
[Federal Register: June 25, 2008 (Volume 73, Number 123)]
[Proposed Rules]               
[Page 36211-36252]
From the Federal Register Online via GPO Access [wais.access.gpo.gov]
[DOCID:fr25jn08-46]                         


[[Page 36211]]

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Part III





Securities and Exchange Commission





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17 CFR Parts 240 and 249b



Proposed Rules for Nationally Recognized Statistical Rating 
Organizations; Proposed Rule


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SECURITIES AND EXCHANGE COMMISSION

17 CFR Parts 240 and 249b

[Release No. 34-57967; File No. S7-13-08]
RIN 3235-AK14

 
Proposed Rules for Nationally Recognized Statistical Rating 
Organizations

AGENCY: Securities and Exchange Commission (``Commission'').

ACTION: Proposed rule.

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SUMMARY: In the first of three related actions the Commission is 
proposing rule amendments that would impose additional requirements on 
nationally recognized statistical rating organizations (``NRSROs'') in 
order to address concerns about the integrity of their credit rating 
procedures and methodologies in the light of the role they played in 
determining credit ratings for securities collateralized by or linked 
to subprime residential mortgages. Second, the Commission also makes a 
proposal related to structured finance products rating symbology. And 
third, in the near future, the Commission intends to propose rule 
amendments that would be intended to reduce undue reliance in the 
Commission's rules on NRSRO ratings.

DATES: Comments should be received on or before July 25, 2008.

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 S7-13-08 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 Secretary, Securities 
and Exchange Commission, 100 F Street, NE., Washington, DC 20549-1090.

All submissions should refer to File Number S7-13-08. 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, 100 F Street, NE., Washington, DC 
20549, on official business days between the hours of 10 a.m. and 3 
p.m. 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 publicly available.

FOR FURTHER INFORMATION CONTACT: Michael A. Macchiaroli, Associate 
Director, at (202) 551-5525; Thomas K. McGowan, Assistant Director, at 
(202) 551-5521; Randall W. Roy, Branch Chief, at (202) 551-5522; Joseph 
I. Levinson, Attorney, at (202) 551-5598; Carrie A. O'Brien, Attorney, 
at (202) 551-5640; Sheila D. Swartz, Special Counsel, at (202) 551-
5545; Rose Russo Wells, Special Counsel, at (202) 551-5527; Division of 
Trading and Markets, Securities and Exchange Commission, 100 F Street, 
NE., Washington, DC 20549-6628 or, with respect to questions involving 
the proposed amendments as they implicate the Securities Act of 1933, 
Kathy Hsu, Special Counsel, at (202) 551-3306 or Eduardo Aleman, 
Special Counsel, at (202) 551-3646; Division of Corporation Finance, 
Securities and Exchange Commission, 100 F Street, NE, Washington, DC 
20549-3628.

SUPPLEMENTARY INFORMATION:

I. Background

A. Introduction

    Beginning in the early 2000s, originators started to increasingly 
make residential mortgage loans based on lower underwriting standards 
(``subprime loans'').\1\ For the first few years there did not appear 
to be any negative repercussions from this lending practice. However, 
beginning in mid-2006, home values leveled off and soon began to 
decline, which, in turn, led to a corresponding increase in 
delinquencies and, ultimately, defaults in subprime loans.\2\ This 
marked increase in subprime loan delinquencies and, ultimately, in 
defaults has had substantial adverse effects on the markets for, and 
market values and liquidity of, residential mortgage-backed securities 
(``RMBS'') backed by subprime loans and on collateralized debt 
obligations (``CDOs'') linked to such loans (collectively ``subprime 
RMBS and CDOs'').\3\
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    \1\ There is no standard definition of a subprime loan. However, 
such a loan can broadly be described as a mortgage loan that does 
not conform to the underwriting standards required for sale to the 
government sponsored enterprises (non-conforming loans) and are made 
to borrowers who: (1) Have weakened credit histories such as payment 
delinquencies, charge-offs, judgments, and bankruptcies; (2) have 
reduced repayment capacity as measured by credit scores (e.g., 
FICO), debt-to-income ratios, loan-to-value rations, or other 
criteria; (3) have not provided documentation to verify all or some 
of the information, particularly financial information, in their 
loan applications; or (4) have any combination of these factors. 
Non-conforming loans made to less risky borrowers fall into two 
other classifications: jumbo and Alt-A.
    \2\ See e.g., Testimony of John C. Dugan, Comptroller of the 
Currency, before the U.S. Senate Committee on Banking, Housing, and 
Urban Affairs (March 4, 2008) (``Dugan March 4, 2008 Senate 
Testimony''), pp. 8-12; Statement of Sheila C. Bair, Chairman, 
Federal Deposit Insurance Corporation, before U.S. Senate Committee 
on Banking, Housing, and Urban Affairs (March 4, 2008) (``Bair March 
4, 2008 Senate Statement''), pp. 5-6.
    \3\ See e.g., Dugan March 4, 2008 Senate Testimony, pp. 12-14; 
Bair March 4, 2008 Senate Statement, pp. 6-7.
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    Moreover, the impacts from the troubles experienced by subprime 
loans extended beyond subprime RMBS and CDOs to the broader credit 
markets and the economy as a whole.\4\ As a result, the parties that 
participated in various parts of the process of making subprime loans, 
packaging them into subprime RMBS and CDOs, and selling these debt 
instruments, including mortgage brokers, loan originators, securities 
sponsors and underwriters, and NRSROs have come under intense scrutiny. 
Today, the Commission is proposing a series of new requirements that 
are designed to address concerns that have been raised about NRSROs in 
light of the role they played in this process. Additionally, two weeks 
from today, the Commission will complete its proposal of this series of 
rule changes. These changes would be intended to reduce undue reliance 
in the Commission's rules on NRSRO ratings, thereby promoting increased 
investor due diligence.
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    \4\ See e.g., Statement of Ben S. Bernanke, Chairman, Board of 
Governors of the Federal Reserve System, before the U.S. Senate 
Committee on Banking, Housing, and Urban Affairs (February 28, 2008) 
(``Bernanke February 28, 2008 Senate Statement''), pp. 1-3; Dugan 
March 4, 2008 Senate Testimony, pp. 12-15.
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B. The Credit Rating Agency Reform Act of 2006

    The purpose of the Credit Rating Agency Reform Act of 2006 (the 
``Rating Agency Act''), enacted on September 29, 2006, is to ``improve 
ratings quality for the protection of investors and in the public 
interest by fostering accountability, transparency, and competition in 
the credit rating industry.'' \5\ The operative provisions of the 
Rating Agency Act became applicable upon the Commission's

[[Page 36213]]

adoption in June 2007 of a series of rules implementing a registration 
and oversight program for credit rating agencies that register as 
NRSROs.\6\
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    \5\ Report of the Senate Committee on Banking, Housing, and 
Urban Affairs to Accompany S. 3850, Credit Rating Agency Reform Act 
of 2006, S. Report No. 109-326, 109th Cong., 2d Sess. (Sept. 6, 
2006) (``Senate Report''), p. 1.
    \6\ See Oversight of Credit Rating Agencies Registered as 
Nationally Recognized Statistical Rating Organizations, Securities 
Exchange Act of 1934 (``Exchange Act'') Release No. 55857 (June 5, 
2007), 72 FR 33564 (June 18, 2007) (``Adopting Release''). The rules 
adopted by the Commission prescribe: how a credit rating agency must 
apply to the Commission for registration as an NRSRO (Rule 17g-1 (17 
CFR 240.17g-1)); the form of the application and the information 
that must be provided in the application (Form NRSRO and the 
Instructions to Form NRSRO (17 CFR 240.249b.300)); the records an 
NRSRO must make and maintain (Rule 17g-2 (17 CFR 240.17g-2)); the 
reports an NRSRO must furnish to the Commission annually (Rule 17g-3 
(17 CFR 240.17g-3)); the areas that must be addressed in an NRSRO's 
procedures to prevent the misuse of material nonpublic information 
(Rule 17g-4 (17 CFR 240.17g-4)); the types of conflicts of interest 
an NRSRO must disclose and manage or is prohibited from having (Rule 
17g-5 (17 CFR 240.17g-5)); and certain unfair, coercive, or abusive 
practices an NRSRO is prohibited from engaging in (Rule 17g-6 (17 
CFR 240.17g-6)).
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    To date, a total of nine credit rating agencies have been granted 
registration with the Commission as NRSROs pursuant to the Rating 
Agency Act and the rules thereunder.\7\ These registrants include the 
credit rating agencies most active in rating subprime RMBS and CDOs: 
Fitch Ratings, Inc. (``Fitch''), Moody's Investors Service 
(``Moody's''), and Standard and Poor's Rating Services (``S&P'').\8\ In 
the fall of 2007, the Commission, exercising the new authority 
conferred by the Rating Agency Act, began a staff examination of the 
NRSROs' activities in rating subprime RMBS and CDOs in order to review 
whether they adhered to their stated and documented procedures and 
methodologies for rating these debt instruments and the extent, if any, 
to which their ratings may have been impaired by conflicts of 
interest.\9\
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    \7\ See Commission Orders granting registration of A.M. Best 
Company, Inc. (34-56507, September 24, 2007), DBRS Ltd. (34-56508, 
September 24, 2007), Fitch, Inc. (34-56509, September 24, 2007), 
Japan Credit Rating Agency, Ltd, (34-56510, September 24, 2007), 
Moody's Investor Services, Inc. (34-56511, September 24, 2007), 
Rating and Investment Information, Inc. (34-56512, September 24, 
2007), Standard & Poor's Rating Services (34-56513, September 24, 
2007), Egan-Jones Rating Company (34-57031, December 21, 2007) and 
LACE Financial Corp. (34-57300, February 11, 2008).
    \8\ According to their most recent Annual Certifications on Form 
NRSRO, S&P rates 197,700 issuers of asset-backed securities, the 
category that includes RMBS, Moody's rates 110,000 such issuers, and 
Fitch rates 75,278 such issuers. No other registered NRSRO reports 
rating more than 1,000 issuers of asset-backed securities. See 
Standard & Poor's 2007 Annual Certification on Form NRSRO, available 
at http://www.standardandpoors.com; Moody's Investor Services 2007 
Annual Certification on Form NRSRO, available at http://
www.moodys.com; Fitch, Inc. 2007 Annual Certification on Form NRSRO, 
available at http://www.fitchratings.com.
    \9\ See Testimony of Christopher Cox, Chairman, Commission, 
before the U.S. Senate Committee on Banking, Housing, and Urban 
Affairs (April 22, 2008) (``Cox April 22, 2008 Senate Testimony''), 
pp. 2-3.
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    In addition to the examination, the Commission has worked closely 
with other regulators and supervisors of the financial markets in 
analyzing the credit market turmoil and in developing recommendations 
and principles for market participants, including NRSROs.\10\ For 
example, the President's Working Group on Financial Markets issued a 
Policy Statement on Financial Market Developments in March 2008.\11\ 
Further, as a member of the International Organization of Securities 
Commissions (``IOSCO''), the Commission played a substantial role in 
drafting The Role of Credit Rating Agencies in Structured Finance 
Markets, which was issued for consultation by IOSCO in March 2008.\12\ 
Also, the Commission, as part of its participation in the Financial 
Stability Forum, worked with its counterparts in the U.S. and abroad on 
The Report of the Financial Stability Forum on Enhancing Market and 
Institutional Resilience released in April 2008, which discussed credit 
rating agencies.\13\
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    \10\ See Id, p. 4.
    \11\ A copy of the policy statement is available at: http://
www.ustreas.gov.
    \12\ A copy of the report is available at: http://www.iosco.org.
    \13\ A copy of the report is available at: http://
www.fsforum.org.
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    These and other efforts have assisted the Commission in identifying 
a number of areas in which its current NRSRO rules could be augmented 
to address concerns about the role NRSROs played in the credit market 
turmoil.\14\ As a result, the Commission is proposing amendments to its 
existing NRSRO rules and a new rule with the goal of improving the 
quality of credit ratings determined by NRSROs generally and, in 
particular, for structured finance products such as RMBS and CDOs.\15\ 
These proposals and the proposals to be considered in two weeks are 
designed to:
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    \14\ See Cox April 22, 2008 Senate Testimony, pp. 6-8.
    \15\ The term ``structured finance product'' as used throughout 
this release refers broadly to any security or money market 
instrument issued by an asset pool or as part of any asset-backed or 
mortgage-backed securities transaction. This broad category of 
financial instrument includes, but is not limited to, asset-backed 
securities (``ABS'') such as RMBS and to other types of structured 
debt instruments such as CDOs, including synthetic and hybrid CDOs.
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     Enhance the disclosure and comparability of credit ratings 
performance statistics;
     Increase the disclosure of information about structured 
finance products;
     Require more information about the procedures and 
methodologies used to determine credit ratings for structured finance 
products;
     Strengthen internal control processes through reporting 
requirements; and
     Address conflicts of interest arising from the process of 
rating structured finance products; and
     Reduce undue reliance in the Commission's rules on NRSRO 
ratings, thereby promoting increased investor due diligence.
    The Commission believes these proposals would further the purpose 
of the Rating Agency Act to improve the quality of NRSRO credit ratings 
by fostering accountability, transparency, and competition in the 
credit rating industry.\16\
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    \16\ See Senate Report, p. 2.
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C. The Role of Credit Ratings in the Credit Market Turmoil

    The growth in the origination of subprime loans began in the early 
2000s.\17\ For example, Moody's reports that subprime loans amounted to 
$421 billion of the $3.038 trillion in mortgages originated in 2002 
(14%) and $640 billion of the $2.886 trillion in mortgages originated 
in 2006 (22%).\18\ This growth was facilitated by steadily rising home 
values and a low interest rate environment.\19\ In addition, increases 
in the breadth of the credit risk transfer markets as a result of new 
investors willing to purchase credit based structured finance products 
provided an opportunity for lenders to originate subprime loans and 
then move them off their balance sheets by packaging and selling them 
through the securitization process to investors as subprime RMBS and 
CDOs.\20\ The investors in subprime RMBS and CDOs included domestic and 
foreign mutual funds, pension funds, hedge funds, banks, insurance 
companies, special investment vehicles, and state government operated 
funds.
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    \17\ See e.g., Statement of Sheila C. Bair, Chairman, Federal 
Deposit Insurance Corporation, before U.S. Senate Committee on 
Banking, Housing, and Urban Affairs (January 31, 2008) (``Bair 
January 31, 2008 Senate Statement''), p. 4.
    \18\ According to Moody's, subprime mortgage loans represented 
$421 billion of $3.038 trillion total mortgage origination in 2002 
and $640 billion of $2.886 trillion total mortgage origination in 
2006. See A Short Guide to Subprime, Moody's, March 25, 2008, p. 1.
    \19\ See e.g., Dugan March 4, 2008 Senate Testimony, pp. 8-11.
    \20\ Id.
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    This ``originate to distribute'' business model created demand for 
residential

[[Page 36214]]

mortgage loans, including subprime loans. For example, according to 
Moody's, of the approximately $2.5 trillion worth of mortgage loans 
originated in 2006, $1.9 trillion were securitized into RMBS and 
approximately 25%, or $520 billion worth, of these loans were 
categorized as subprime.\21\ The demands of the loan securitization 
markets encouraged lenders to lower underwriting standards to maintain 
a steady volume of loans and to use less traditional products such as 
adjustable rate, negative amortization, and closed-end second lien 
mortgages.\22\
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    \21\ Subprime Residential Mortgage Securitizations: Frequently 
Asked Questions, Moody's, April 19, 2007, p. 1.
    \22\ See e.g., Bernanke February 28, 2008 Senate Testimony, p. 
1; Dugan March 4, 2008 Senate Testimony, pp. 8-10.
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1. The Creation of Subprime RMBS and CDOs
    The creation of an RMBS begins by packaging a pool of mortgage 
loans, usually numbering in the thousands, and transferring them to a 
bankruptcy remote trust. The trust purchases the loan pool and becomes 
entitled to the interest and principal payments made by the borrowers. 
The trust finances the purchase of the loan pool through the issuance 
of RMBS. The monthly interest and principal payments from the loan pool 
are used to make monthly interest and principal payments to the 
investors in the RMBS.
    The trust typically issues different classes of RMBS (known as 
``tranches'') offering a sliding scale of coupon rates based on the 
level of credit protection afforded to the security. Credit protection 
is designed to shield the tranche securities from loss of interest and 
principal arising from defaults of the loans backing the RMBS. The 
degree of credit protection afforded a tranche security is known as its 
``credit enhancement'' and is provided through several means. The 
primary source of credit enhancement is subordination, which creates a 
hierarchy of loss absorption among the tranche securities. For example, 
if a trust issued securities in 10 different tranches of securities, 
the first (or senior) tranche would have nine subordinate tranches, the 
next highest tranche would have eight subordinate tranches and so on 
down the capital structure. Losses of interest and principal 
experienced by the trust from delinquencies and defaults among loans in 
the pool are allocated first to the lowest tranche until its principal 
amount is exhausted and then to the next lowest tranche and so on up 
the capital structure. Consequently, the senior tranche would not incur 
any loss until the principal amounts from all the lower tranches have 
been exhausted through the absorption of losses from the underlying 
loans.
    A second form of credit enhancement is over-collateralization, 
which is the amount that the principal balance of the mortgage pool 
underlying the trust exceeds the principal balance of the tranche 
securities issued by the trust. This excess principal creates an 
additional ``equity'' tranche below the lowest tranche security to 
absorb losses. In the example above, the equity tranche would sit below 
the 10th tranche security and protect it from the first losses 
experienced as a result of defaulting loans.
    A third form of credit enhancement is excess spread, which consists 
of the amount by which the interest derived from the underlying loans 
in the aggregate exceeds interest payments due to investors in the 
tranche securities in the aggregate plus the administrative expenses of 
the trust such as fees due the loan servicer as well as premiums due on 
derivatives contracts and bond insurance. In other words, the excess 
spread is the amount that the monthly interest income from the pool of 
loans exceeds the weighted average interest due to the RMBS 
bondholders. This excess spread can be used to build up loss reserves 
or pay off delinquent interest payments due to a tranche security.
    A fourth form of credit enhancement sometimes employed is bond 
insurance. When used, bond insurance is typically purchased only for 
the senior RMBS tranche.
    The creation of a typical CDO is similar to that of an RMBS. A 
bankruptcy remote trust is created to hold the CDO's assets and issue 
its securities. The underlying assets, however, are generally debt 
securities rather than mortgage loans. The CDO trust uses the interest 
and principal payments from the approximately 200 underlying debt 
securities to make interest and principal payments to investors in the 
securities issued by the trust. The trust is structured to provide 
differing levels of credit enhancement to the securities it issues. 
Similar to RMBS, credit enhancement is provided through subordination, 
over-collateralization, excess spread, and bond insurance. In addition 
to the underlying assets, one significant difference between a CDO and 
an RMBS is that the CDO may be actively managed such that its 
underlying assets change over time, whereas the mortgage loan pool 
underlying an RMBS remains static for the most part.
    In recent years, CDOs have been some of the largest purchasers of 
subprime RMBS and the drivers of demand for those securities. For 
example, according to Fitch, the average percentage of subprime RMBS in 
the collateral pools of CDOs it rated grew from 43.3% in 2003 to 71.3% 
in 2006.\23\ Generally, the CDOs holding subprime RMBS issued fell into 
one of two categories: High grade and mezzanine. High grade CDOs are 
generally defined as those that hold RMBS tranches with AAA, AA, or A 
credit ratings, whereas mezzanine CDOs are those that hold RMBS 
tranches rated predominantly BBB. Securities issued by mezzanine CDOs 
pay higher yields than those issued by high grade CDOs since the BBB-
rated RMBS underlying the mezzanine CDOs pay higher yields than the AAA 
to A rated RMBS underlying high grade CDOs. In addition to CDOs holding 
subprime RMBS, a market for CDOs holding other CDOs that held subprime 
RMBS developed in recent years. These debt instruments are known as 
``CDOs-squared.''
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    \23\ Rating Stability of Fitch-Rated Global Cash Mezzanine 
Structured Finance CDOs with Exposure to U.S. Subprime RMBS, Fitch, 
April 2, 2007, p. 1.
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    As the market for mortgage related CDOs grew, CDO issuers began to 
use credit default swaps to replicate the performance of subprime RMBS 
and CDOs. In this case, rather than purchasing subprime RMBS or CDOs, 
the CDO entered into credit default swaps referencing subprime RMBS or 
CDOs, or indexes on RMBS. These CDOs, in some cases, are composed 
entirely of credit default swaps (``synthetic CDOs'') or a combination 
of credit default swaps and cash RMBS (``hybrid CDOs''). The use of 
credit default swaps allowed the CDO securities to be issued more 
quickly, since the issuer did not have to wait to accumulate actual 
RMBS for the underlying collateral pool.
2. Determining Credit Ratings for Subprime RMBS and CDOs
    A key step in the process of creating and ultimately selling a 
subprime RMBS and CDO is the issuance of a credit rating for each of 
the tranches issued by the trust (with the exception of the most junior 
``equity'' tranche). The credit rating for each rated tranche indicated 
the credit rating agency's view as to the creditworthiness of the debt 
instrument in terms of the likelihood that the issuer would default on 
its obligations to make interest and principal payments on the debt 
instrument.\24\ To varying degrees,

