposing to prescribe a specific time period within which an NRSRO's ratings would need to be updated. Specifying a time period within which a credit rating agency must update or affirm a rating might be problematic because the appropriate time period for responding to a material event may vary considerably based on, for example, the complexity of an issuer or the specific security being rated. Accordingly, it may be appropriate for a credit rating agency to have the flexibility to respond to material events relating to its ratings on a case-by-case basis. This approach responds to comments that the Commission should not set detailed standards as to when a rating agency should update its ratings.\66\ --------------------------------------------------------------------------- \66\ See, e.g., supra note 59. --------------------------------------------------------------------------- Questions: Should the Commission provide additional interpretation regarding what it means for a credit rating agency's credit ratings to be ``current assessments''? Should the Commission specify the time period? Will the proposed rule's provisions provide sufficient assurance to the markets that ratings are current? 2. The Second Component a. General Acceptance in the Financial Markets As discussed above, the notion that a credit rating agency be ``nationally recognized'' for purposes of the NRSRO concept was designed to ensure that credit ratings used for regulatory purposes are credible and reliable, and are reasonably relied upon by the marketplace. Responding to most commenters to the 2003 Concept Release that NRSRO status should be based primarily on a credit rating agency's wide acceptance in the marketplace, the second proposed component of the ``NRSRO'' definition focuses on whether a credit rating agency is generally accepted in the financial markets as an issuer of credible and reliable ratings by the predominant users of securities ratings. The Commission is proposing that the second component of the NRSRO definition require a credit rating agency to be generally accepted in the financial markets. Such acceptance would reflect the markets' belief in the credibility and reliability of the ratings provided by the credit rating agency and should provide some level of assurance to those relying on ratings with regard to the dependability and consistency of the ratings for a variety of regulatory purposes. For example, net capital calculations and haircuts that are determined through use of these credit ratings are more likely to be reliable than those determined without the use of such ratings and, thus, could be more likely to protect customers and other market participants from harm in the event of a broker-dealer failure. Further, linking the evaluation of a credit rating agency's ratings to the views of the predominant users of securities ratings would be helpful. Predominant users generally include financial market participants who hold large inventories of proprietary debt securities, preferred stock, and commercial paper, such as broker-dealers, mutual funds, pension funds, and insurance companies. These firms--given their large inventories of rated fixed income securities--generally have developed sophisticated internal credit rating departments which rate issuers and counterparties. However, they also rely on external ratings from credit rating agencies to compare against and test their internal rating and analysis. Given the importance of credit ratings to the business of these market participants, and to the stability of the financial markets as a whole, the Commission believes that incorporating their views into the definition of NRSRO provides a certain level of credibility and reliability to NRSRO ratings. The Commission proposes that a credit rating agency could meet the second component of the NRSRO definition through a variety of objective means. For example, in appropriate circumstances, a credit rating agency could do so through statistical data that demonstrates market reliance on the credit rating agency's ratings (e.g., market movements in response to ratings changes). A credit rating agency also might be able to satisfy the second component if authorized officers of users of securities ratings representing a substantial percentage of the relevant market attest that the credit rating agency's ratings are credible and actually relied on by the users. Questions: How else could the Commission define the term ``NRSRO'' in order for users of a credit rating agency's ratings to determine whether such ratings are credible and are reasonably relied upon by the marketplace? Are the approaches discussed above useful for determining whether a credit rating agency meets the second component of the proposed definition? Are there other types of information that would be appropriate? For example, should the fact that a credit rating agency has many subscribers support a finding that the credit rating agency satisfies the second component? What types of statistical data could be relied on to determine if a credit rating agency's credit ratings are relied on by the marketplace? What standards should be considered to assess such statistical data? Should the views of issuers be a relevant consideration in determining whether a credit rating agency meets the second component of the NRSRO definition? b. Limited Coverage NRSROs Commenters at both the Commission's credit rating agency hearings and responding to the 2003 Concept Release generally supported the idea that the definition of the term ``NRSRO'' could include credit rating agencies that confine their activities to limited sectors of the debt market or to limited (or largely non-U.S.) geographic areas. While several commenters suggested that the Commission distinguish between full- and limited-coverage NRSROs,\67\ others represented that credit rating agencies should only be able to meet the definition as full- coverage NRSROs because, in their view, it would be difficult for limited coverage NRSROs to provide a full and accurate assessment of credit risks without a broader expertise in credit risk assessment.