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many investors rely on credit ratings in making the decision to 
purchase subprime RMBS or CDOs, particularly with respect to the senior 
AAA rated tranches. Some investors use the credit ratings to assess the 
risk of the debt instruments. In part, this may be due to the large 
number of debt instruments in the market and their complexity. Other 
investors use credit ratings to satisfy client investment mandates 
regarding the types of securities they can invest in or to satisfy 
regulatory requirements based on certain levels of credit ratings, or a 
combination of these conditions. Moreover, investors typically only 
have looked to ratings issued by Fitch, Moody's, and S&P, which causes 
the arrangers \25\ of the subprime RMBS and CDOs to use these three 
NRSROs to obtain credit ratings for the tranche securities they brought 
to market.
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    \24\ See, e.g., Inside the Ratings: What Credit Ratings Mean, 
Fitch, August 2007 (``Inside the Ratings''), p. 2; Testimony of 
Michael Kanef, Group Managing Director, Moody's Investors Service, 
Before the United States Senate Committee on Banking, Housing, and 
Urban Affairs (September 26, 2007) (``Kanef September 26, 2007 
Senate Testimony''), p. 2; Principles-Based Rating Methodology For 
Global Structured Finance Securities, S&P, May 29, 2007, p. 3. Since 
credit ratings are issued for tranches of RMBS and CDOs 
individually, rather than for the issuers of those tranches, the 
NRSRO credit ratings are estimates of the probability of default of 
each RMBS or CDO tranche as an independent instrument.
    \25\ As bankruptcy remote stand-alone legal entities, RMBS and 
CDO trusts had no employees. Consequently, they relied on third-
parties to create and manage them. The term ``arranger'' is used 
herein to refer to the party that oversees the creation of the RMBS 
and CDO, which would include the process of obtaining credit ratings 
for the various tranches. Frequently, the arranger also served as 
the underwriter of the securities.
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    The procedures followed by these three NRSROs in developing ratings 
for subprime RMBS are generally similar. The arranger of the RMBS 
initiates the rating process by sending the credit rating agency a 
range of data on each of the subprime loans to be held by the trust 
(e.g., principal amount, geographic location of the property, credit 
history and FICO score of the borrower, ratio of the loan amount to the 
value of the property, and type of loan: First lien, second lien, 
primary residence, secondary residence), the proposed capital structure 
of the trust, and the proposed levels of credit enhancement to be 
provided to each RMBS tranche issued by the trust. Upon receipt of the 
information, the NRSRO assigns a lead analyst who is responsible for 
analyzing the loan pool, proposed capital structure, and proposed 
credit enhancement levels and, ultimately, for formulating a ratings 
recommendation for a rating committee composed of analysts and/or 
senior-level personnel not involved in the analytic process.
    The next step in the ratings process is the development of 
predictions, based on a quantitative expected loss model and other 
qualitative factors, as to how many of the loans in the collateral pool 
would default under stresses of varying severity. This analysis also 
includes assumptions as to how much principal would be recovered after 
a defaulted loan is foreclosed. Each NRSRO generally uses between 40 
and 60 specific credit characteristics to analyze each loan in the 
collateral pool of an RMBS in order to assess the potential future 
performance of the loan under various possible scenarios. These 
characteristics include the loan information described above as well as 
the amount of equity that the borrowers have in their homes, the amount 
of documentation provided by borrowers to verify their assets and/or 
income levels, and whether the borrowers intend to rent or occupy the 
homes.\26\
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    \26\ See, e.g., Kanef September 26, 2007, Senate Testimony, p. 
7.
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    The purpose of this loss analysis is to determine how much credit 
enhancement a given tranche security would need for a particular 
category of credit rating. The severest stress test (i.e., the one that 
would result in the greatest number of defaults among the underlying 
loans) is run to determine the amount of credit enhancement required 
for an RMBS tranche issued by the trust to receive an AAA rating. For 
example, this test might result in an output that predicted that under 
the ``worst case'' scenario, 40 percent of the loans in the underlying 
pool would default and that after default the trust would recover only 
50 percent of the principal amount of each loan in foreclosure. 
Consequently, to get an AAA rating, an RMBS tranche security issued by 
the trust would need credit enhancement sufficient to cover at least 20 
percent of the principal amount of all the RMBS tranches issued by the 
trust. In other words, absent other forms of credit enhancement such as 
excess spread, at least 20 percent of the principal amount of the RMBS 
tranches issued by the trust, including the equity tranche, would have 
to be subordinate to the senior tranche and, therefore, obligated to 
absorb the losses resulting from 40% of the underlying loans 
defaulting.\27\ The next severest stress test is run to determine the 
amount of credit enhancement required of the AA tranche and so on down 
the capital structure. The lowest rated tranche (typically BB or B) is 
analyzed under a more benign market scenario. Consequently, its 
required level of credit enhancement--typically provided primarily or 
exclusively by a subordinate equity tranche--is based on the number of 
loans expected to default in the normal course given the lowest 
possible level of macroeconomic stress.
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    \27\ To the extent that the RMBS included other forms of credit 
enhancement besides the subordination and over-collateralization 
provided in this example, e.g., excess spread, this 20 percent 
subordination figure would be reduced accordingly.
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    Following the determination of the level of credit enhancement 
required for each credit rating category, the next step in the ratings 
process is to check the proposed capital structure of the RMBS against 
these requirements. For example, if the proposed structure would create 
a senior RMBS tranche that had 18 percent of the capital structure 
subordinate to it (the other RMBS tranches, including, as applicable, 
an equity tranche), the analyst reviewing the transaction might 
conclude that based on the output of the loss model the senior tranche 
should be rated AA since it would need 20 percent subordination to 
receive an AAA credit rating. Additionally, the analyst could take 
other factors into consideration such as the quality of the loan 
servicer or the actual performance of similar pools of loans underlying 
other RMBS trusts to determine that in this case 18 percent 
subordination would be sufficient to support an AAA rating (to the 
extent these factors were not covered by the model).
    Typically, if the analyst concludes that the capital structure of 
the RMBS did not support the desired ratings--in the example above, if 
it determined that 18 percent credit enhancement is insufficient for 
the desired AAA rating--this preliminary conclusion would be conveyed 
to the arranger. The arranger could accept that determination and have 
the trust issue the securities with the proposed capital structure and 
the lower rating or adjust the structure to provide the requisite 
credit enhancement for the senior tranche to get the desired AAA rating 
(e.g., shift 2 percent of the principal amount of the senior tranche to 
a lower tranche or add or remove certain mortgages from the proposed 
asset pool). Generally, arrangers aim for the largest possible senior 
tranche, i.e., to provide the least amount of credit enhancement 
possible, since the senior tranche--as the highest rated tranche--pays 
the lowest coupon rate of the RMBS' tranches and, therefore, costs the 
arranger the least to fund.
    The next step in the process is a cash flow analysis on the 
interest and principal expected to be received by the trust from the 
pool of subprime loans to determine whether it will be sufficient to 
pay the interest and principal due on each RMBS tranche issued by the 
trust. The NRSROs use quantitative cash flow

[[Page 36216]]

models that analyze the amount of principal and interest payments 
expected to be generated from the loan pool each month over the terms 
of the RMBS tranche securities under various stress scenarios. The 
outputs of this model are compared against the priority of payments 
(the ``waterfall'') to the RMBS tranches specified in the trust legal 
documents. The waterfall documentation could specify over-
collateralization and excess spread triggers that, if breached, would 
reallocate principal and interest payments from lower tranches to 
higher tranches until the minimum levels of over-collateralization and 
excess spread were reestablished. Ultimately, the monthly principal and 
interest payments derived from the loan pool need to be enough to 
satisfy the monthly payments of principal and interest due by the trust 
to the investors in the RMBS tranches as well as to cover the 
administrative expenses of the trust.
    In addition to expected loss and cash flow analysis, the analysts 
review the legal documentation of the trust to evaluate whether it is 
bankruptcy remote, i.e., isolated from the effects of any potential 
bankruptcy or insolvency of the arranger. They also review operational 
and administrative risk associated with the trust, using the results of 
periodic examinations of the principal parties involved in the issuance 
of the security, including the mortgage originators, the issuer of the 
security, the servicer of the mortgages in the loan pool, and the 
trustee.\28\ In assessing the servicer, for example, an NRSRO might 
review its past performance with respect to loan collection, billing, 
recordkeeping, and the treatment of delinquent loans.
---------------------------------------------------------------------------

    \28\ Principal parties are not rated de novo in each RMBS 
transaction; rather, each NRSRO has its own procedures and schedules 
for reviewing those parties on a periodic basis in order to 
incorporate its assessment of those entities into the rating 
process.
---------------------------------------------------------------------------

    Following these steps, the analyst develops a rating recommendation 
for each RMBS tranche, which then is presented to a rating committee 
composed of analysts and/or senior-level personnel not involved in the 
analytic process. The rating committee votes on the ratings for each 
tranche and usually approaches the arranger privately to notify it of 
the ratings decisions. In most cases, an arranger can appeal a rating 
decision, although the appeal is not always granted (and, if granted, 
may not necessarily result in any change in the rating decision). Final 
ratings decisions are published and subsequently monitored through 
surveillance processes. The NRSRO typically is paid only if the credit 
rating is issued, though sometimes it receives a breakup fee for the 
analytic work undertaken even if the credit rating is not issued.
    The process for assigning ratings to subprime CDOs also involves a 
review of the creditworthiness of each tranche of the CDO. As with 
RMBS, the process centers on an examination of the pool of assets held 
by the trust and analysis of how they would perform individually and in 
correlation during various stress scenarios. However, this analysis is 
based primarily on the credit rating of each RMBS or CDO in the 
underlying pool or referenced through a credit default swap entered 
into by the CDO. In other words, the credit rating is the primary 
characteristic of the underlying debt instruments that the NRSROs take 
into consideration when performing their loss analysis. Hence, this 
review of the debt instruments in the collateral pool and the potential 
correlations among those securities does not ``look through'' those 
securities to their underlying asset pools. The analysis, consequently, 
generally only goes one level down to the credit ratings of the 
underlying instruments or reference securities.
    CDOs collateralized by RMBS or by other CDOs often are actively 
managed. Consequently, there can be frequent changes to the composition 
of the cash assets (RMBS or CDOs), synthetic assets (credit default 
swaps), or combinations of cash and synthetic assets in the underlying 
pool. As a result, NRSRO ratings for managed CDOs are based not on the 
closing date composition of the pool but instead on covenanted limits 
for each potential type of asset that could be put in the pool. 
Typically, following a post-closing period in which no adjustments can 
be made to a CDO's collateral pool, the CDO's manager has a 
predetermined period of several years in which to adjust that asset 
pool through various sales and purchases pursuant to covenants set 
forth in the CDO's indenture. These covenants set limitations and 
requirements for the collateral pools of CDOs, often by establishing 
minimum and maximum concentrations for certain types of securities or 
certain ratings.
    NRSROs use a CDO's indenture guidelines to run ``worst-case'' 
scenarios based on the various permutations of collateral permitted 
under the indenture. For example, an indenture might specify that a 
CDO's collateral pool must include between 10 and 20 percent AAA-rated 
subprime RMBS, with the remaining 80 to 90 percent composed of 
investment-grade, but not AAA, subprime RMBS. In preparing a rating for 
that CDO, an NRSRO will run its models based on all possible collateral 
pools permissible under the indenture guidelines, placing the most 
weight on the results from the weakest potential pools (i.e., the 
minimum permissible amount, 10 percent, of AAA-rated securities and the 
lowest-rated investment grade securities for the remaining 90 percent). 
As with RMBS ratings, the model results are then compared against the 
capital structure of the proposed CDO to confirm that the level of 
subordination, over-collateralization and excess spread available to 
each tranche provides the necessary amount of credit enhancement to 
sustain a particular rating.
3. The Downgrades in Credit Ratings of Subprime RMBS and CDOs
    As noted above, the development of the credit risk transfer markets 
gave rise to an ``originate to distribute'' model whereby mortgage 
loans are originated with the intent to securitize them. Under this 
model, arrangers earn fees from originating, structuring, and 
underwriting RMBS and servicing the loans underlying the RMBS, as well 
as frequently a third set of fees from structuring, underwriting, and 
managing CDOs composed of RMBS. Moreover, the yields offered by 
subprime RMBS and CDO tranches (as compared to other types of similarly 
rated debt instruments) led to increased investor demand for these debt 
instruments. The originate to distribute model creates incentives for 
originating high volumes of mortgage loans while simultaneously 
reducing the incentives to maintain high underwriting standards for 
making such loans. The continued growth of the housing market through 
2006, which led to increased competition among lenders, also 
contributed to looser subprime loan underwriting standards.\29\
---------------------------------------------------------------------------

    \29\ See e.g., Dugan March 4, 2008 Senate Testimony, p. 10; 
Bernanke February 28, 2008 Senate Testimony, p. 1.
---------------------------------------------------------------------------

    By mid-2006, however, the steady rise in home prices that had 
fueled this growth in subprime lending came to an end as prices began 
to decline.\30\ Moreover, widespread areas of the country began to 
experience declines whereas, in the past, poor housing markets 
generally had been confined to distinct geographic areas.\31\ The 
downturn in the housing market has been accompanied by a marked 
increase

[[Page 36217]]

in delinquencies and defaults of subprime loans.\32\
---------------------------------------------------------------------------

    \30\ See e.g., Id; Bair March 4, 2008 Senate Statement, pp. 5-8; 
Bair January 31, 2008 Senate Statement, p. 3.
    \31\ See e.g., Bair January 31, 2008 Senate Statement, p. 3.
    \32\ Id.
---------------------------------------------------------------------------

    The increases in delinquency and default rates have been 
concentrated in loans made in 2006 and 2007, which indicates that 
borrowers have been falling behind within months of the loans being 
made.\33\ For example, by the fourth quarter of 2006, the percentage of 
subprime loans underlying RMBS rated by Moody's that were in default 
within six months of the loans being made stood at 3.54 percent, nearly 
four times the average six month default rate of 0.90 percent between 
the first quarter of 2002 and the second quarter of 2005. Similarly, 
default rates for subprime loans within 12 months of the loans being 
made rose to 7.39 percent as compared to 2.00 percent for the period 
from the first quarter of 2002 through the second quarter of 2005.\34\ 
Figures released by S&P show similar deterioration in the performance 
of recent subprime loans.\35\ According to S&P, the serious delinquency 
rate \36\ for subprime loans underlying RMBS rated by S&P within twelve 
months of the initial rating was 4.97 percent of the current aggregate 
pool balance for subprime RMBS issued in 2005, 10.55 percent for 
subprime RMBS issued in 2006, and 15.19 percent for subprime RMBS 
issued in 2007.\37\
---------------------------------------------------------------------------

    \33\ See e.g., Bair March 24, 2008 Senate Statement, p. 6 
(``Serious delinquency rates on subprime mortgages securitized in 
2006 are significantly higher than those for any of the previous 
three years.'').
    \34\ Early Defaults Rise in Mortgage Securitizations: Updated 
Data Show Continued Deterioration, Moody's, September 19, 2007, pp. 
3-4.
    \35\ U.S. Subprime RMBS Performance Update: January 2008 
Distribution Date, S&P, February 25, 2008, p. 1.
    \36\ Defined as 90-plus day delinquencies, foreclosures, and 
real estate owned. Id.
    \37\ Id.
---------------------------------------------------------------------------

    Along with the deterioration in the performance of subprime loans, 
there has been an increase in the losses incurred after the loans are 
foreclosed. According to S&P, the actual realized losses on loans 
underlying 2007 subprime RMBS after 12 months of seasoning were 65 
percent higher than the losses recorded for RMBS issued in 2006 at the 
same level of seasoning.\38\
---------------------------------------------------------------------------

    \38\ Id.
---------------------------------------------------------------------------

    The rising delinquencies and defaults in subprime loans backing the 
RMBS rated by the NRSROs has exceeded the projections on which they 
based their initial ratings. Furthermore, the defaults and foreclosures 
on subprime loans have resulted in realizable losses to the lower RMBS 
tranches backed by the loans and, correspondingly, to the lower CDO 
tranches backed by those RMBS. As discussed above, the reduction in the 
amount of monthly principal and interest payments coming from the 
underlying pool of subprime loans or, in the case of a CDO, RMBS 
tranches or other CDO tranches is allocated to the tranches in 
ascending order. In addition to directly impairing the affected 
tranche, the losses--by reducing the principal amount of these 
tranches--decreased the level of subordination protecting the more 
senior tranches. In other words, losses suffered by the junior tranches 
of an RMBS or CDO directly reduced the level of credit enhancement--the 
primary factor considered by NRSROs in rating tranched securities--
protecting the senior tranches of the instrument. These factors have 
caused the NRSROs to reevaluate, and in many cases downgrade, their 
ratings for these instruments.
     As of February 2008, Moody's had downgraded at least one 
tranche of 94.2 percent of the subprime RMBS deals it rated in 2006 
(including 100 percent of 2006 RMBS deals backed by subprime second-
lien mortgage loans) and 76.9 percent of all subprime RMBS deals it 
rated in 2007. Overall, 53.7 percent and 39.2 percent of 2006 and 2007 
tranches, respectively, had been downgraded by that time. RMBS tranches 
backed by first lien loans issued in 2006 were downgraded an average of 
6.0 notches from their original ratings, while RMBS tranches backed by 
second-lien loans issued that year were downgraded 9.7 notches on 
average. The respective figures for 2007 first- and second-lien backed 
tranches were 5.6 and 7.8 notches.\39\
---------------------------------------------------------------------------

    \39\ U.S. Subprime RMBS 2005-2007 Vintage Rating Actions Update: 
January 2008, Moody's, February 1, 2008, pp. 2-4.
---------------------------------------------------------------------------

     As of March 2008, S&P had downgraded 44.3 percent of the 
subprime RMBS tranches it had rated between the first quarter of 2005 
and the third quarter of 2007, including 87.2 percent of second-lien 
backed securities. Downgrades to subprime RMBS issued in 2005 averaged 
four to six notches, while the average for those issued in 2006 and 
2007 was 6.0 to 11 notches.\40\
---------------------------------------------------------------------------

    \40\ Transition Study: Structured Finance Rating Transition And 
Default Update as of March 21, 2008, S&P, March 28, 2008, pp. 2-3.
---------------------------------------------------------------------------

     As of December 7, 2007, Fitch had issued downgrades to 
1,229 of the 3,666 tranches of subprime RMBS issued in 2006 and the 
first quarter of 2007, representing a par value of $23.8 billion out of 
a total of $193 billion.\41\ Subsequently, on February 1, 2008, Fitch 
placed all subprime first-lien RMBS issued in 2006 and the first half 
of 2007, representing a total outstanding balance of approximately $139 
billion, on Rating Watch Negative.\42\
---------------------------------------------------------------------------

    \41\ U.S. RMBS Update, Fitch, February 20, 2008 p. 5.
    \42\ Update on U.S. Subprime and Alt-A: Performance And Rating 
Reviews, Fitch, March 20, 2008, p. 13.
---------------------------------------------------------------------------

    The extensive use of subprime RMBS in the collateral pools of CDOs 
has led to similar levels of downgrade rates for those securities as 
well. Moreover, the use of subprime RMBS as reference securities for 
synthetic CDOs magnified the effect of RMBS downgrades on CDO ratings. 
Surveillance of CDO credit ratings has been complicated by the fact 
that the methodologies used by the NRSROs to rate them relied heavily 
on the credit rating of the underlying RMBS or CDOs. Consequently, to 
adjust the CDO rating, the NRSROs first have needed to complete their 
reviews of the ratings for the underlying RMBS or adjust their 
methodologies to sufficiently account for the anticipated poor 
performance of the RMBS.\43\ Ultimately, the NRSROs have downgraded a 
substantial number of CDO ratings.
---------------------------------------------------------------------------

    \43\ For example, in November 2007, Fitch announced that in 
rating CDOs with asset pools which included subprime RMBS, it would 
adjust all subprime RMBS securities on Rating Watch Negative 
downwards by three categories--or notches--(six in the case of 2007 
subprime RMBS rated BBB+ or lower) before factoring them into a re-
assessment of the CDO's rating. See Global Criteria for the Review 
of Structured Finance CDOs With Exposure to U.S. Subprime RMBS, 
Fitch, November 15, 2007, p. 4.
---------------------------------------------------------------------------

     Over the course of 2007, Moody's issued 1,655 discrete 
downgrade actions (including multiple rating actions on the same 
tranche), which constituted roughly ten times the number of downgrade 
actions in 2006 and twice as many as in 2002, previously the most 
volatile year for CDOs. Further, the magnitude of the downgrades 
(number of notches) was striking. The average downgrade was roughly 
seven notches as compared to a previous average of three to four 
notches prior to 2007. In the words of a March 2008 report by Moody's, 
``[T]he scope and degree of CDO downgrades in 2007 was unprecedented.'' 
\44\
---------------------------------------------------------------------------

    \44\ 2008 U.S. CDO Outlook and 2007 Review, Moody's, March 3, 
2008, p. 6.
---------------------------------------------------------------------------

     As of April 1, 2008, S&P had downgraded 3,068 tranches 
from 705 CDO transactions, totaling $321.9 billion in issuance, and 
placed 443 ratings from 119 transactions, with a value of $33.8 
billion, on CreditWatch negative, ``as a result of stress in the

[[Page 36218]]

U.S. residential mortgage market and credit deterioration of U.S. 
RMBS.'' \45\
---------------------------------------------------------------------------

    \45\ 86 Ratings Lowered On 20 U.S. CDOs Of ABS Deals; $9.107 
Billion In Issuance Affected, S&P, April 1, 2008, p. 1.
---------------------------------------------------------------------------

     By mid-December, 2007, Fitch had issued downgrades to 158 
of the 431 CDOs it had rated with exposure to RMBS.\46\ Among the 30 
CDOs with exposure to the subprime RMBS which ``suffered the greatest 
extent and magnitude of negative rating migration,'' all but $82.7 
million of the $20.7 billion in balance was downgraded.\47\
---------------------------------------------------------------------------

    \46\ Summary of Global Structured Finance CDO Rating Actions, 
Fitch, December 14, 2007, p. 1.
    \47\ Id., p. 6.
---------------------------------------------------------------------------

    The scope and magnitude of these downgrades has caused a loss of 
confidence among investors in the reliability of RMBS and CDO credit 
ratings issued by the NRSROs.\48\ This lack of confidence in the 
accuracy of NRSRO ratings has been a factor in the broader dislocation 
in the credit markets.\49\ For example, the complexity of assessing the 
risk of structured finance products and the lack of commonly accepted 
methods for measuring the risk has caused investors to leave the 
market, including the market for AAA instruments, particularly 
investors that had relied primarily on NRSRO credit ratings in 
assessing whether to purchase these instruments.\50\ This has had a 
significant impact on the liquidity of the market for these 
instruments.\51\
---------------------------------------------------------------------------

    \48\ See, e.g., Dugan March 4, 2008 Senate Testimony, p. 13.
    \49\ Id., Bair March 4, 2008 Senate Statement, p. 7.
    \50\ Id., Bernanke February 28, 2008 Senate Testimony, p. 3.
    \51\ See, e.g., Dugan March 4, 2008 Senate Testimony, p. 13; 
Bair January 31, 2008 Senate Testimony, pp. 3-4.
---------------------------------------------------------------------------

    In the wake of these events, the NRSROs that rated subprime RMBS 
and CDOs have come under intense criticism and scrutiny. It has been 
suggested that changes may be needed to address the conflicts of 
interest inherent in the process of rating RMBS and CDOs.\52\ The 
NRSROs that have been the primary ratings providers for subprime RMBS 
and related CDOs each operate under an ``issuer-pays'' model in which 
they are paid by the arranger to rate a proposed RMBS or CDO. The 
arranger has an economic interest in obtaining the highest credit 
rating possible for each security issued by the trust and the NRSRO has 
an economic interest in having the arranger select it to rate the next 
RMBS or CDO brought by the arranger to market. Observers have 
questioned whether, given the incentives created by this arrangement, 
the NRSROs are able to issue unbiased ratings, particularly as the 
volume of deals brought by certain arrangers increased in the mid-
2000s.\53\ The above concerns are compounded by the arrangers' ability 
to ``ratings shop.'' Ratings shopping is the process by which an 
arranger will bring its proposed RMBS and CDO transaction to multiple 
NRSROs and choose, on a deal-wide or tranche-by-tranche basis, which 
two (or in some cases one) to use based on the preliminary ratings of 
the NRSROs.
---------------------------------------------------------------------------

    \52\ See, e.g., Opening Statement of Senator Richard C. Shelby 
for the Hearing of the U.S. Senate Committee on Banking, Housing, 
and Urban Affairs (September 26, 2007), pp. 1-2.
    \53\ See, e.g., Testimony of Professor John C. Coffee, Jr., 
Adolf A. Berle Professor of Law, Columbia University Law School, 
before the U.S. Senate Committee on Banking, Housing, and Urban 
Affairs (September 26, 2007), pp. 4-5.
---------------------------------------------------------------------------

    In addition, the interaction between the NRSRO and the arranger 
during the RMBS and CDO rating process has raised concerns that the 
NRSROs are rating products they designed (i.e., evaluating their own 
work).\54\ A corporate issuer is more constrained in how it can adjust 
in response to an NRSRO to improve its creditworthiness in order to 
obtain a higher rating. In the context of structured finance products, 
the arranger has much more flexibility to make adjustments to obtain a 
desired credit rating by, for example, changing the composition of the 
assets in the pool held by the trust or the subordination levels of the 
tranche securities issued by the trust. In fact, an arranger frequently 
will inform the NRSRO of the rating it wishes to obtain for each 
tranche and will choose an asset pool, trust structure, and credit 
enhancement levels based on its understanding of the NRSRO's 
quantitative and qualitative models. The credit analyst will use the 
expected loss and cash flow models to, in effect, check whether the 
proposed assets, trust structure and credit enhancement levels are 
sufficient to support the credit ratings desired by the arranger.
---------------------------------------------------------------------------

    \54\ See, e.g., Opening Statement of Senator Jack Reed for the 
Hearing of the U.S. Senate Committee on Banking, Housing, and Urban 
Affairs (September 26, 2007), pp. 1-2.
---------------------------------------------------------------------------

    The NRSRO rules adopted by the Commission in June of 2007 preceded 
the full emergence of the credit market turmoil. The Commission, in 
light of its experience since the final rules became effective, is 
proposing amendments to those rules and a new rule with the goal of 
further enhancing the utility of NRSRO disclosure to investors, 
strengthening the integrity of the ratings process, and more 
effectively addressing the potential for conflicts of interest inherent 
in the ratings process for structured finance products.

II. Proposed Amendments

A. Amendments to Rule 17g-5

    The Commission adopted Rule 17g-5, in part, pursuant to authority 
``to prohibit, or require the management and disclosure of, any 
conflicts of interest relating to the issuance of credit ratings by an 
[NRSRO].'' \55\ The rule identifies a series of conflicts arising from 
the business of determining credit ratings. Under the rule, some of 
these conflicts must be disclosed and managed, while other specified 
conflicts are prohibited outright.
---------------------------------------------------------------------------

    \55\ See Section 15E(h)(2) of the Exchange Act (15 U.S.C. 78o-
7(h)(2)).
---------------------------------------------------------------------------

    Paragraph (a) of Rule 17g-5 prohibits an NRSRO from having a 
conflict identified in paragraph (b) of the rule unless the NRSRO 
discloses the type of conflict on Form NRSRO and establishes, 
maintains, and enforces procedures to manage it.\56\ Paragraph (b) 
identifies eight types of conflicts, which include being paid by 
issuers or underwriters to determine credit ratings with respect to 
securities or money market instruments they issue or underwrite \57\ or 
being paid by persons for subscriptions to receive or access credit 
ratings where such persons also may own investments or have entered 
into transactions that could be favorably or adversely impacted by a 
credit rating.\58\
---------------------------------------------------------------------------

    \56\ 17 CFR 240.17g-5(a).
    \57\ 17 CFR 240.17g-5(b)(1).
    \58\ 17 CFR 240.17g-5(b)(5).
---------------------------------------------------------------------------

    Paragraph (c) of Rule 17g-5 prohibits outright four types of 
conflicts of interest. Consequently, an NRSRO would violate the rule if 
it has the type of conflict described in paragraph (c) even if it 
disclosed the conflict and established procedures to manage it. In the 
Adopting Release, the Commission explained that these conflicts were 
prohibited because they would be difficult to manage given their 
potential to cause undue influence.\59\
---------------------------------------------------------------------------

    \59\ Adopting Release, 72 FR at 33598.
---------------------------------------------------------------------------

    The Commission is proposing to amend Rule 17g-5 to require the 
disclosure and establishment of procedures to manage an additional 
conflict and to prohibit certain other conflicts outright, as described 
below.

[[Page 36219]]

1. Addressing the Particular Conflict Arising From Rating Structured 
Finance Products by Enhancing the Disclosure of Information Used in the 
Rating Process
a. The Proposed Amendment
    The Commission is proposing to amend Rule 17g-5 \60\ to add to the 
list of conflicts that must be disclosed and managed the additional 
conflict of repeatedly being paid by certain arrangers to rate 
structured finance products. This conflict is a subset of the broader 
conflict already identified in paragraph (b)(1) of Rule 17g-5; namely, 
``being paid by issuers and underwriters to determine credit ratings 
with respect to securities or money market instruments they issue or 
underwrite.'' \61\ In the case of structured finance products, the 
Commission preliminarily believes this ``issuer/underwriter-pay'' 
conflict is particularly acute because certain arrangers of structured 
finance products repeatedly bring ratings business to the NRSROs.\62\ 
As sources of constant deal based revenue, some arrangers have the 
potential to exert greater undue influence on an NRSRO than, for 
example, a corporate issuer that may bring far less ratings business to 
the NRSRO.\63\ Consequently, the Commission is proposing amendments to 
Rule 17g-5 that would require additional measures to address this 
particular type of ``issuer/underwriter-pay'' conflict.
---------------------------------------------------------------------------

    \60\ 17 CFR 240.17g-5.
    \61\ 17 CFR 240.17g-5(b)(1). As the Commission noted when 
adopting Rule 17g-5, the concern with conflict identified in 
paragraph (b)(1) ``is that an NRSRO may be influenced to issue a 
more favorable credit rating than warranted in order to obtain or 
retain the business of the issuer or underwriter.'' Adopting 
Release, 72 FR at 33595.
    \62\ See e.g., Testimony of Professor John C. Coffee, Jr., Adolf 
A. Berle Professor of Law, Columbia University Law School, before 
the U.S. Senate Committee on Banking, Housing, and Urban Affairs 
(April 22, 2008) (``Coffee April 22, 2008 Senate Testimony''), pp. 
4-6.
    \63\ Id.
---------------------------------------------------------------------------

    Specifically, the proposed amendment would re-designate paragraph 
(b)(9) of Rule 17g-5 as paragraph (b)(10) and in new paragraph (b)(9) 
identify the following conflict: issuing or maintaining a credit rating 
for a security or money market instrument issued by an asset pool or as 
part of any asset-backed or mortgage-backed securities transaction that 
was paid for by the issuer, sponsor, or underwriter of the security or 
money market instrument. To address this conflict, proposed new 
paragraph (a)(3) would require that as a condition to the NRSRO rating 
a structured finance product the information provided to the NRSRO and 
used by the NRSRO in determining the credit rating would need to be 
disclosed through a means designed to provide reasonably broad 
dissemination of the information.\64\ The intent behind this disclosure 
is to create the opportunity for other NRSROs to use the information to 
rate the instrument as well. Any resulting ``unsolicited ratings'' 
could be used by market participants to evaluate the ratings issued by 
the NRSRO hired to rate the product and, in turn, potentially expose an 
NRSRO whose ratings were influenced by the desire to gain favor with 
the arranger in order to obtain more business.\65\
---------------------------------------------------------------------------

    \64\ This proposed requirement would be in addition to the 
current requirements of paragraph (a) that an NRSRO disclose the 
type of conflict of interest in Exhibit 6 to Form NRSRO; and 
establish, maintain and enforce written policies and procedures to 
address and manage the conflict of interest. 17 CFR 240 17g-5(a)(1) 
and (2).
    \65\ As used herein, an ``unsolicited rating'' is one that is 
determined without the consent and/or payment of the obligor being 
rated or issuer, underwriter, or arranger of the securities being 
rated.
---------------------------------------------------------------------------

    The proposed amendment would require the disclosure of information 
provided to an NRSRO by the ``issuer, underwriter, sponsor, depositor, 
or trustee.'' The Commission preliminarily believes that, taken 
together, these are the parties that provide all relevant information 
to the NRSRO to be used in the initial rating and rating monitoring 
processes. The Commission is not proposing to specify the party--NRSRO, 
arranger, issuer, depositor, or trustee--that would need to disclose 
the information. It may be that the issuer through the arranger and 
trustee would be in the best positions to disclose the information. In 
this case, in contracting with these parties to provide a rating for a 
structured finance product, the NRSRO could require a representation 
from them that the necessary information would be disclosed as required 
by the proposed rule. The Commission notes, however, that the proposed 
rule does not provide a safe harbor for an NRSRO arising from such a 
representation. Consequently, an NRSRO would violate the proposed rule 
if it issued a credit rating for a structured finance product where the 
information is not disclosed notwithstanding any representations from 
the arranger.
    The goal of this proposed amendment is to promote the effective 
management of this conflict of interest, increase the transparency of 
the process for rating structured finance products, and foster 
competition by making it feasible for more market participants, in 
particular NRSROs that are not contracted by the arranger to issue a 
rating but still wish to do so, to perform credit analysis on the 
instrument and to monitor the instrument's creditworthiness. As noted 
above, by providing the opportunity for more NRSROs to determine credit 
ratings for structured finance products, this proposal is designed to 
increase the number of ratings extant for a given instrument and, in 
particular, promote the issuance of ratings by NRSROs that are not 
hired by the arranger. The goal would be to expose an NRSRO that was 
unduly influenced by the ``arranger-pay'' conflict into issuing higher 
than warranted ratings.\66\ An ancillary benefit would be that the 
proposal could make it easier for users of credit ratings to identify 
potentially inaccurate credit ratings and incompetent NRSROs. The 
proposal also is designed to make it more difficult for arrangers to 
exert influence on the NRSROs that they hire to determine ratings for 
structured finance products. Specifically, by opening up the rating 
process to greater scrutiny, the proposal is designed to make it easier 
for the hired NRSRO to resist pressure from the arranger by increasing 
the likelihood that any steps taken to inappropriately favor the 
arranger could be exposed to the market. Further, as noted above, an 
ancillary benefit of the proposal is that it could operate as a check 
on inaccuracy and incompetence.
---------------------------------------------------------------------------

    \66\ The Commission notes that ``unsolicited'' ratings could be 
used to obtain business with arrangers by creating a track record of 
favorable ratings. The Commission believes the potential to expose 
such conduct would be equal to that of exposing an NRSRO influenced 
by the ``arranger-pay'' conflict insomuch as the paid for ratings 
(usually at least two) would be consistently lower than the 
``unsolicited'' ratings.
---------------------------------------------------------------------------

    To further these goals, the proposal would require the disclosure 
of the following information:
     All information provided to the nationally recognized 
statistical rating organization by the issuer, underwriter, sponsor, 
depositor, or trustee that is used in determining the initial credit 
rating for the security or money market instrument, including 
information about the characteristics of the assets underlying or 
referenced by the security or money market instrument, and the legal 
structure of the security or money market instrument; \67\
---------------------------------------------------------------------------

    \67\ See proposed paragraph (a)(3)(i)(A) and (B) of Rule 17g-5.
---------------------------------------------------------------------------

     All information provided to the nationally recognized 
statistical rating organization by the issuer, underwriter, sponsor, 
depositor, or trustee that is used by the nationally recognized 
statistical rating organization in undertaking credit rating 
surveillance on the security or money market

[[Page 36220]]

instrument, including information about the characteristics and 
performance of the assets underlying or referenced by the security or 
money market instrument.\68\
---------------------------------------------------------------------------