\68\ --------------------------------------------------------------------------- \67\ Id. \68\ See, e.g., Letter from Jonathan C. Conley, Federated Investment Management Company, to Jonathan G. Katz, Secretary, Commission (July 28, 2003). --------------------------------------------------------------------------- Based on the staff's experience in issuing no-action letters to credit rating agencies, a credit rating agency that has developed a general acceptance in the financial markets for a limited sector of the debt market or a limited geographic area could meet the NRSRO definition. As noted in Section II.B., NRSRO no-action letters have been provided to [[Page 21313]] such firms in the past. In these instances, even though the credit rating agencies were generally accepted in the financial markets for a limited sector of the debt market or a limited geographic area, their market acceptance was based on the credibility and reliably of their ratings. Accordingly, the regulatory use of those ratings in Commission rules and regulations was appropriate and consistent with the purposes underlying the NRSRO concept. Questions: Should a credit rating agency that is recognized by the financial marketplace for issuing credible and reliable ratings within a limited sector or geographic area meet the NRSRO definition only for its ratings within such sector or geographic area, or more broadly? If a credit rating agency meets the NRSRO definition only with respect to its ratings within a particular sector or geographic area, would the NRSRO classification interfere with the credit rating agency's ability to expand its business? How should ratings from such an NRSRO be identified so that broker-dealers and other users of NRSRO ratings for regulatory purposes can determine which credit ratings from the NRSRO may be used for regulatory purposes? We noted above that commenters mentioned that it would be difficult for limited coverage NRSROs to provide a full and accurate assessment of credit risks without a broader expertise in credit risk assessment. We request further comment on this view given our proposal to permit limited coverage NRSROs. 3. The Third Component The third proposed component of the NRSRO definition is designed to ensure that to meet the definition of the term ``NRSRO,'' a credit rating agency uses systematic procedures designed to ensure credible and reliable ratings, manage conflicts of interest, and prevent the misuse of nonpublic information. It also addresses the need for credit rating agencies to have sufficient financial resources to ensure compliance with such procedures, if they are to meet the definition. The Commission preliminarily believes that including in the proposed definition the requirement that an entity use systematic rating procedures in producing credit ratings should help to ensure that NRSRO ratings are based on a thorough credit analysis of issuers and their financial obligations. This type of analysis should, in turn, assist the credit rating agency in producing credible and reliable ratings, which as discussed above, would further the purposes underlying the regulatory uses of NRSRO ratings. The Commission preliminarily believes that the following would be important for assessing whether a credit rating agency meets the third component of the proposed definition: (i) The experience and training of a firm's rating analysts (pertaining to the analysts' ability to understand and analyze relevant information); (ii) the average number of issues covered by analysts (relevant to whether analysts are capable of continuously monitoring and assessing relevant developments relating to their ratings); (iii) the information sources reviewed and relied upon by the credit rating agency and how the integrity of information utilized in the ratings process is verified (relating to the extent and quality of information upon which a firm's ratings are based); (iv) the extent of contacts with the management of issuers, including access to senior level management and other appropriate parties (pertaining to, among other things, the quality and credibility of an issuer's management and to attempt to better understand the issuer's financial and operational condition); (v) the organizational structure of the credit rating agency (to demonstrate, among other things, the firm's independence from the companies it rates and from potential conflicts of interest that may result from related businesses or those of an affiliate); (vi) how the credit rating agency identifies and manages or proscribes conflicts of interest affecting its ratings business; (vii) how the credit rating agency monitors and enforces compliance with its procedures designed to prohibit the misuse of material, nonpublic information; and (viii) the financial resources of the credit rating agency (regarding whether, among other things, a credit rating agency has sufficient financial resources to ensure that it maintains appropriate staffing levels to continuously monitor the issuers whose securities it rates and to operate independently of economic pressures or control from the companies it rates and from subscribers). a. Analyst Experience and Training There was no consensus among commenters to the 2003 Concept Release as to whether the experience and training of a credit rating agency's staff should be a factor in determining whether a credit rating agency is an NRSRO. Similarly, there was no consensus as to whether the Commission should include in an NRSRO definition minimum standards for the training and qualifications of the credit rating agency's credit analysts. Several commenters indicated that the competency of a credit rating agency's staff should be a relevant consideration in connection with being an NRSRO, and that experience and training of a credit rating agency's staff are of particular importance.\69\ Several commenters suggested that, to be an NRSRO, a credit rating agency should develop minimum standards for training and qualification of its analysts, and that compliance with such standards should be verified when assessing whether a credit rating agency is an NRSRO.\70\ There was also support among commenters that an NRSRO should take steps to verify whether members of its staff have been subject to disciplinary action by a financial (or other) regulatory authority.\71\ --------------------------------------------------------------------------- \69\ See, e.g., Letter from Mark Roemer, Finance Strategies, Siemens AG, to Commission (July 28, 2003). \70\ See, e.g., Letter from William M. Wells, Chief Financial Officer, Bunge Limited, to Commission (July 28, 2003). \71\ See, e.g., Letter from Joseph E. Cantwell, President, Cantwell & Company, to Commission (July 22, 2003). --------------------------------------------------------------------------- While several commenters were of the view that minimum training standards for NRSROs would be appropriate, a few indicated that oversight of training methods would add little value to the NRSRO concept.\72\ One commenter recommended that NRSROs should be required to disclose staff qualifications and staff size on a periodic basis.\73\ Several comment