    \68\ See proposed paragraph (a)(3)(ii) of Rule 17g-5.
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    For the purposes of the proposed amendment, the Commission would 
consider only information that is taken into account in generating the 
credit rating or in performing surveillance to be ``used'' by the NRSRO 
in those contexts. This would exclude information about collateral 
pools (i.e., ``loan tapes'') provided by the arranger containing a mix 
of assets that is different than the composition of the final 
collateral pool upon which the credit rating is based. The proposed 
rule also would exclude from disclosure most, if not all, 
communications between the NRSRO and the issuer, underwriter, sponsor, 
depositor, or trustee to the extent the communications do not contain 
information necessary for the NRSRO to determine an initial credit 
rating or perform surveillance on an existing credit rating.
    The Commission recognizes that the NRSRO would define the 
information that it uses for purposes of generating credit ratings and, 
likely, would obtain representations from the arranger that the 
information is being disclosed as required under the rule. There is a 
potential that an NRSRO that uses relatively little information to 
generate credit ratings would be favored by arrangers to minimize the 
amount of information subject to the disclosure requirement. The 
Commission preliminarily believes that there is some degree of 
standardization as to the information used by NRSROs to rate structured 
finance products (e.g., loan level information, payment priorities 
among the issued tranched securities, and legal structure of the 
issuer). An NRSRO that requires less than the standard level of 
information would need to convince users of credit ratings, most 
notably investors, that its ratings process was credible. Otherwise, 
arrangers ultimately would not use the NRSRO since it would be more 
difficult to sell the structured finance products if they carried 
ratings that were not accepted by the marketplace. Nonetheless, the 
Commission, if this proposal is adopted, intends to monitor whether it 
results in a significant reduction in the information provided to 
NRSROs.
    The timing and scope of the disclosures of the first set 
information described above--information used in determining the 
initial credit rating--would depend on the nature of the offering: 
public, private, or offshore. \69\ In an offering registered under the 
Securities Act of 1933 (15 U.S.C. 77a et seq.), the information would 
need to be disclosed on the date the underwriter and the issuer or 
depositor set the offering price of the securities being rated (the 
``pricing date''). \70\ In offerings that are not registered under the 
Securities Act of 1933 (15 U.S.C. 77a et seq.), the information would 
need to be disclosed to investors in the offering and entities meeting 
the definition of ``credit rating agency'' in Section 3(a)(61) of the 
Exchange Act (which would include credit rating agencies registered, 
and not registered, as NRSROs) \71\ and on the pricing date and 
disclosed publicly on the first business day after the transaction 
closes.
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    \69\ See Sections II.A.1.b.i--iii below for a broader discussion 
of the scope of the disclosures that would be required under the 
proposed amendments.
    \70\ See proposed paragraph (a)(3)(i)(A) of Rule 17g-5.
    \71\ 15 U.S.C. 78c(a)(61).
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    The Commission is proposing the pricing date as the time of the 
first disclosures because it preliminarily believes that this is the 
earliest date upon which the asset pool and legal structure of the 
trust are settled on. Thus, the information that would be disclosed 
would reflect the actual characteristics of the securities to be issued 
and not, for example, preliminary assets pools with different 
compositions of loans. At the same time, the disclosure of the 
information before the securities are sold is designed to provide the 
opportunity for other credit rating agencies to use the information to 
develop ``unsolicited ratings'' for the tranche securities before they 
are purchased by investors. To the extent unsolicited ratings are 
issued, they would provide investors with a greater range of credit 
assessments and, in particular, assessments from credit rating agencies 
that are not subject to the ``arranger-pay'' conflict.
    The Commission anticipates that the information that would need to 
be disclosed (i.e., the information used by the hired NRSRO to 
determine the initial rating) generally would include the 
characteristics of the assets in the pool underlying the structured 
finance product and the legal documentation setting forth the capital 
structure of the trust, payment priorities with respect to the tranche 
securities issued by the trust (the waterfall), and all applicable 
covenants regarding the activities of the trust. For example, for an 
initial rating for an RMBS, this information generally would include 
the ``loan tape'' (frequently a spreadsheet) that identifies each loan 
in the pool and its characteristics such as type of loan, principal 
amount, loan-to-value ratio, borrower's FICO score, and geographic 
location of the property. In addition, the disclosed information also 
would include a description of the structure of the trust, the credit 
enhancement levels for the tranche securities to be issued by the 
trust, and the waterfall cash flow priorities. With respect to the loan 
pool information, the Commission does not intend that the proposed 
disclosure would include any personal identifying information on 
individual borrowers or properties (such as names, phone numbers, 
addresses or tax identification numbers).
    After the disclosure of the information used by the NRSRO to 
perform the initial rating, the proposed amendment would require the 
disclosure of information about the underlying assets that is provided 
to, and used by, the NRSRO to perform any ratings surveillance.\72\ The 
Commission anticipates that generally this information would consist of 
reports from the trustee describing how the assets in the pool 
underlying the structured finance product are performing. For an RMBS 
credit rating, this information likely would include the ``trustee 
report'' customarily generated to reflect the performance of the loans 
constituting the collateral pool. For example, an RMBS trustee may 
generate reports describing the percentage of loans that are 30, 60, 
and 90 days in arrears, the percentage that have defaulted, the 
recovery of principal from defaulted loans, and information regarding 
any modifications to the loans in the asset pool. The disclosure of 
this information would allow NRSROs that were not hired to rate the 
deal, including ones that determined unsolicited initial ratings, to 
monitor on a continuing basis the creditworthiness of the tranche 
securities issued by the trust. The proposed amendment provides that 
this information would need to be disclosed at the time it is provided 
to the NRSRO. This is designed to put other NRSROs and other interested 
parties on an equal footing with the NRSRO hired by the arranger 
insomuch as they would all obtain the information at the same time. 
Consequently, they all could begin any surveillance processes 
simultaneously.
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    \72\ Proposed paragraph (a)(3)(ii) of Rule 17g-5.
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    The goal of this aspect of the proposal again would be to expose an 
NRSRO that was allowing business considerations to impact its judgment.

[[Page 36221]]

For example, in order to maintain favor with a particular arranger, an 
NRSRO may be reluctant to downgrade a credit rating for a structured 
finance product to its appropriate category even where a downgrade is 
implied by its surveillance procedures and methodologies. Increasing 
the number of credit ratings extant for the instrument, including 
ratings not paid for by the arranger, would make it more difficult to 
conceal the fact that a particular NRSRO was being unduly influenced by 
an arranger as to its surveillance process.
    As discussed below, the manner and breadth of the disclosures, 
including how widely the information could be disseminated, would 
depend on the nature of the offering for the rated structured finance 
product: public, private, or offshore. The proposed amendment's 
requirement that the information be ``disclosed through a means 
designed to provide reasonably broad dissemination'' would be 
interpreted by the Commission to mean in the manner described in 
sections II.A.1.b.i--iii below that discuss the proposed amendment in 
the context of public, private, and offshore offerings.
    The Commission is proposing these amendments to Rule 17g-5, in 
part, pursuant to the authority in Section 15E(h)(2) of the Exchange 
Act.\73\ The provisions in this section of the statute provide the 
Commission with authority to prohibit, or require the management and 
disclosure of, any potential conflict of interest relating to the 
issuance of credit ratings by an NRSRO.\74\ The Commission 
preliminarily believes the proposed amendments are necessary and 
appropriate in the public interest and for the protection of investors 
because they are designed to address conflicts of interest and improve 
the quality of credit ratings for structured finance products by: (1) 
Increasing the transparency of the ratings process and thereby making 
it more apparent when an NRSRO may be allowing business considerations 
to impair its objectivity and (2) enhancing competition by creating the 
opportunity for NRSROs that are not hired to rate structured products 
to nonetheless determine credit ratings and establish track records for 
rating these products.
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    \73\ 15 U.S.C. 78o-7(h)(2).
    \74\ Id.
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    The Commission preliminarily believes that it is appropriate to 
require an NRSRO to address and manage the conflict of interest raised 
by the NRSRO's recurring relationships with structured finance product 
arrangers by making the rating process more transparent in terms of the 
information used to determine the ratings. This would create an 
opportunity for other NRSROs (including subscriber based NRSROs), 
unregistered credit rating agencies, and other interested parties to 
assess the creditworthiness of these products and issue their own 
credit ratings or credit assessments.\75\ Market participants and 
observers would be able to compare the ratings of the NRSROs hired by 
the arrangers against the ratings of NRSROs and others not hired by the 
arrangers. As discussed above, the Commission preliminarily believes 
that this would enhance the integrity of the ratings process by making 
it easier for users of credit ratings to compare NRSROs and evaluate 
whether an NRSRO's objectivity had been compromised by the undue 
influence of an arranger. It also could make it easier for the NRSROs 
hired to determine credit ratings for structured finance products to 
resist pressure from arrangers insomuch as the parties would be aware 
that the potential for exposing a compromised NRSRO had been increased 
through the proposed amendment's disclosure requirements.
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    \75\ As discussed below, for private offerings and offshore 
offerings, this information would not be disclosed publicly before 
the offering closes but instead would be provided via a password-
protected Internet Web site to credit rating agencies and accredited 
investors. After the offering closes, the information would be 
required to be disclosed publicly and, therefore, made available to 
market observers such as academics.
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    The Commission generally requests comment on all aspects of this 
proposed amendment. In addition, the Commission requests comment on the 
following questions related to the proposal.
     Would the information proposed to be required to be 
disclosed sufficient to permit the determination of an unsolicited 
credit rating? Conversely, would the proposed amendment require the 
disclosure of more information than would be necessary to permit the 
determination of an unsolicited credit rating? Commenters believing 
more information should be disclosed should specifically describe the 
additional information and the practicality of requiring its 
disclosure, while commenters believing that less information should be 
disclosed should specifically describe what information would be 
unnecessary and explain why it would be unnecessary to disclose.
     The proposed amendment would require the disclosure of 
information provided to an NRSRO by the ``issuer, underwriter, sponsor, 
depositor, or trustee'' based on the Commission's preliminary belief 
that these would be the parties relevant to an NRSRO's performance of 
the ratings process, i.e., that taken together, these are the parties 
that would provide all relevant information to the NRSRO. Are there 
other entities that should be included in this category?
     Should the Commission provide a ``safe harbor'' so that an 
NRSRO that obtained a representation from one or more parties to a 
transaction to disclose the required information would not be held in 
violation of the rule if the party did not fulfill its disclosure 
obligations under the representation?
     Should the Commission also require the disclosure of 
information about the steps, if any, that were taken by the NRSRO, 
issuer, underwriter, sponsor, depositor, or trustee to verify 
information about the assets underlying or referenced by the security 
or money market instrument, or, if no such steps were taken, a 
disclosure of that fact?
     Would the disclosure of the initial information on the 
pricing date provide enough time for other NRSROs to determine 
unsolicited ratings before the securities were sold to investors? If 
not, would it be appropriate to require that this information be 
disclosed prior to the pricing date? Alternatively, would it be more 
appropriate to require NRSROs hired by the arranger to wait a period of 
calendar or business days (e.g., 2, 4, 10 days) after the asset pool is 
settled upon by the arranger before issuing the initial credit rating 
in order to provide other NRSROs with sufficient time to determine an 
unsolicited rating?
     Should the Commission also require the disclosure of the 
results of any steps taken by the NRSRO, issuer, underwriter, sponsor, 
depositor, or trustee to verify information about the assets underlying 
or referenced by a structured finance product? Alternatively, should 
the Commission require a general disclosure of whether any steps were 
taken to verify the information and, if so, a description of those 
steps?
     Do NRSROs obtain information about the underlying assets 
of structured products--particularly in the surveillance process--from 
third-parties such as vendors rather than from issuers, underwriters, 
sponsors, or trustees? If so, would it be necessary to require the 
disclosure of this information as proposed or can the goals of the 
proposed amendments in promoting unsolicited ratings be achieved under 
current practices insomuch as the information necessary for 
surveillance can be obtained from third-party vendors, albeit for a 
fee?

[[Page 36222]]

     Does the information provided to NRSROs by issuers, 
underwriters, sponsors, depositors, or trustees about assets underlying 
structured products (e.g., mortgage loans, home equity loans, consumer 
loans, credit card receivables) commonly include personal identifying 
information about individuals such as names, social security numbers, 
addresses, and telephone numbers? If so, are there practical ways to 
ensure that this information is not disclosed?
     Does any of the information provided to NRSROs by issuers, 
underwriters, sponsors, depositors, or trustees about assets underlying 
structured products contain proprietary information? Commenters that 
believe this is the case should specifically identify any such 
information.
b. Proposed Guidance for Compliance With Provisions of the Securities 
Act of 1933
    As noted above, the proposed amendments to Rule 17g-5 that would 
require the disclosure of information about the underlying assets of a 
structured finance product implicate the Securities Act.\76\ As 
explained below, the means by which information would be disclosed for 
the purposes of the proposed amendments to Rule 17g-5 would be governed 
by the nature of the offering. The Securities Act restricts the types 
of offering communications that issuers or other parties subject to the 
Securities Act's provisions (such as underwriters) may use during a 
registered public offering and, for private offerings, restricts the 
methods by which communications may be made so as to avoid general 
solicitation or general advertising of the private offering to 
potential purchasers. Communications that may be considered offers \77\ 
are subject to these restrictions.\78\ Likewise, with respect to 
unregistered offshore offerings that are intended to comply with the 
safe harbor provisions of Regulation S, communications that are deemed 
to be offers in the United States or directed selling efforts in the 
United States are prohibited. Information about securities that are the 
subject of an offering that has been provided to NRSROs and is required 
to be disclosed pursuant to the proposed rules would be considered 
offers or directed selling efforts and therefore subject to these 
restrictions relating to offering communications.\79\
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    \76\ 15 U.S.C. 77a et seq.
    \77\ Securities Act Section 2(a)(3) (15 U.S.C. 77b(a)(3)) 
defines an ``offer'' as any attempt to offer to dispose of, or 
solicitation of any offer to buy, a security or interest in a 
security for value. The term ``offer'' has been interpreted broadly 
and goes beyond the common law concept of an offer. See Diskin v. 
Lomasney & Co., 452 F. 2d 871 (2d Cir. 1971); SEC v. Cavanaugh, 1 F. 
Supp. 2d 337 (S.D.N.Y. 1998). The Commission has explained that 
``the publication of information and publicity efforts, made in 
advance of a proposed financing which have the effect of 
conditioning the public mind or arousing public interest in the 
issuer in its securities constitutes an offer * * *.'' Guidelines 
for the Release of Information by Issuers Whose Securities are in 
Registration, Securities Act Release No. 5180 (August 16, 1971), 36 
FR 16506.
    \78\ Before the registration statement is filed, all offers, in 
whatever form, are prohibited. See Securities Act Section 5(c) (15 
U.S.C. 77e(c)). Between the filing of the registration statement and 
its effectiveness, offers made in writing (including by e-mail or 
Internet), by radio, or by television are limited to a ``statutory 
prospectus'' that conforms to the information requirements of 
Securities Act Section 10. See Securities Act Section 5(b)(1) (15 
U.S.C. 77e(b)(1)) and Securities Act Section 10 (15 U.S.C. 77j). 
After the registration statement is declared effective, offering 
participants may make written offers only through a statutory 
prospectus, except that they may use additional offering materials 
if a final prospectus that meets the requirements of Securities Act 
Section 10(a) is sent or given prior to or with those materials. See 
Securities Act Section 2(a)(10) (15 U.S.C. 77b(a)(10)) and Section 
5(b)(1).
    \79\ This may be the case even if the information relates to 
pools backing prior issuances. In an offering of securities backed 
by the same class of assets, the information provided for 
surveillance and required to be disclosed pursuant to proposed Rule 
17g-5(a)(3)(iii) may be static pool data as described in Item 1105 
of Regulation AB (17 CFR 229.1105).
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    In the following three sections, the Commission provides guidance 
on how the information that would be required to be disclosed under 
proposed new paragraph (a)(3) of Rule 17g-5 (``Paragraph (a)(3) 
Information'') would need to be disclosed under the proposed amendment 
and consistent with the Securities Act. As discussed below, the manner 
and breadth of the disclosures under the proposed amendment would 
depend on whether the structured finance product was issued under a 
public, private, or offshore offering.
i. Public Offerings
    With respect to registered offerings at the time the Paragraph 
(a)(3) Information would be required to be disclosed (the pricing 
date), the information would be written communications and the issuer, 
underwriter, or other offering participant also would have to comply 
with the Securities Act with regard to the disclosure of such written 
communications.\80\ In addition, such written communications would be 
subject to the civil liability and antifraud provisions of the 
Securities Act.\81\
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    \80\ See Securities Offering Reform, Securities Act Release 33-
8591 (July 19, 2005), 70 FR 44722 (August 3, 2005) (the ``Securities 
Offering Reform Release'') for a discussion of the definition of 
written communications and rules relating to permitted 
communications in registered offerings. See also Asset-Backed 
Securities, Securities Act Release No. 8518 (December 22, 2004) 70 
FR 1506 (January 7, 2005) (the ``Asset-Backed Securities Release'') 
for rules applicable to offerings of asset-backed securities.
    \81\ Under the Securities Act, purchasers of an issuer's 
securities in a registered offering have private rights of action 
for materially deficient disclosure in registration statements under 
Section 11 and in prospectuses and oral communications under Section 
12(a)(2). Under Securities Act Section 12(a)(2) and Securities Act 
Rule 159, the liability determination as to an oral communication, 
prospectus, or statement, as the case may be, does not take into 
account information conveyed to a purchaser only after the time of 
sale (including the contract of sale), including information 
contained in a final prospectus, prospectus supplement, or Exchange 
Act filing that is filed or delivered subsequent to the time of sale 
(including the contract of sale) where the information is not 
otherwise conveyed at or prior to that time. The time of sale under 
the Securities Act includes the time of the contract of sale--the 
time at which an investor has taken the action the investor must 
take to become committed to purchase the securities and therefore 
entered into a contract of sale.
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    As discussed in the Commission's Securities Offering Reform Release 
adopting several reforms to the securities offering process,\82\ 
issuers of structured finance products have potentially two sets of 
rules under the Securities Act on which they may rely in using written 
offering materials. If the offering is registered on Securities Act 
Form S-3,\83\ then the written materials may constitute ABS 
informational and computational materials, as defined in Item 1101 of 
Regulation AB,\84\ and

[[Page 36223]]

should be filed on Exchange Act Form 8-K \85\ in accordance with Rules 
167 and 426 of the Securities Act.\86\ The written materials may 
constitute a free writing prospectus, as defined in Rule 405 of the 
Securities Act.\87\ In that case, the information that is disclosed 
must be filed in accordance with Rules 164 and 433 of the Securities 
Act.\88\ Given that the Paragraph (a)(3) Information could constitute 
offering materials, the Commission believes it is important to explain 
how the rules under the Securities Act may be relied upon when 
Paragraph (a)(3) Information is made publicly available.\89\
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    \82\ See Section III.D.3.b.iii(C)(3)(a)(iii) of the Securities 
Offering Reform Release, 70 FR 44722, 44751.
    \83\ 17 CFR 239.13. An ABS issuer is eligible to use Form S-3 if 
the conditions of General Instruction V are met.
    \84\ 17 CFR 229.1101. Item 1101 of Regulation AB provides the 
following definition:
    (a) ABS informational and computational material means a written 
communication consisting solely of one or some combination of the 
following:
    (1) Factual information regarding the asset-backed securities 
being offered and the structure and basic parameters of the 
securities, such as the number of classes, seniority, payment 
priorities, terms of payment, the tax, Employment Retirement Income 
Security Act of 1974, as amended, (29 U.S.C. 1001 et seq.) 
(``ERISA'') or other legal conclusions of counsel, and descriptive 
information relating to each class ( e.g., principal amount, coupon, 
minimum denomination, anticipated price, yield, weighted average 
life, credit enhancements, anticipated ratings, and other similar 
information relating to the proposed structure of the offering);
    (2) Factual information regarding the pool assets underlying the 
asset-backed securities, including origination, acquisition and pool 
selection criteria, information regarding any prefunding or 
revolving period applicable to the offering, information regarding 
significant obligors, data regarding the contractual and related 
characteristics of the underlying pool assets ( e.g., weighted 
average coupon, weighted average maturity, delinquency and loss 
information and geographic distribution) and other factual 
information concerning the parameters of the asset pool appropriate 
to the nature of the underlying assets, such as the type of assets 
comprising the pool and the programs under which the loans were 
originated;
    (3) Identification of key parties to the transaction, such as 
servicers, trustees, depositors, sponsors, originators and providers 
of credit enhancement or other support, including a brief 
description of each such party's roles, responsibilities, background 
and experience;
    (4) Static pool data, as referenced in Item 1105 of this 
Regulation AB, such as for the sponsor's and/or servicer's 
portfolio, prior transactions or the asset pool itself;
    (5) Statistical information displaying for a particular class of 
asset-backed securities the yield, average life, expected maturity, 
interest rate sensitivity, cash flow characteristics, total rate of 
return, option adjusted spread or other financial or statistical 
information relating to the class or classes under specified 
prepayment, interest rate, loss or other hypothetical scenarios. 
Examples of such information under the definition include:
    (i) Statistical results of interest rate sensitivity analyses 
regarding the impact on yield or other financial characteristics of 
a class of securities from changes in interest rates at one or more 
assumed prepayment speeds;
    (ii) Statistical information showing the cash flows that would 
be associated with a particular class of asset-backed securities at 
a specified prepayment speed; and
    (iii) Statistical information reflecting the financial impact of 
losses based on a variety of loss or default experience, prepayment, 
interest rate and related assumptions.
    (6) The names of underwriters participating in the offering of 
the securities, and their additional roles, if any, within the 
underwriting syndicate;
    (7) The anticipated schedule for the offering (including the 
approximate date upon which the proposed sale to the public will 
begin) and a description of marketing events (including the dates, 
times, locations, and procedures for attending or otherwise 
accessing them); and
    (8) A description of the procedures by which the underwriters 
will conduct the offering and the procedures for transactions in 
connection with the offering with an underwriter or participating 
dealer (including procedures regarding account-opening and 
submitting indications of interest and conditional offers to buy). 
The Commission confirmed in the Asset-Backed Securities Release that 
loan level information could be included in ABS information and 
computational materials.
    \85\ 17 CFR 249.308.
    \86\ 17 CFR 230.167 and 17 CFR 230.426.
    \87\ 17 CFR 230.405. The contents of free writing prospectuses 
are not limited to ABS informational and computational materials.
    \88\ 17 CFR 230.164 and 17 CFR 230.433. Rule 433 also provides 
that a free writing prospectus or portion thereof required to be 
filed under Rule 433 containing only ABS informational and 
computational materials may be filed under Rule 433 but within the 
time frame required for satisfaction of the conditions of Rule 426, 
and that such filing will satisfy the conditions of Rule 433.
    \89\ Depending on whether the materials constitute a free 
writing prospectus or ABS informational and computational materials, 
the liability provisions governing the disclosure may differ. Free 
writing prospectuses are subject to liability under Section 12(a)(2) 
and Section 17(a) of the Securities Act. 15 U.S.C. 77l(a)(2) and 15 
U.S.C. 77q(a). A free writing prospectus will not be part of a 
registration statement subject to liability under Securities Act 
Section 11 unless the issuer elects to file it as part of the 
registration statement. See also Asset-Backed Securities Release at 
footnote 335. On the other hand, ABS informational and computational 
materials also are subject to Section 12(a)(2) and Section 17(a) 
liability, but they must be filed on Form 8-K and therefore, by 
virtue of incorporation by reference into a registration statement, 
are subject to Section 11 liability.
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    Most elements of the Paragraph (a)(3) Information would need to be 
filed in accordance with the rules governing free writing prospectuses 
or ABS informational and computational materials pursuant to Rules 433 
and 426.\90\ Currently, the timing or filing requirements under these 
rules is tied to when the information is provided to specific 
investors. However, unlike other free writing prospectuses and ABS 
informational and computational materials that may be provided to 
specific investors, in a public offering, the Paragraph (a)(3) 
Information would be required to be disclosed publicly. Therefore, the 
Commission believes that it is appropriate to clarify when the 
materials should be filed with the Commission.
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    \90\ 17 CFR 230.433 and 17 CFR 230.426.
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    Under Rule 426, ABS informational and computational materials are 
required to be filed by the later of the due date for filing the final 
prospectus under Rule 424(b) or two days after the date of first use. 
Under Rule 433, a free writing prospectus must be filed with the 
Commission no later than the date of first use. However, in order to 
conform certain asset-backed free writing prospectuses with the filing 
requirements for ABS informational and computational materials in Rule 
426, Rule 433(d)(6) provides that a free writing prospectus containing 
only ABS information and computational materials may be filed in the 
time provided by Rule 426(b). Thus, under both rules the information 
must be filed by the later of the due date for filing the final 
prospectus under Rule 424(b) or two days after the date of first use.
    In addition, Rule 433 requires filing by issuers of free writing 
prospectuses prepared by or on behalf of, or used or referred to by, 
issuers or, depositors, sponsors, servicers, or affiliated depositors, 
whether or not the issuer, but not by underwriters or dealers, unless 
they contain issuer information or are distributed in a manner 
reasonably designed to lead to its broad dissemination. The Paragraph 
(a)(3) Information that would be required to be disclosed would not be 
considered underwriter or dealer information, even if prepared by the 
underwriter or dealer, given the broad dissemination and thus would 
need to be filed.
    Rules 164 and 167 provide the exemption from Section 5(b)(1) of the 
Securities Act for the use of free writing prospectuses and ABS 
informational and computational materials, respectively. For the most 
part, Rule 164 should be available for the use of the Paragraph (a)(3) 
Information, even where the issuer is an ineligible issuer,\91\ given 
that the rule provides that ineligible issuers that are asset-backed 
issuers may use a free writing prospectus as long as the free writing 
prospectus contains only specified information.\92\ Much of the 
Paragraph

[[Page 36224]]

(a)(3) Information should contain information that can be included in a 
free writing prospectus used by an asset-backed issuer pursuant to Rule 
164. To the extent that Rule 167 is not available because the offering 
is registered on Form S-1 rather than Form S-3, and Rule 164 is not 
available, the information should be filed in an amendment to the 
registration statement.
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    \91\ An ``ineligible issuer,'' as the term is defined in Rule 
405 of the Securities Act, includes, in the case of asset-backed 
issuers, the depositor or any issuing entities previously 
established, directly or indirectly by the depositor, who are not 
current in their Exchange Act reports and other materials required 
to be filed during the prior 12 months (or such shorter period that 
the issuer was required to file such reports and materials), other 
than reports on Form 8-K required solely pursuant to an item 
specified in General Instruction I.A.4 of Form S-3.
    \92\ In asset-backed offerings by ineligible issuers, free 
writing prospectuses used by ineligible issuers are limited to the 
following information:
    (1) Factual information regarding the asset-backed securities 
being offered and the structure and basic parameters of the 
securities, such as the number of classes, seniority, payment 
priorities, terms of payment, the tax, ERISA or other legal 
conclusions of counsel, and descriptive information relating to each 
class (e.g., principal amount, coupon, minimum denomination, 
anticipated price, yield, weighted average life, credit 
enhancements, anticipated ratings, and other similar information 
relating to the proposed structure of the offering);
    (2) factual information regarding the pool assets underlying the 
asset-backed securities, including origination, acquisition and pool 
selection criteria, information regarding any prefunding or 
revolving period applicable to the offering, information regarding 
significant obligors, data regarding the contractual and related 
characteristics of the underlying pool assets (e.g., weighted 
average coupon, weighted average maturity, delinquency and loss 
information and geographic distribution) and other factual 
information concerning the parameters of the asset pool appropriate 
to the nature of the underlying assets, such as the type of assets 
comprising the pool and the programs under which the loans were 
originated;
    (3) identification of key parties to the transaction, such as 
servicers, trustees, depositors, sponsors, originators and providers 
of credit enhancement or other support, including a brief 
description of each such party's roles, responsibilities, background 
and experience;
    (4) static pool data;
    (5) the names of underwriters participating in the offering of 
the securities, and their additional roles, if any, within the 
underwriting syndicate;
    (6) the anticipated schedule for the offering (including the 
approximate date upon which the proposed sale to the public will 
begin) and a description of marketing events (including the dates, 
times, locations, and procedures for attending or otherwise 
accessing them); and
    (7) a description of the procedures by which the underwriters 
will conduct the offering and the procedures for transactions in 
connection with the offering with an underwriter or participating 
dealer (including procedures regarding account opening and 
submitting indications of interest and conditional offers to buy).
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    In addition, the Commission understands that currently at least 
some of the information that would constitute Paragraph (a)(3) 
Information, if not included in a free writing prospectus, is often 
included as a schedule to pooling and servicing agreements. Those 
agreements, along with their schedules and exhibits, should be filed by 
the time of the offering of securities. Therefore they should be filed 
at the time of the takedown as exhibits to a Form 8-K incorporating 
them by reference into the Form S-3 registration statement.\93\
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    \93\ See Form S-3 (17 CFR 239.13), Form 8-K (17 CFR 249.308) and 
Item 601(b)(4) of Regulation S-K (17 CFR 229.601).
---------------------------------------------------------------------------

    The Commission generally requests comment on all aspects of this 
proposed guidance. In addition, the Commission requests comment on the 
following questions related to the proposal.
     Do we need to give more guidance on the relationship 
between the proposed disclosure requirements regarding information 
about the underlying assets provided to, and used by, the NRSRO to 
perform ratings surveillance and the requirements of Regulation FD? 
\94\ If commenters believe that the proposed requirements are not 
consistent with Regulation FD, they should provide a detailed 
explanation as to why not.
---------------------------------------------------------------------------

    \94\ 17 CFR 243.100 to 103.
---------------------------------------------------------------------------

     The proposed disclosure requirements regarding information 
about the underlying assets provided to, and used by, the NRSRO to 
perform ratings surveillance may be the same as the information 
required to be disclosed on Form 10-D for so long as the issuer has an 
Exchange Act reporting obligation. Given that the Form 10-D reporting 
obligation is typically suspended for most asset-backed issuers after 
the first year of reporting, does the proposed disclosure requirement 
raise any issues regarding Exchange Act reporting?
     ABS informational and computation materials, as defined in 
Item 1101 of Regulation AB, can include, among other things, factual 
information regarding the pool assets underlying the asset-backed 
securities, including origination, acquisition and pool selection 
criteria, information regarding any prefunding or revolving period 
applicable to the offering, information regarding significant obligors, 
data regarding the contractual and related characteristics of the 
underlying pool assets (e.g., weighted average coupon, weighted average 
maturity, delinquency and loss information and geographic distribution) 
and other factual information concerning the parameters of the asset 
pool appropriate to the nature of the underlying assets, such as the 
type of assets comprising the pool and the programs under which the 
loans were originated.\95\ As noted above, the Commission believes that 
at least some of the proposed Paragraph (a)(3) Information could fall 
within this category and therefore constitute ABS informational and 
computational materials. Since there may be a wide variety of 
information that is provided to an NRSRO, it is not clear that all 
information provided would fit within the definition of ABS 
informational and computation materials, or in the various categories 
of free writing prospectus. Should the Commission provide additional 
interpretation regarding what types of material that could be provided 
and would be required to be disclosed to fit within this category? Is 
there information that is likely to be provided and disclosed that does 
not appear to fit within these definitions? Should the Commission 
instead revise the definitions to specifically include the information 
required to be disclosed?
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    \95\ See Asset-Backed Securities Release.
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     Is there any need for the Commission to revise Securities 
Act Rules 426 or 433 to clarify when the materials need to be filed?
     Are there any additional requirements in Regulation AB or 
under the Securities Act that are implicated by the proposed 
amendments? Is there any information that would typically need to be 
disclosed under this proposed amendment that is not already generally 
disclosed in filings with the Commission?
     Should the Commission amend Regulation AB to require that 
the Paragraph (a)(3) Information be disclosed?
ii. Private Offerings
    The proposed amendments also would implicate the Securities Act 
restrictions affecting private offerings. Offerings of securities made 
in reliance on an exemption from registration contained in Securities 
Act Section 4(2),\96\ the rules promulgated thereunder or pursuant to 
Regulation D,\97\ are offerings that are not made to the public. As a 
result, general solicitation or advertising is prohibited in these 
offerings under Securities Act Section 4(2) and the applicable 
Securities Act rules.\98\ As a result of the application of the general 
solicitation and advertising restrictions, public disclosure of 
offering or security information pursuant to the proposed rules could 
cause the private offering exemptions to be unavailable to securities 
offerings to which the proposed rules apply.
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    \96\ 15 U.S.C. 77d(2).
    \97\ 17 CFR 230.501 through 230.508.
    \98\ See Securities Act Section 4(2) (15 U.S.C. 77d(2)) and 
Securities Act Rules 504, 505 and 506 of Regulation D (17 CFR 
230.504, 230.505 and 230.506). An exception to the prohibition 
against general solicitation applies to some limited offerings under 
Rule 504(b)(1) (17 CFR 230.504(b)(1)) when an issuer has satisfied 
state securities laws of specified types. See Revision of Rule 504 
of Regulation D, the ``Seed Capital'' Exemption, Securities Act 
Release No. 7644 (February 25, 1999), 64 FR 11090. The restriction 
on general solicitation or advertising applies to all methods by 
which the communication can be made, including electronic, paper, 
mail, radio, television, or in newspapers or magazines.
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    As discussed above, the Commission believes it is likely that much 
of the information that would need to be disclosed under the proposed 
amendment would contain extensive loan level data, and thus anticipates 
that a common medium for disclosure of this information would be an 
Internet Web site. The Commission has indicated that the placement of 
private offering materials on an Internet Web site, without sufficient 
procedures to limit access only to accredited investors, is 
inconsistent with the prohibition against general solicitation or 
advertising in Securities Act Rule 502(c).\99\ However, as discussed 
above, the Commission also believes that to address the conflict of 
interest inherent in the structured finance product arranger-pay 
business model it would be beneficial to make this information 
available to investors and entities meeting the definition of ``credit 
rating agency'' in Section 3(a)(61) of the Exchange Act (which would 
include NRSROs) \100\ on the date the placement agent and the issuer or 
depositor set the offering price of the securities being

[[Page 36225]]

rated, and to the general public on the first business day after the 
offering closes.
    The Commission believes, therefore, that in a private offering, 
Paragraph (a)(3) Information would need to be provided to investors, 
NRSROs, and credit rating agencies by posting the information on a 
password-protected Internet Web site.\101\ On the first business day 
after the offering closes, however, the Paragraph (a)(3) Information 
would need to be disclosed publicly. The Commission believes that 
removing the password protection from the Internet Web site where the 
Paragraph (a)(3) Information is posted after the offering closes is 
consistent with the Securities Act restrictions on private offerings 
while satisfying the requirements of proposed Rule 17g-5(a)(3).
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    \99\ See Use of Electronic Media, Securities Act Release No. 
7856 (April 28, 2000), 65 FR 25843 (the ``Electronic Media 
Release''). The Commission noted in the Electronic Media Release 
that the federal securities laws apply equally to information 
contained on an issuer's Web site as they do to other communications 
made by or attributed to the issuer.
    \100\ 15 U.S.C. 78c(a)(61).
    \101\ A password-protected Web site would meet the requirements 
of an amended Rule 17g-5 in the context of private offerings.
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    As discussed above, the Commission believes it would be appropriate 
to allow early access to credit rating agencies other than those hired 
to issue a rating to provide them with an opportunity to perform 
independent assessments of the validity of ratings and identify flaws, 
opportunities for improvement, or compromised procedures in the hired 
NRSRO's approach. While permitting access to this information to credit 
rating agencies in addition to accredited investors extends beyond the 
Commission's previous interpretations on what constitutes a general 
solicitation or advertising, the Commission believes it balances those 
issues with the benefits of having other credit rating agencies able to 
assess the quality of, or provide additional, ratings.\102\ This 
approach is designed to promote competition among NRSROs by providing 
credit rating agencies that were not paid by the issuer to rate the 
issuer's products with information they need to issue unsolicited 
ratings and allowing other market participants to also have access to 
the information to allow them to evaluate the ratings. In a private 
offering, disclosure of this information is undertaken in two steps in 
order to avoid issues of general solicitation. The Commission is 
providing the above guidance only in the context of the proposed 
amendments. Moreover, the guidance expressed in this release is 
applicable only if the proposed amendments are adopted.
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    \102\ The Commission noted in Interpretative Release on 
Regulation D, Securities Act Release No. 6455 (March 3, 1983), 17 
CFR 231, that Rule 502(c) relates to the nature of the offering, not 
the nature of the offerees.
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    The Commission generally requests comment on all aspects of this 
proposed guidance. In addition, the Commission requests comment on the 
following questions related to the proposal.
     Are there other parties besides credit rating agencies and 
investors that should be eligible to access Paragraph (a)(3) 
Information in the context of a private offering without raising issues 
of general solicitation?
     Should any of the foregoing guidance regarding the use of 
Paragraph (a)(3) Information be codified?
     Is expanding the categories of parties who can access the 
information that would be contained in the proposed Paragraph (a)(3) 
Information consistent with the purposes of the Securities Act?
     Is there any Paragraph (a)(3) Information that should 
remain accessible only to credit rating agencies and investors, rather 
than, as proposed, disclosed to the public on the business day after 
the offering has closed?
     Should the requirement to publicly disclose the Paragraph 
(a)(3) Information on the first business day after the offering has 
closed also permit the NRSRO, depositor, etc. to omit deal-specific 
information relating to the transaction such that only ``generic'' 
information is provided to the public?
     Does disclosure of information provided for purposes of 
credit rating surveillance raise issues of general solicitation in the 
context of subsequent offerings of the same asset class? If so, does 
this vary by asset class?
iii. Offshore Offerings
    Similar to private offerings, the proposed amendments would 
implicate restrictions under Regulation S. Under the General Statement 
of Regulation S,\103\ the provisions of Section 5 of the Securities Act 
apply to offers and sales of securities that occur in the United States 
and do not apply to those that occur outside the United States. 
Regulation S contains various safe harbor procedures that issuers, 
offering participants and others can follow for unregistered offerings 
outside the United States. These procedures include restrictions 
against offers being made to persons in the United States\104\ and 
restrictions against directed selling efforts in the United States by 
the issuer, distributor, any of their respective affiliates, or persons 
acting on their behalf.\105\
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    \103\ Rule 901 of Regulation S, 17 CFR 230.901.
    \104\ Rule 903(a)(1).
    \105\ Rule 903(a)(2).
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    As noted above, the Commission believes that it is likely that much 
of the information that would be required to be disclosed would contain 
extensive loan level data and thus anticipates that a common medium for 
disclosure of this information would be an Internet Web site. The 
Commission has provided guidance with respect to the use of Internet 
Web sites for securities offerings outside the United States.\106\ This 
guidance sets out a general approach that when adequate measures are 
implemented to prevent U.S. persons from participating in an offshore 
offer, the Commission would not view the offer as occurring in the 
United States for registration purposes. The Commission believes that 
this guidance can be equally applied to the proposed disclosure of the 
proposed Paragraph (a)(3) Information.
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    \106\ See Statement of the Commission Regarding Use of Internet 
Web Sites to Offer Securities, Solicit Securities Transactions or 
Advertise Investment Services Offshore, Securities Act Release No. 
7516 (March 23, 1998).
---------------------------------------------------------------------------

    Under this guidance, what constitutes adequate measures would 
depend on all of the facts and circumstances of a particular 
transaction. As the Commission noted previously:

    ``We generally would not consider an offshore Internet offer 
made by a non-U.S. offeror as targeted at the United States, 
however, if: (1) the Web site contains a prominent disclaimer making 
it clear that the offer is directed only to countries other than the 
United States; * * * and (2) the Web site offeror implements 
procedures that are reasonably designed to guard against sales to 
U.S. persons in the offshore offering.'' \107\
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    \107\ Id.>

These procedures are not exclusive.
    The Commission's prior guidance distinguishes among foreign issuers 
and U.S. issuers each conducting offshore offerings under Regulation S 
and U.S. offerings conducted on an exempt basis. The Commission 
believes it is appropriate to continue this treatment with respect to 
the proposed disclosure of the Paragraph (a)(3) Information. Under this 
guidance, a foreign issuer making an offshore offering with no 
concurrent U.S. private offering is not required to password-protect 
Internet-based offering communications so long as adequate measures are 
put in place. Thus, credit rating agencies and other market 
participants should be able to have ready access to any Paragraph 
(a)(3) Information that is posted by a foreign issuer. A foreign issuer 
making an offshore offering concurrently with private offerings in the 
United States could implement additional other procedures to prevent 
its offshore Internet communications from being

[[Page 36226]]

used to solicit participants for its U.S.-based exempt offering, and 
U.S. issuers conducting an offshore offering should implement 
procedures similar to those for private placements, such as password-
type procedures, under which only non-U.S. persons can obtain access to 
the materials. Consistent with the procedures for private offerings, 
there could be pricing date disclosure to credit rating agencies that 
are not purchasers in the offering through a password-protected 
Internet Web site. As a result, when a foreign issuer is conducting a 
U.S. private offering under Section 4(2), and when a U.S. issuer is 
conducting an offshore offering under Regulation S or a private 
offering under Section 4(2), it would follow the procedures outlined in 
Section II.A.1.b.ii above with respect to private offerings, including 
procedures calling for public disclosure of Paragraph (a)(3) 
Information on the business day after the closing date.
    The Commission generally requests comment on all aspects of this 
proposed guidance. In addition, the Commission requests comment on the 
following questions related to the proposal.
     Are there other parties besides credit rating agencies 
that should be eligible to access Paragraph (a)(3) Information in the 
context of an offshore offering without raising issues of directed 
selling efforts or offers of securities in the Unites States?
     Should any of the foregoing guidance regarding the use of 
Paragraph (a)(3) Information be codified?
     Is expanding the categories of parties who can access the 
information that would be contained in the proposed Paragraph (a)(3) 
Information consistent with the purposes of the Securities Act?
     Is there any Paragraph (a)(3) Information that should 
remain accessible only to credit rating agencies and investors, rather 
than, as proposed, be disclosed to the public on the business day after 
the offering has closed?
     Should the requirement to publicly disclose the Paragraph 
(a)(3) Information on the first business day after the offering has 
closed also permit the NRSRO, depositor, etc. to omit deal-specific 
information relating to the transaction such that only ``generic'' 
information is provided to the public?
2. Rule 17g-5 Prohibition on Conflict of Interest Related to Rating an 
Obligor or Debt Security Where Obligor or Issuer Received Ratings 
Recommendations From the NRSRO or Person Associated With the NRSRO
    The Commission is proposing to amend Rule 17g-5(c) to add a new 
paragraph (5) that would prohibit an NRSRO from issuing a credit rating 
with respect to an obligor or security where the NRSRO or a person 
associated with the NRSRO, as defined in Section 3(a)(63) of the 
Exchange Act,\108\ made recommendations to the obligor or the issuer, 
underwriter, or sponsor of the security (that is, the parties 
responsible for structuring the security) about the corporate or legal 
structure, assets, liabilities, or activities of the obligor or issuer 
of the security. This proposal would prohibit the NRSRO and, in 
particular, its credit analysts from making recommendations to 
obligors, issuers, underwriters, and sponsors such as arrangers of 
structured finance products about how to obtain a desired credit rating 
during the rating process. It also would prohibit an NRSRO from issuing 
a credit rating where a person associated with the NRSRO, such as an 
affiliate, made such recommendations.
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    \108\ 15 U.S.C. 78c(a)(63).
---------------------------------------------------------------------------

    The Commission is proposing this amendment to Rule 17g-5, in part, 
pursuant to the authority in Section 15E(h)(2) of the Exchange 
Act.\109\ The provisions of this section of the statute provide the 
Commission with authority to prohibit, or require the management and 
disclosure of, any potential conflict of interest relating to the 
issuance of credit ratings by an NRSRO.\110\ The Commission 
preliminarily believes the proposed amendment is necessary and 
appropriate in the public interest and for the protection of investors 
because it would address a potential practice that could impair the 
objectivity, and, correspondingly, the quality, of a credit rating. It 
has been suggested that during the process of rating structured finance 
products the NRSROs have recommended to arrangers how to structure a 
trust or complete an asset pool to receive a desired credit rating and 
then rated the securities issued by the trust--in effect, rating their 
own work.\111\ This proposal would prohibit this conduct based on the 
Commission's preliminary belief that it creates a conflict that cannot 
be effectively managed insomuch as it would be very difficult for an 
NRSRO to remain objective when assessing the creditworthiness of an 
obligor or debt security where the NRSRO or person associated with the 
NRSRO made recommendations about steps the obligor or issuer of the 
security could take to obtain a desired credit rating.
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    \109\ 15 U.S.C. 78o-7(h)(2).
    \110\ Id.
    \111\ See e.g., Coffee April 22, 2008 Senate Testimony, pp. 2-3.
---------------------------------------------------------------------------

    The proposal is not intended to prohibit all interaction between 
the NRSRO and the obligor, issuer, underwriter, or sponsor during the 
rating process. The Commission preliminarily believes that the 
transparency of an NRSRO's procedures and methodologies for determining 
credit ratings is enhanced when the NRSRO explains to obligors and 
issuers the bases, assumptions, and rationales behind rating decisions. 
For example, the Commission understands that in the structured finance 
area, NRSROs may provide information to arrangers about the output of 
expected loss and cash flow models. The information provided by the 
NRSRO during the rating process allows the arranger to better 
understand the relationship between model outputs and the NRSRO's 
decisions with respect to necessary credit enhancement levels to 
support a particular rating. The arranger then can consider the 
feedback and determine independently the steps it will take, if any, to 
adjust the structure, credit enhancement levels, or asset pool. 
However, if the feedback process turns into recommendations by the 
NRSRO about changes the arranger could make to the structure or asset 
pool that would result in a desired credit rating, the NRSRO's role 
would transition from an objective credit analyst to subjective 
consultant. In this case, the Commission believes it would be difficult 
for the NRSRO to remain impartial since the expectation would be that 
the changes suggested by the NRSRO would result in the credit ratings 
sought by the arranger.
    The prohibition would extend to recommendations by persons 
associated with the NRSRO to address affiliates. For example, an 
NRSRO's holding company could establish an affiliate to provide 
consulting services to issuers about how to obtain desired credit 
ratings from the NRSRO subsidiary. The Commission believes it would be 
difficult for the NRSRO to remain objective in this situation since the 
financial success of the affiliate would depend on issuers getting the 
ratings they desired after taking any steps recommended by the 
affiliate. This would create undue pressure on the NRSRO's credit 
analysts to determine credit ratings that favored the affiliate.
    The Commission generally requests comment on all aspects of this 
proposed amendment. In addition, the Commission requests comment on the 
following questions related to the proposal.
     Is this type of conflict one that could be addressed 
through disclosure and procedures to manage it instead of prohibiting 
it? Should the Commission,

[[Page 36227]]

rather than prohibiting it, add this type of conflict to the list of 
conflicts in paragraph (b) of Rule 17g-5, which, under paragraph (a) of 
the rule, must be addressed through disclosure and procedures to manage 
them?
     Would there be practical difficulties for an NRSRO that is 
part of a large conglomerate in monitoring the business activities of 
persons associated with the NRSRO such as affiliates located in other 
countries to comply with the proposed requirement? If so, given the 
greater separation between the NRSRO and these types of persons 
associated with the NRSRO, should the Commission require instead that, 
for these types of persons associated with the NRSRO only, the NRSRO 
disclose this conflict and manage it through information barriers 
rather than prohibit it?
     The Commission recognizes that the line between providing 
feedback during the rating process and making recommendations about how 
to obtain a desired rating may be hard to draw in some cases. 
Consequently, should the Commission specify the type of interactions 
between an NRSRO and the person seeking the rating that would and would 
not constitute recommendations for the purposes of this rule? 
Commenters that believe the Commission should provide more guidance on 
this issue should provide suggested definitions.
3. Rule 17g-5 Prohibition on Conflict of Interest Related to the 
Participation of Certain Personnel in Fee Discussions
    The Commission is proposing to amend Rule 17g-5 \112\ by adding a 
new paragraph (c)(6) of Rule 17g-5 to address the conflict of interest 
that arises when a fee paid for a rating is discussed or arranged by a 
person within the NRSRO who has responsibility for participating in 
determining credit ratings (including analysts and rating committee 
members) or for developing or approving procedures or methodologies 
used for determining credit ratings, including qualitative and 
quantitative models.
---------------------------------------------------------------------------

    \112\ 17 CFR 240.17g-5.
---------------------------------------------------------------------------

    The Commission is proposing this amendment to Rule 17g-5, in part, 
pursuant to the authority in Section 15E(h)(2) of the Exchange 
Act.\113\ The provisions of this section of the statute provide the 
Commission with authority to prohibit, or require the management and 
disclosure of, any potential conflict of interest relating to the 
issuance of credit ratings by an NRSRO.\114\ The Commission 
preliminarily believes the proposed amendment is necessary and 
appropriate in the public interest or for the protection of investors 
because it would address a potential practice that could impair the 
objectivity, and, correspondingly, the quality, of a credit rating. 
This amendment is designed to effectuate the separation within the 
NRSRO of persons involved in fee discussions from persons involved in 
the credit rating analytical process. While the incentives of the 
persons discussing fees could be based primarily on generating revenues 
for the NRSRO; the incentives of the persons involved in the analytical 
process should be based on determining accurate credit ratings. There 
is a significant potential for these distinct incentive structures to 
conflict with one another where persons within the NRSRO are engaged in 
both activities.
---------------------------------------------------------------------------

    \113\ 15 U.S.C. 78o-7(h)(2).
    \114\ Id.
---------------------------------------------------------------------------

    The potential consequences are that a credit analyst or person 
responsible for approving credit ratings or credit rating methodologies 
could, in the context of negotiating fees, let business considerations 
undermine the objectivity of rating process. For example, an individual 
involved in a fee negotiation with an issuer might not be impartial 
when it comes to rating the issuer's securities. In addition, persons 
involved in approving the methodologies and processes used to determine 
credit ratings could be reluctant to adjust a model to make it more 
conservative if doing so would make it more difficult to negotiate fees 
with issuers. For these reasons, the Commission preliminarily believes 
that this conflict should be prohibited.
    The Commission generally requests comment on all aspects of this 
proposed amendment. In addition, the Commission requests comment on the 
following items related to the proposal.
     Should the proposed prohibition also be extended to cover 
participation in fee negotiations by NRSRO personnel with supervisory 
authority over the NRSRO personnel participating in determining credit 
ratings or developing or approving procedures or methodologies used for 
determining credit ratings?
     Instead of prohibiting this conflict outright, would 
disclosure and procedures to manage the conflict adequately address the 
conflict? If so, what specific disclosures should be required? What 
other measures should be required in addition to disclosures?
     Would there be practical difficulties in separating 
analytic and fee discussions for a small NRSRO, including one that has 
limited staff, that are significant enough that the Commission should 
consider a different mechanism to address the conflict? If so, what 
sort of mechanism and with what conditions? Should the Commission adopt 
an exemption from the prohibition for small NRSROs and, instead, 
require them to disclose the conflict and establish procedures to 
manage it? For example, the exemption could apply to NRSROs that have 
less than 10, 20, or 50 associated persons. Commenters that endorse an 
exemption for small NRSROs should provide specific details as to how 
the Commission should define an NRSRO as ``small'' for purposes of the 
exemption. For example, for purposes of the Final Regulatory 
Flexibility Analysis for the Adopting Release the Commission concluded 
that an NRSRO with total assets of $5 million or less was a ``small'' 
entity for purposes of the Regulatory Flexibility Act.\115\ Would that 
be an appropriate way to define a small NRSRO for purposes of this 
exemption?
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    \115\ See Adopting Release, 72 FR at 33618.
---------------------------------------------------------------------------

4. Rule 17g-5 Prohibition of Conflict of Interest Related to Receipt of 
Gifts
    The Commission is proposing to amend Rule 17g-5 \116\ by adding a 
new paragraph (c)(7) that would prohibit an NRSRO from having a 
conflict of interest relating to the issuance or maintenance of 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, other than items provided in the context of 
normal business activities such as meetings that have an aggregate 
value of no more than $25. Thus, this proposed prohibition would 
prohibit any gifts to credit analysts and persons on credit rating 
committees from the obligors, issuers, underwriters, or sponsors with 
respect to whom they had determined, monitored or approved credit 
ratings. It also would create an exception for items provided during 
normal business activities such as meetings to the extent they do not 
in the aggregate exceed $25 per meeting. For example, the provision of 
pens, notepads, or minor refreshments, such as soft drinks or coffee, 
generally are incidental to meetings and other normal course business 
interactions and not treated as gifts per se. The proposed $25 
exception is designed to be high enough

[[Page 36228]]

to permit these types of exchanges without implicating the prohibition.
---------------------------------------------------------------------------

    \116\ 17 CFR 240.17g-5.
---------------------------------------------------------------------------

    The Commission is proposing these amendments to Rule 17g-5, in 
part, pursuant to the authority in Section 15E(h)(2) of the Exchange 
Act.\117\ The provisions in this section of the statute provide the 
Commission with authority to prohibit, or require the management and 
disclosure of, any potential conflict of interest relating to the 
issuance of credit ratings by an NRSRO as the Commission deems 
necessary or appropriate in the public interest or for the protection 
of investors.\118\ The Commission preliminarily believes the proposed 
amendment is necessary and appropriate in the public interest or for 
the protection of investors because it would address a potential 
practice that could impair the objectivity, and, correspondingly, the 
quality, of a credit rating.
---------------------------------------------------------------------------

    \117\ 15 U.S.C. 78o-7(h)(2).
    \118\ Id.
---------------------------------------------------------------------------

    Persons seeking credit ratings for an obligor or debt security 
could use gifts to gain favor with the analyst responsible for 
determining the credit ratings and cause the analyst to be less 
objective during the rating process. In the case of a substantial gift, 
the potential to impact the analyst's objectivity could be immediate. 
With smaller gifts, the danger is that over time the cumulative effect 
of repeated gifts can impact the analyst's objectivity. Therefore, the 
proposal would establish an absolute prohibition on gifts with the 
exception of minor incidentals provided in business meetings.
    The Commission generally requests comment on all aspects of this 
proposed amendment. In addition, the Commission request comment on the 
following questions related to the proposal.
     Instead of prohibiting this conflict outright, should the 
Commission require that NRSROs disclose it and establish procedures to 
manage it? If so, what specific disclosures should be required?
     Instead of prohibiting gifts outright, should the 
Commission establish a yearly limit on the aggregate value of gifts 
that would be permitted under the prohibition? For example, the 
Commission could provide in the rule that the prohibition would not be 
triggered until the aggregate value of all gifts received from a 
particular person in a twelve month period exceeded $100, $500 or 
$1,000 or some other amount.
     Is the proposed $25 aggregate value an appropriate 
threshold for incidentals provided at meetings, or should a higher or 
lower threshold be applied?
     Should the Commission adopt a recordkeeping requirement 
with respect to the receipt of gifts by analysts and persons 
responsible for approving credit ratings in addition to the 
prohibition? For example, the Commission could require an NRSRO to 
document for each gift the identity of the person providing the gift, 
the recipient, and the nature of the gift.

B. Amendments to Rule 17g-2

    The Commission adopted Rule 17g-2, in part, pursuant to authority 
in Section 17(a)(1) of the Exchange Act requiring NRSROs to make and 
keep such records, and make and disseminate such reports, as the 
Commission prescribes by rule as necessary or appropriate in the public 
interest, for the protection of investors, or otherwise in furtherance 
of the Exchange Act.\119\ Rule 17g-2 requires an NRSRO to make and 
retain certain records relating to its business and to retain certain 
other business records made in the normal course of business 
operations. The rule also prescribes the time periods and manner in 
which all these records are required to be retained. The Commission is 
proposing to amend this rule to require NRSROs to make and retain 
certain additional records and to require that some of these proposed 
new records be made publicly available.
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    \119\ See Section 5 of the Rating Agency Act and 15 U.S.C. 
78q(a)(1).
---------------------------------------------------------------------------

1. A Record of Rating Actions and the Requirement That They Be Made 
Publicly Available
    The Commission is proposing to amend Exchange Act Rule 17g-2 \120\ 
to add a new paragraph (8) to Rule 17g-2 that would require a 
registered NRSRO to make and retain a record showing all rating actions 
(initial rating, upgrades, downgrades, and placements on watch for 
upgrade or downgrade) and the date of such actions identified by the 
name of the security or obligor and, if applicable, the CUSIP for the 
rated security or the Central Index Key (CIK) number for the rated 
obligor. Furthermore, the Commission is proposing to amend Rule 17g-
2(d) to require that this record be made publicly available on the 
NRSRO's corporate Internet Web site in an interactive data file that 
uses a machine-readable computer code that presents information in 
eXtensible Business Reporting Language (``XBRL'') in electronic format 
(``XBRL Interactive Data File''). The purpose of this disclosure is to 
provide users of credit ratings, investors, and other market 
participants and observers the raw data with which to compare how the 
NRSROs initially rated an obligor or security and, subsequently, 
adjusted those ratings, including the timing of the adjustments. In 
order to expedite the establishment of a pool of data sufficient to 
provide a useful basis of comparison, this requirement would apply to 
all currently rated securities or obligors as well as to all future 
credit ratings.
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    \120\ 17 CFR 240.17g-2.
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    The goal of this proposal is to foster greater accountability of 
the NRSROs with respect to their credit ratings as well as competition 
among the NRSROs by making it easier for persons to analyze the actual 
performance of the credit ratings the NRSROs issue in terms of accuracy 
in assessing creditworthiness. The disclosure of this information on 
the history of each credit rating would create the opportunity for the 
marketplace to use the information to develop performance measurement 
statistics that would supplement those required to be published by the 
NRSROs themselves in Exhibit 1 to Form NRSRO. The intent is to tap into 
the expertise and flexibility of credit market observers and 
participants to create better and more useful means to compare credit 
ratings. This goal is to make NRSROs more accountable for their ratings 
by enhancing the transparency of the results of their rating processes 
for particular securities and obligors and classes of securities and 
obligors and encourage competition within the industry by making it 
easier for users of credit ratings to judge the output of the NRSROs.
    As noted above, the proposed amendments would require that the 
record be made publicly available on the NRSRO's corporate Internet Web 
site in an XBRL Interactive Data File that uses a machine-readable 
computer code that presents information in XBRL. The Commission is 
proposing to require that an NRSRO use this format to publicly disclose 
the ratings action data because it would allow users to dynamically 
search and analyze the information, thereby facilitating the comparison 
of information across different NRSROs. In addition, an XBRL 
Interactive Data File would enable investors, analysts, and the 
Commission staff to capture and analyze the ratings action data more 
quickly and at less of a cost than is possible using another format. 
The Commission further believes that the XBRL Interactive Data File 
would be compatible with a wide range of open source and proprietary 
XBRL software applications and that as the ratings action data becomes 
more widely available, advances in interactive data software, online 
viewers, search

[[Page 36229]]

engines, and other Web-based tools may further enhance the 
accessibility and usability of the data.
    The Commission's experience in having certain issuers use XBRL for 
EDGAR filings has demonstrated the benefits of this format to 
investors, filers, and Commission staff.\121\ Expanding its use to 
NRSRO ratings history data would be consistent with Commission policy 
to utilize this format where practical.
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    \121\ See Extension of Interactive Data Voluntarily Reporting 
Program in the EDGAR System to Include Mutual Fund Risk/Return 
Summary Information. Securities Act Release No. 8823 (August 20, 
2007).
---------------------------------------------------------------------------

    The proposed amendment to Rule 17g-2(d) also would provide that the 
records be made publicly available no later than six months after the 
date of the rating action. The Commission anticipates that the record 
required under this amendment would need to be updated frequently as 
new credit ratings are issued and existing credit ratings are upgraded, 
downgraded and put on ratings watch. For purposes of the internal 
record, the NRSRO would need to keep the record current to reflect the 
complete ratings history of each extant credit rating. However, for 
purposes of the requirement to make the record publicly available, the 
NRSRO would be permitted to disclose the record on its Internet Web 
site six months after the record is updated to reflect a new ratings 
action. The proposed six-month time lag for publicly disclosing the 
updated record is designed to accommodate NRSROs that operate using the 
subscriber-pay model because they are paid for access to their current 
credit ratings. It also is designed to preserve the revenues that 
NRSROs operating using the issuer-pay model derive from selling 
download access to their current credit ratings.\122\ The Commission 
preliminarily believes the six-month time lag would not have any 
negative effect on the goal of this proposed amendment because the 
information on credit ratings actions that would be disclosed--perhaps 
many years' worth for some credit ratings--should be sufficient to 
develop meaningful performance metrics for comparing NRSROs.
---------------------------------------------------------------------------

    \122\ The accommodation of subscriber-pay models acknowledges 
the Rating Agency Act's intent to encourage the subscriber-pays 
model (see Senate Report, p. 7) while simultaneously ensuring equal 
treatment for NRSROs operating under an issuer-pays model.
---------------------------------------------------------------------------

    Finally, the proposed amendments also would amend the instructions 
to Exhibit 1 to Form NRSRO to require the disclosure of the Web address 
where the XBRL Interactive Data File could be accessed. This is 
designed to inform persons who use credit ratings where the ratings 
histories can be obtained.
    The Commission is proposing these amendments, in part, under 
authority to require NRSROs to make and keep for prescribed periods 
such records as the Commission prescribes as necessary or appropriate 
in the public interest, for the protection of investors, or otherwise 
in furtherance of the purposes of the Exchange Act.\123\ The Commission 
preliminarily believes the proposed new recordkeeping and disclosure 
requirements are necessary and appropriate in the public interest and 
for the protection of investors, or otherwise in furtherance of the 
purposes of the Exchange Act. Specifically, by proposing to require 
NRSROs to make ratings actions publicly available in an XBRL 
Interactive Data File, market participants would be able to create 
their own performance measurement metrics, including default and 
transition matrices, by which to judge the accuracy of NRSRO ratings. 
In addition, users of credit ratings would be able to compare side-by-
side how each NRSRO initially rated a particular security, when the 
NRSRO took actions to adjust the rating upward or downward, and the 
degree of those adjustments. Furthermore, users of credit ratings, 
academics and information venders could use the raw data to perform 
analyses comparing how the NRSROs differ in their initial ratings and 
their monitoring for different types of asset classes. This could 
identify an NRSRO that is an outlier in terms of issuing high or low 
credit ratings or consistently reassesses ratings on a delayed basis 
for some or all asset classes when compared to other NRSROs. It also 
could help identify NRSROs that are consistently more or less accurate 
than others. This information also may identify NRSROs whose 
objectivity may be impaired because of conflicts of interest.
---------------------------------------------------------------------------

    \123\ See Section 17(a)(1) of the Exchange Act (15 U.S.C. 
78q(a)(1)).
---------------------------------------------------------------------------

    The Commission generally requests comment on all aspects of this 
proposed amendment. In addition, the Commission requests comment on the 
following questions related to the proposal.
     Is the six-month delay before publicly disclosing a rating 
action sufficiently long to address the business concerns of the 
subscriber-based NRSROs and the issuer-paid NRSROs? Should the delay be 
for a longer period such as one or two years or even longer? 
Alternatively, is six months too long and should it be a shorter period 
of time such as three months or even shorter?
     Should the rule require that a notice be published along 
with the XBRL Interactive Data File warning that because of the 
permitted delay in updating the record some of the credit ratings in 
the record may no longer reflect the NRSRO's current assessment of the 
creditworthiness of the obligor or debt security? For example, the 
notice could explain that the information in the record is sixth months 
old and state that the credit ratings contained in record may not be 
up-to-date.
     Are there ways in which the NRSROs should be required to 
sort the credit ratings contained on the record such as by asset class 
or type of ratings?
     What mechanisms are appropriate for identifying rated 
securities? Are there other identifiers in addition, or as an 
alternative, to CUSIP or CIK number that could be used in the rule?
     Should the Commission allow the ratings action data to be 
provided in a format other than XBRL, such as pipe delimited text data 
(``PDTD'') or eXtensible Markup Language (``XML'')? Is there another 
format that is more widely used or would be more appropriate than XBRL 
for NRSRO data? What are the advantages/disadvantages of requiring the 
XBRL format?
     Should the Commission require that the information on the 
assets underlying a structured finance products discussed in Section 
II.A.1.a above be provided in a specific format such as PDTD, XML, or 
XBRL? Again, is there another format that is more widely used or would 
be more appropriate for such data? What are the advantages/
disadvantages of requiring a specific format?
     Should the Commission take the lead in creating the new 
tags that are needed for the XBRL format or should it allow the tags to 
be created by another group and then review the tags? How long would it 
take to create new tags?
     The Commission anticipates that the data provided by 
NRSROs would be simple and repetitive (i.e., the data would be name, 
CUSIP, date, rating, date, rating, etc.). Is there a need for more 
detailed categories of data?
     What would be the costs to an NRSRO to provide data in the 
XBRL format? Would there be a cost burden on smaller NRSROs? Is there 
another format that would cost less but still allow investors and 
analysts to easily download and analyze the data?
     Should the Commission institute a test phase for providing 
this information in an XBRL format (such as a voluntary pilot program, 
similar to what it is currently doing for EDGAR filings)? How long 
should this test phase last?
     Where is the best place to store the data provided by 
NRSROs? Currently,

[[Page 36230]]

information that needs to be made publicly available is stored on each 
NRSRO's Web site. Should the Commission create a central database to 
store the information? If so, should it use the EDGAR database or 
should it create a new database?
2. A Record of Material Deviation From Model Output
    The Commission is proposing to amend paragraph (a)(2) of Rule 17g-2 
to add an additional record that would be required to be made for each 
current credit rating, namely, if a quantitative model is a substantial 
component in the process of determining the credit rating, a record of 
the rationale for any material difference between the credit rating 
implied by the model and the final credit rating issued. The NRSRO 
issuing the rating would be responsible for making the determination of 
what constituted a ``substantial component'' of the rating process as 
well as what constituted a ``material'' difference between the rating 
issued and the rating implied by the model.\124\ This proposal is 
designed to enhance the recordkeeping processes of the NRSROs so that 
Commission examiners (and any internal auditors of the NRSRO) could 
reconstruct the analytical process by which a credit rating was 
determined. This would facilitate their review of whether the NRSRO 
followed its disclosed and internally documented procedures for 
determining credit ratings.
---------------------------------------------------------------------------

    \124\ The Commission notes that it would consider the RMBS and 
CDO rating process described above in Section I.C.2 as using a 
quantitative model as a substantial component in the ratings 
process.
---------------------------------------------------------------------------

    The requirement to make the record would be triggered in cases 
where a quantitative model is a substantial component of the credit 
ratings process for the type of obligor or security being rated and the 
output of the model would result in a materially different conclusion 
if the NRSRO relied on it without making an out-of-model adjustment. 
For example, the Commission preliminarily believes the expected loss 
and cash flow models used by the NRSROs to rate RMBS and CDOs are 
substantial components of the rating process. The following 
hypothetical scenario is intended as an illustrative example of an 
instance when an out-of-model adjustment would be material to the RMBS 
rating process thereby triggering the requirement to document the 
rationale for the adjustment under the proposed rule. A credit analyst 
uses the NRSRO's expected loss model to analyze a $1 billion (aggregate 
principal amount) loan pool received from an arranger that is proposed 
to collateralize an RMBS. The results of the model imply that the 
senior RMBS tranche would need to have at least 20% subordination in 
order to receive an AAA rating. However, the NRSRO's methodologies and 
procedures for rating RMBS allow for the subordination level suggested 
by the model output to be adjusted based on certain qualitative factors 
such as the experience and competence of the loan servicer or the 
recent performance of similar loan pools. Based on the superior 
competence of the loan servicer, the analyst concludes that the senior 
tranche only needs 19% subordination and, ultimately, the ratings 
committee agrees. Consequently, the RMBS is issued with a senior 
tranche having 19% subordination and receiving an AAA rating from the 
NRSRO. In this case, under the proposed amendment, the NRSRO would be 
required to make a record that identified the rationale--the servicer's 
superior competence--for determining a credit rating that was different 
from the rating implied by the model.
    As the above scenario demonstrates, the failure to make such a 
record could hamper the ability of the Commission to review whether an 
NRSRO was following its stated procedures for determining credit 
ratings. In the above scenario, the analyst could adjust the rating 
requirements implied by the model by applying qualitative factors with 
respect to the loan servicer or the performance of similar pools. A 
record indicating which rationale was applied would make it easier for 
the Commission to review whether the procedures were followed.
    The Commission is proposing this amendment, in part, under 
authority to require NRSROs to make and keep for prescribed periods 
such records as the Commission prescribes as necessary or appropriate 
in the public interest, for the protection of investors, or otherwise 
in furtherance of the purposes of the Exchange Act.\125\ The Commission 
preliminarily believes this proposed new recordkeeping requirement is 
necessary and appropriate in the public interest and for the protection 
of investors, or otherwise in furtherance of the purposes of the 
Exchange Act. Specifically, as explained above, the Commission 
preliminarily believes that maintaining records identifying the 
rationale for material divergences from the ratings implied by 
qualitative models used as a substantial component in the ratings 
process would assist the Commission in evaluating whether an NRSRO is 
adhering to its disclosed procedures for determining ratings. Further, 
as the Commission noted in the Adopting Release, ``books and records 
rules have proven integral to the Commission's investor protection 
function because the preserved records are the primary means of 
monitoring compliance with applicable securities laws.'' In the absence 
of such a recordkeeping requirement, there may be no way to determine 
whether an analyst modified the requirements for obtaining a certain 
category of credit rating (e.g. AAA) as indicated by the model results 
by applying appropriate qualitative factors permitted under the NRSRO's 
documented procedures or because of undue influence from the person 
seeking the credit rating or other inappropriate reasons such as those 
prohibited by Rule 17g-6.\126\
---------------------------------------------------------------------------

    \125\ See Section 17(a)(1) of the Exchange Act (15 U.S.C. 
78q(a)(1)).
    \126\ 17 CFR 240.17g-6. Rule 17g-6 prohibits an NRSRO from 
engaging in certain unfair, abusive or coercive practices such as 
issuing a credit rating that is not determined in accordance with 
the NRSRO's established procedures and methodologies for determining 
credit ratings based on whether the rated person will purchase the 
credit rating. See 17 CFR 240.17g-6(a)(2).
---------------------------------------------------------------------------

    The Commission generally requests comment on all aspects of this 
proposed amendment. In addition, the Commission requests comment on the 
following questions related to the proposal.
     Would this proposal have the impermissible effect of 
regulating the substance of credit ratings in any way?
     Should the Commission define in the rule when the use of a 
model would be a ``substantial component'' in the process of 
determining a credit rating? Commenters endorsing the adoption of such 
a definition should provide specific proposals.
     Are there certain types of rated products (e.g., corporate 
debt, municipal bonds) which generally employ a quantitative model as a 
substantial component of the ratings process? Commenters should 
identify the types of bonds and a general description of the models 
used to rate them.
     Should the Commission define in the rule when the 
divergence from a model would be ``material''? Commenters endorsing the 
adoption of such a definition should provide specific proposals.
     Is the hypothetical scenario of the RMBS rating process 
used to illustrate when a divergence would be material for purposes of 
the proposed amendment reasonable? For example, is the adjustment of 
the subordination level from 20% to 19% for a $1 billion loan pool a 
material divergence? Would

[[Page 36231]]

a lesser adjustment of the subordination level (e.g., 20% to 19.5%) 
also be material?
     Are there alternative types of records that may be created 
or retained by an NRSRO that would allow the Commission to understand 
when and why an NRSRO's final rating differed materially from the 
rating implied by the model?
     Should the Commission require that the information about 
material deviations from the rating implied by the model be publicly 
disclosed by the NRSRO in the presale report or when the rating is 
issued?
3. Records Concerning Third-Party Analyst Complaints
    The Commission is proposing an amendment to Exchange Act Rule 17g-2 
\127\ to add a requirement that an NRSRO retain records of any 
complaints regarding the performance of a credit analyst in determining 
credit ratings. Specifically, the proposed amendment would add a new 
paragraph (b)(8) to Rule 17g-2 to require an NRSRO to retain any 
communications that contain complaints about the performance of a 
credit analyst in initiating, determining, maintaining, monitoring, 
changing, or withdrawing a credit rating.
---------------------------------------------------------------------------

    \127\ 17 CFR 240.17g-2.
---------------------------------------------------------------------------

    The Commission is proposing these amendments, in part, under 
authority to require NRSROs to make and keep for prescribed periods 
such records as the Commission prescribes as necessary or appropriate 
in the public interest, for the protection of investors, or otherwise 
in the furtherance of the Exchange Act.\128\ The Commission 
preliminarily believes the proposed new recordkeeping requirements are 
necessary and appropriate in the public interest and for the protection 
of investors, or otherwise in furtherance of the Exchange Act, because 
they would assist the Commission in reviewing how NRSROs address 
conflicts interest that could impair the integrity of their credit 
rating processes. For example, an NRSRO might respond to complaints 
from issuers that an analyst is too conservative by removing the 
analyst from the responsibility of rating the securities of those 
issuers and assigning a new analyst that is more willing to determine 
credit ratings desired by the issuers. As discussed above with respect 
to the proposed amendments to Rule 17g-5, the potential for this type 
of response to complaints about analysts is particularly acute in the 
structured finance area given that certain arrangers of structured 
finance products repeatedly bring ratings business to the NRSROs.\129\ 
The pressure to maintain the business relationship with these arrangers 
could cause an NRSRO to remove an analyst responsible for rating the 
structured finance products these arrangers bring to market if they 
complained about how the analyst was determining credit ratings and 
implied that they might take their business to other NRSROs.
---------------------------------------------------------------------------

    \128\ See Section 17(a)(1) of the Exchange Act (15 U.S.C. 
78q(a)(1)).
    \129\ See e.g., Coffee April 22, 2008 Senate Testimony, pp. 4-6.
---------------------------------------------------------------------------

    The records proposed under these amendments would allow the 
Commission, in evaluating the integrity of the NRSRO's ratings process, 
to better assess whether analyst reassignments or terminations were for 
reasons unconnected to a conflict of interest (e.g., the analyst's poor 
performance) or as a result of the ``arranger-pay'' conflict of 
interest described above. For example, the examiners could review the 
complaint file that would be established by this proposed amendment and 
follow-up with the relevant persons within the NRSRO as to how the 
complaint was addressed. The potential for such a review by Commission 
examiners could reduce the willingness of an NRSRO to re-assign or 
terminate a credit analyst for inappropriate business considerations.
    The Commission generally requests comment on all aspects of this 
proposed amendment. In addition, the Commission requests comment on the 
following questions related to the proposal.
     In addition to the proposed recordkeeping requirement, 
should the Commission require the NRSROs to publicly disclose when an 
analyst has been re-assigned from the responsibility to rate an obligor 
or the securities of an issuer, underwriter, or sponsor?
     Should the Commission require NRSROs to retain any 
communications containing a request from an obligor, issuer, 
underwriter, or sponsor that the NRSRO assign a specific analyst to a 
transaction in addition to the proposed requirement to retain 
complaints about analysts?
4. Clarifying Amendment to Rule 17g-2(b)(7)
    Paragraph (b)(7) of Rule 17g-2 currently requires an NRSRO to 
retain all internal and external communications that relate to 
``initiating, determining, maintaining, changing, or withdrawing a 
credit rating.'' The Commission is proposing to add the word 
``monitoring'' to this list. The intent is to clarify that NRSRO 
recordkeeping rules extend to all aspects of the credit rating 
surveillance process as well as the initial rating process. This was 
the intent when the Commission originally adopted the rule as indicated 
by the use of the term ``maintaining.'' The Commission believes that 
adding the term ``monitoring''--a term of art in the credit rating 
industry--would better clarify this requirement.
    The Commission generally requests comment on all aspects of this 
proposed amendment. In addition, the Commission requests comment on the 
following question related to the proposal.
     Should the Commission delete the term ``maintaining'' from 
paragraph (b)(7) and proposed new paragraph (b)(8) of Rule 17g-2 as it 
has the same meaning as ``monitoring?''

C. Amendments to the Instructions for Form NRSRO

    Form NRSRO is the means by which credit rating agencies apply to be 
registered with the Commission and registered NRSROs update information 
they must publicly disclose. Much of the information elicited in Form 
NRSRO is required to be submitted to the Commission pursuant to the 
statutory requirements of Section 15E(a)(1)(B) of the Exchange 
Act.\130\ The Commission added certain additional information to be 
submitted in the Form.\131\ As discussed below, the Commission, in 
part, under its authority pursuant to Section 15E(a)(1)(B)(x), is now 
proposing to amend Form NRSRO to further enhance the quality and 
usefulness of the information to be furnished and disclosed by 
registered NRSROs by requiring specified information in addition to 
that which is statutorily defined in the Section 15E of the Exchange 
Act.
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    \130\ 15 U.S.C. 78o-7(a)(1)(B).
    \131\ 15 U.S.C. 78o-7(a)(1)(B)(x).
---------------------------------------------------------------------------

1. Enhanced Ratings Performance Measurement Statistics on Form NRSRO
    As discussed above, the Commission is proposing to require the 
disclosure of the historical rating actions relating to each current 
credit rating of an NRSRO through amendments to Rule 17g-2. The intent 
is to make available the raw data necessary for the marketplace to 
develop and apply credit ratings performance metrics. At the same time, 
the Commission is proposing to amend the instructions to Exhibit 1 to 
Form NRSRO to enhance the comparability of the performance measurement 
statistics the NRSROs are required to publicly disclose in the Form. 
Currently, the

[[Page 36232]]

instructions require the disclosure of ``performance measurement 
statistics of the credit ratings of the Applicant/NRSRO over short-
term, mid-term, and long-term periods (as applicable) through the most 
recent calendar year-end.'' The Commission, in adopting this 
requirement, did not require disclosure of performance statistics in 
Form NRSRO beyond those specified in Section 15E(a)(1)(B)(i) of the 
Exchange Act.\132\ In the Adopting Release, the Commission explained 
that it was not prepared to prescribe standard metrics at that time in 
light of the varying approaches suggested by some commenters and the 
opposition of other commenters to having the Commission impose any 
standards.\133\ The Commission also stated that it would continue to 
consider the issue to determine the feasibility, as well as the 
potential benefits and limitations, of devising measurements that would 
allow reliable comparisons of the accuracy of the NRSROs' credit 
ratings.\134\
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    \132\ See 15 U.S.C. 78o-7(a)(1)(B)(i).
    \133\ See Adopting Release, 72 FR at 33574.
    \134\ Id.
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    The Commission, with the benefit of further consideration of the 
issue, now preliminarily believes that the instructions to Exhibit 1 
can prescribe greater specificity about how the performance statistics 
must be generated without intruding into the processes and 
methodologies by which NRSROs determine credit ratings. For example, 
through the examination process, the Commission has become more 
familiar with the procedures and methodologies used by the NRSROs to 
determine credit ratings. Through this experience, the Commission 
preliminarily believes it can prescribe generic requirements for the 
performance statistics that would accommodate the different procedures 
and methodologies used by the NRSROs.
    The first proposed amendment would augment the instructions to 
Exhibit 1 by requiring the disclosure of separate sets of default and 
transition statistics for each asset class of credit rating for which 
an applicant is seeking registration as an NRSRO or an NRSRO is 
registered and any other broad class of credit ratings issued by the 
NRSRO. This would result in the generation of performance statistics 
that are specific to each class of credit ratings for which the NRSRO 
is registered (or an applicant is seeking registration). This proposal 
is designed to make it easier for users of credit ratings to compare 
the accuracy of NRSRO credit ratings on a class-by-class basis.
    The proposed amendment also would require an NRSRO registered in 
the class of credit ratings described in Section 3(a)(62)(B)(iv) of the 
Rating Agency Act\135\ (or an applicant seeking registration in that 
class) when generating the performance statistics for that class to 
include credit ratings of any security or money market instrument 
issued by an asset pool or as part of any asset-backed or mortgage-
backed securities transaction. This is designed to ensure the inclusion 
of ratings actions for credit ratings of structured finance products 
that do not meet the narrower statutory definition of ``issuers of 
asset-backed securities (as that term is defined is section 1101(c) of 
part 229 of title 17, Code of Federal Regulations).''\136\
---------------------------------------------------------------------------

    \135\ 15 U.S.C. 78c(a)(62)(B)(iv).
    \136\ See Id.
---------------------------------------------------------------------------

    The second proposed amendment would require that these class-by-
class disclosures be broken out over 1, 3 and 10-year periods. Section 
15E(a)(1)(B)(i) of the Exchange Act requires that the performance 
statistics be over short, mid, and long-term periods.\137\ The proposed 
amendment would define those statutorily prescribed periods in specific 
years so that the performance statistics generated by the NRSROs cover 
comparable time periods. The Commission preliminarily believes that 1, 
3, and 10 year periods are reasonable definitions of the terms ``short-
term, mid-term, and long-term periods'' as used in Section 
15E(a)(1)(B)(i) of the Exchange Act.\138\ For example, the 1 year 
period would provide users with information about how the credit 
ratings are currently performing. In effect, it could serve as an early 
warning mechanism if a problem developed in an NRSRO's rating processes 
due to flaws or conflicts. Similarly, the 3 year period would provide 
information about the how the ratings were currently performing but, by 
including more historical data, smooth out spikes in the 1 year 
statistics to give a better sense of how the ratings perform over time. 
The 3 year statistics also would serve as a bridge to the longer term 
10 year statistics. The 10 year statistics would show users how the 
ratings in a particular class of securities perform over the long 
range.
---------------------------------------------------------------------------

    \137\ 15 U.S.C. 78o-7(a)(1)(B)(i).
    \138\ 15 U.S.C. 78o-7(a)(1)(B)(i).
---------------------------------------------------------------------------

    The third proposed amendment would modify what ratings actions are 
required to be included in these performance measurement statistics by 
replacing the term ``down-grade and default rates'' with ``ratings 
transition and default rates.'' The proposed switch to ``ratings 
transition'' rates from ``downgrade'' rates is designed to clarify that 
upgrades (as well as downgrades) should be included in the statistics. 
The fact that an NRSRO upgrades a substantial amount of credit ratings 
may be just as indicative of a flaw in the initial rating as a large 
number of downgrades. For example, an NRSRO could try to manipulate its 
performance statistics by issuing overly conservative ratings.
    The final proposed amendment would specify that the default 
statistics required under the exhibit must show defaults relative to 
the initial rating and incorporate defaults that occur after a credit 
rating is withdrawn. This amendment is designed to prevent an NRSRO 
from manipulating the performance statistics by not including defaults 
when generating statistics for a category of credit ratings (e.g., AA) 
because the defaults occur after the rating is downgraded to a lower 
category (e.g., CC) or withdrawn.
    The Commission is proposing these amendments, in part, under 
authority to require such additional information in the application as 
it finds necessary or appropriate in the public interest or for the 
protection of investors.\139\ The Commission preliminarily believes the 
proposed new disclosure requirements for Exhibit 1 are necessary and 
appropriate and in the public interest or for the protection of 
investors. Specifically, the information that would be required under 
the proposed amendments would aid investors by allowing them to 
evaluate how the credit ratings of an NRSRO perform (i.e., the 
percentage of credit ratings that migrate to another category of credit 
rating and the percentage of rated obligors and securities that 
default) on a class-by-class basis. This would provide better 
information on how an NRSRO's ratings have performed within the field 
of financial products relevant to any given user of credit ratings and 
investor. For example, an investor contemplating the purchase of a 
highly-rated subprime RMBS would be able to consider the performance of 
an NRSRO's ratings of structured finance products, which would be more 
useful than the NRSRO's general performance statistics across all 
classes of credit ratings. Specifically, an NRSRO may be much better at 
assessing the creditworthiness of corporate debt securities than of 
structured finance products. Consequently, performance statistics of 
such an NRSRO that incorporate all classes of credit ratings

[[Page 36233]]

(e.g., corporate debt and structured finance products) would be less 
precise in terms of evaluating the performance of the NRSRO's credit 
ratings for structured finance products.
---------------------------------------------------------------------------

    \139\ See Section 15E(a)(1)(B)(x) of the Exchange Act (15 U.S.C. 
78o-7(a)(1)(B)(x)).
---------------------------------------------------------------------------

    Furthermore, by defining ``short-term, mid-term, and long-term'' 
periods as 1, 3, and 10-year timeframes, the proposed amendment would 
provide a better basis for comparing the performance of different 
NRSROs as the statistics for each NRSRO would cover the same periods. 
Finally, the replacement of the ``down-grade'' requirement with a 
``ratings transition'' requirement and the clarification of what 
default statistics would need to be incorporated into the ratings 
performance statistics would further enhance investor understanding of 
NRSRO performance by requiring that similar information be captured in 
the NRSROs' performance rating statistics and eliminating certain ways 
that could be used to ``pad'' statistics.
    The Commission generally requests comment on all aspects of these 
proposed amendments. In addition, the Commission requests comment on 
the following questions related to the proposals.
     Should the Commission prescribe specific standards for the 
performance statistics, such as requiring an NRSRO to disclose how its 
credit ratings performed relative to metrics such as credit spreads? 
Commenters endorsing such an approach should provide specific details 
as to how it could be implemented; taking into consideration factors 
such as the issues related to the difficulty of obtaining timely and 
consistent pricing information for many debt instruments and the 
volatility of credit spreads.
     Should the Commission require performance statistics in a 
more granular form than by class of credit ratings? For example, should 
the Commission require for structured finance products statistics by 
more narrowly defined asset classes such as CDOs and RMBS or types of 
asset-backed securities such as those backed by home loans, credit 
cards, or commercial real estate? Commenters endorsing greater 
granularity should provide specific details, including definitions of 
the credit rating classes.
     Should the Commission prescribe different time periods for 
the short, medium, and long term statistics than 1, 3, and 10 years, 
respectively. For example, should the periods be 6 months, 2 years and 
7 years or 2, 5, and 15 years or some other set of time periods?
2. Enhanced Disclosure of Ratings Methodologies
    The Commission is proposing to amend the instructions for Exhibit 2 
to Form NRSRO to require enhanced disclosures about the procedures and 
methodologies an NRSRO uses to determine credit ratings. Section 
15E(a)(1)(B)(ii) of the Exchange Act requires that an application for 
registration as an NRSRO contain information regarding the procedures 
and methodologies used by the firm to determine credit ratings.\140\ 
The Commission implemented this requirement by prescribing through the 
instructions to Form NRSRO that an applicant and NRSRO must provide 
general descriptions of their procedures and methodologies for 
determining credit ratings and that the descriptions must be 
sufficiently detailed to provide users of credit ratings with an 
understanding of the procedures and methodologies. The instructions 
also identified various areas that are required to be addressed in 
Exhibit 2, including, as applicable, descriptions of the NRSRO's 
policies for determining whether to initiate a credit rating; the 
public and non-public sources of information used in determining credit 
ratings, including information and analysis provided by third-party 
venders; and the quantitative and qualitative models and metrics used 
to determine credit ratings.
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    \140\ 15 U.S.C. 78o-7(a)(1)(B)(ii).
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    The Commission is proposing to add three additional areas that an 
applicant and a registered NRSRO would be required to address in the 
descriptions of its procedures and methodologies in Exhibit 2. The 
inclusion of these would serve to better disclose the actions an 
applicant and NRSRO is, or is not taking, in determining credit 
ratings. The additional areas required to be addressed in the exhibit 
would be:
     Whether and, if so, how information about verification 
performed on assets underlying or referenced by a security or money 
market instrument issued by an asset pool or as part of any asset-
backed or mortgage-backed securities transaction is relied on in 
determining credit ratings;
     Whether and, if so, how assessments of the quality of 
originators of assets underlying or referenced by a security or money 
market instrument issued by an asset pool or as part of any asset-
backed or mortgage-backed securities transaction play a part in the 
determination of credit ratings; and
     How frequently credit ratings are reviewed, whether 
different models or criteria are used for ratings surveillance than for 
determining initial ratings, 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 Commission is proposing these amendments, in part, under 
authority to require such additional information in the application as 
it finds necessary or appropriate in the public interest or for the 
protection of investors.\141\ The Commission preliminarily believes the 
proposed new disclosure requirements for Exhibit 2 are necessary and 
appropriate and in the public interest or for the protection of 
investors. Specifically, they are designed to provide greater clarity 
around three areas of the NRSROs' rating processes, particularly for 
structured finance products, where questions have been raised in the 
context of the credit market turmoil: Namely, the verification 
performed on information provided in loan documents; the quality of 
loan originators; and the surveillance of existing ratings and how 
changes to models are applied to existing ratings. The amendments are 
designed to enhance the disclosures NRSROs make in these areas and, 
thereby, allow users of credit ratings to better evaluate the quality 
of their ratings processes.
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    \141\ See Section 15E(a)(1)(B)(x) of the Exchange Act (15 U.S.C. 
78o-7(a)(1)(B)(x)).
---------------------------------------------------------------------------

    The first proposed amendment would require an NRSRO to disclose 
whether it considers in its rating process for structured finance 
product steps taken to verify information about the assets in the pool 
backing the structured finance product. Underwriters and sponsors of 
structured finance products frequently take some steps to verify 
information provided by borrowers in loan documentation. Generally, 
they have been reluctant to provide this information to NRSROs for 
proprietary reasons. The proposed amendment would not require that the 
NRSROs incorporate verification (or the lack of verification) into 
their ratings processes. Rather, it would require an NRSRO to disclose 
whether and, if so, how information about verification performed on the 
assets is relied on in determining credit ratings for structured 
finance products. For example, an NRSRO would need to disclose, as 
applicable: If it does not consider steps taken to verify the 
information; if it

[[Page 36234]]

requires some minimum level of verification to be performed before it 
will determine a credit rating for a structured finance product; and 
how it incorporates the level of verification performed into its 
procedures and methodologies for determining credit ratings (e.g., if 
it compensates for the lack of verification by requiring greater levels 
of credit enhancement for the tranche securities).
    The Commission preliminarily believes this disclosure would benefit 
users of credit ratings by providing information about the potential 
accuracy of an NRSRO's credit ratings. As noted above, the NRSROs 
determine credit ratings for structured finance products based on 
assumptions in their models as to how the assets underlying the 
instruments will perform under varying levels of stress. These 
assumptions are based on the characteristics of the assets (e.g., value 
of the property, income of the borrower) as reported by the arranger of 
the structured finance product. If this information is inaccurate, the 
capacity of the model to predict the potential future performance of 
the assets may be significantly impaired. Consequently, information 
about whether an NRSRO requires that some level of verification be 
performed or takes other steps to account for the lack of verification 
or a low level of verification would be useful to users of credit 
ratings in assessing the potential for an NRSRO's credit ratings to be 
adversely impacted by bad information about the assets underlying a 
rated structured finance product.
    The second proposed amendment would require an NRSRO to disclose 
whether it considers qualitative assessments of the originator of 
assets underlying a structured finance product in the rating process 
for such products. Certain qualities of an asset originator, such as 
its experience and underwriting standards, may impact the quality of 
the loans it originates and the accuracy of the associated loan 
documentation. This, in turn, could influence how the assets ultimately 
perform and the ability of the NRSRO's models to predict their 
performance. Consequently, the failure to perform any assessment of the 
loan originators could increase the risk that an NRSRO's credit ratings 
may not be accurate. Therefore, disclosures as to whether the NRSRO 
performs any qualitative assessments of the originators would be useful 
in comparing the efficacy of the NRSRO's procedures and methodologies.
    The third proposed amendment would require an NRSRO to disclose the 
frequency of its surveillance efforts and how changes to its 
quantitative and qualitative ratings models are incorporated into the 
surveillance process. The Commission believes that users of credit 
ratings would find information about these matters useful in comparing 
the ratings methodologies of different NRSROs. For example, how often 
and with what models an NRSRO monitors its credit ratings would be 
relevant to assessing the accuracy of the ratings insomuch as ratings 
based on stale information and outdated models may not be as accurate 
as ratings of like products determined using newer data and models. 
Moreover, with respect to new types of rated obligors and debt 
securities, the NRSROs refine their models as more information about 
the performance of these obligors and debt securities is observed and 
incorporated into their assumptions. Consequently, as the models evolve 
based on more robust performance data, credit ratings of obligors or 
debt securities determined using older models may be at greater risk 
for being inaccurate than the newer ratings. Therefore, whether the 
NRSRO verifies the older ratings using the newer methodologies would be 
useful to users of credit ratings in assessing the accuracy of the 
credit ratings.
    The Commission generally requests comment on all aspects of the 
proposed amendments. In addition, the Commission requests comment on 
the following question related to the proposals.
     Are there other areas of the ratings process where 
enhanced disclosure on Form NRSRO would benefit investors and other 
users of credit ratings? Commenters endorsing further disclosures 
should specifically identify them.

D. Amendment to Rule 17g-3 (Report of Credit Rating Actions)

    The Commission adopted Rule 17g-3 pursuant to authority in Section 
15E(k) \142\ of the Exchange Act, which requires an NRSRO to furnish to 
the Commission, on a confidential basis \143\ and at intervals 
determined by the Commission, such financial statements and information 
concerning its financial condition as the Commission, by rule, may 
prescribe as necessary or appropriate in the public interest or for the 
protection of investors. The statute also provides that the Commission 
may, by rule, require that the financial statements be certified by an 
independent public accountant.\144\ In addition, Section 17(a)(1) of 
the Exchange Act \145\ requires an NRSRO to make and keep such records, 
and make and disseminate such reports, as the Commission prescribes by 
rule as necessary or appropriate in the public interest, for the 
protection of investors, or otherwise in furtherance of the Exchange 
Act.\146\
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    \142\ 15 U.S.C. 78o-7(k).
    \143\ An applicant can request that the Commission keep this 
information confidential. See Section 24 of the Exchange Act (15 
U.S.C. 78x), 17 CFR 240.24b-2, 17 CFR 200.80 and 17 CFR 200.83.
    \144\ Id.
    \145\ 15 U.S.C. 78q(a)(1).
    \146\ See Section 5 of the Rating Agency Act and 15 U.S.C. 
78q(a)(1).
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    Rule 17g-3 requires an NRSRO to furnish the Commission on an annual 
basis the following reports: Audited financial statements; unaudited 
consolidated financial statements of the parent of the NRSRO, if 
applicable; an unaudited report concerning revenue categories of the 
NRSRO; an unaudited report concerning compensation of the NRSRO's 
credit analysts; and an unaudited report listing the largest customers 
of the NRSRO. The rule further requires an NRSRO to furnish the 
Commission these reports within 90 days of the end of its fiscal year.
    The Commission is proposing to amend Rule 17g-3 to require an NRSRO 
to furnish the Commission with an additional annual report of the 
number of credit rating actions during the fiscal year in each class of 
security for which the NRSRO is registered. Specifically, the amendment 
would add a new paragraph (a)(6) to Rule 17g-3, which would require an 
NRSRO to provide the Commission with a report of the number of credit 
rating actions (upgrades, downgrades, and placements on watch for an 
upgrade or downgrade) during the fiscal year in each class of credit 
ratings for which the NRSRO is registered with the Commission. A note 
to paragraph (a)(6) would clarify that for the purposes of reporting 
credit rating actions in the asset-backed security class of credit 
ratings described in Section 3(a)(62)(B)(iv) of the Rating Agency Act 
\147\ an NRSRO would need to include credit rating actions on any 
security or money market instrument issued by an asset pool or as part 
of any asset-backed or mortgage-backed securities transaction. This is 
designed to ensure the inclusion of information about ratings actions 
for credit ratings of structured finance products that do not meet the 
narrower statutory definition of ``issuers of asset-backed securities 
(as that term is defined in section 1101(c) of part 229 of title 17, 
Code of Federal Regulations).'' \148\
---------------------------------------------------------------------------

    \147\ 15 U.S.C. 78c(a)(62)(B)(iv).
    \148\ See Id.
---------------------------------------------------------------------------

    The Commission is proposing this amendment, in part, under 
authority to require an NRSRO to ``make and

[[Page 36235]]

disseminate such reports as the Commission, by rule, prescribes as 
necessary or appropriate in the public interest, for the protection of 
investors, or otherwise in furtherance of the purposes of [the Exchange 
Act].'' \149\ The Commission preliminarily believes this proposed 
amendment is necessary and appropriate in the public interest, for the 
protection of investors, or otherwise in furtherance of the purposes of 
the Exchange Act because it would assist the Commission in its 
examination function of NRSROs. Large spikes in ratings actions within 
a class of credit ratings could indicate the processes for determining 
the ratings may be compromised by inappropriate factors. For example, a 
substantial increase in the number of downgrades in a particular class 
of credit ratings may be indicative of the fact that the initial 
ratings were higher than the NRSRO's procedures and methodologies would 
have implied because the NRSRO sought to gain favor with issuers and 
underwriters by issuing higher ratings. A substantial increase in 
upgrades also could be the result of the NRSRO attempting to gain favor 
with issuers and underwriters.
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    \149\ See Section 17(a)(1) of the Exchange Act (15 U.S.C. 
78q(a)(1)).
---------------------------------------------------------------------------

    The Commission recognizes that an increase in the number of ratings 
actions in a particular class of credit ratings may be the result of 
macroeconomic factors broadly impacting the rated obligors or 
securities. In this case, the ratings actions would be the result of 
appropriate credit analysis and not inappropriate extraneous factors. 
On the other hand, large numbers of actions could be a signal that the 
process for rating and monitoring ratings in the impacted class has 
been compromised by improper practices such as failing to adhere to 
disclosed and internally documented ratings procedures and 
methodologies, having prohibited conflicts, failing to establish 
reasonable procedures to manage conflicts, or engaging in unfair, 
coercive, or abusive conduct. Consequently, the report would be a 
valuable tool to improve the focus of examination resources.
    The Commission generally requests comment on all aspects of this 
proposed amendment. In addition, the Commission requests comment on the 
following questions related to the proposal.
     Could the performance statistics currently required in 
Exhibit 1 to Form NRSRO, as well as the proposed enhancements to those 
statistics, be used to target potential problem areas in an NRSRO's 
credit rating processes in the same manner as this proposed report 
thereby making the report redundant?
     Should the Commission also require NRSROs to furnish an 
``early warning'' report to the Commission when the number of 
downgrades in a class of credit ratings passes a certain percentage 
threshold (e.g., 5%, 10%, 15%, or 20%) within a number of calendar or 
business days (e.g., 2, 5, 10, or 15 days) after the threshold is 
passed, similar to the broker-dealer notification rule (See 17 CFR 
240.17a-11)?

III. Proposed New Rule 17g-7 (Special Reporting or Use of Symbols to 
Differentiate Credit Ratings for Structured Finance Products)

    The Commission is proposing a new rule, Rule 17g-7, to address 
concerns that certain investors assumed the risk characteristics for 
structured finance products, particularly highly rated instruments, 
were the same as for other types of similarly rated instruments. This 
proposal also is designed to address concerns that some investors may 
not have performed internal risk analysis on structured finance 
products before purchasing them, although at least one survey indicates 
that many institutional investors asserted that this was not a 
widespread problem.\150\ Specifically, under proposed Rule 17g-7, each 
time an NRSRO published a credit rating for a structured finance 
product it also would be required to publish a report describing how 
the credit ratings procedures and methodologies and credit risk 
characteristics for structured finance products differ from those of 
other types of rated instruments such as corporate and municipal debt 
securities. The objective of this proposal is to alert investors that 
there are different rating methodologies and risk characteristics 
associated with structured finance products. As an alternative to 
publishing the report, an NRSRO would be allowed to use ratings symbols 
for structured finance products that differentiated them from the 
credit ratings for other types of debt securities.
---------------------------------------------------------------------------

    \150\ See Introducing Assumption Volatility Scores and Loss 
Sensitivities for Structured Finance Securities, Moody's, May 14, 
2007, p. 3.
---------------------------------------------------------------------------

    More specifically, paragraph (a) of proposed Rule 17g-7 would 
require an NRSRO to publish a report accompanying every credit rating 
it publishes for a security or money market instrument issued by an 
asset pool or as part of any asset-backed or mortgage-backed securities 
transaction that describes the rating methodology used to determine the 
credit rating and how it differs from a rating for any other type of 
obligor or debt security and how the risks associated with a security 
or money market instrument issued by an asset pool or as part of any 
asset-backed or mortgage-backed securities transaction are different 
from other types of rated obligors and debt securities. A possible risk 
associated with this approach is that investors would come to view such 
reports as ``boilerplate'' and therefore would not review them.
    However, the Commission preliminarily believes that requiring an 
NRSRO to publish such a report along with each publication of a credit 
rating for a structured finance product likely would provide certain 
investors with useful information about structured finance products. 
The goal of the proposal is to spur investors to perform more rigorous 
internal risk analysis on structured finance products so that they do 
not overly rely on NRSRO credit ratings in making investment decisions. 
A possible ancillary benefit of such reports is that they could cause 
certain investors to seek to better understand risks that are not 
necessarily addressed in credit ratings of structured products, such as 
market and liquidity risk.
    Because the goal of the rule is to foster greater independent 
analysis by investors, the Commission preliminarily believes that 
permitting an NRSRO to comply with the rule by differentiating its 
structured finance product rating symbols would be an equally effective 
alternative. The differentiated symbol would alert investors that a 
structured product was being rated and, therefore, raise the question 
of how it differs from other types of debt instruments.
    The Commission is not proposing to require that specific rating 
symbols be used to distinguish credit ratings for structured finance 
products. An NRSRO would be permitted to choose the appropriate symbol. 
The Commission preliminarily believes that methods for identifying 
credit ratings for structured finance products could include using a 
different rating symbol altogether, such as a numerical symbol, or 
appending identifying characters to existing ratings scales, e.g., 
``AAA.sf'' or ``AAASF.''
    The Commission is proposing these amendments under authority to 
require an NRSRO to ``make and disseminate such reports as the 
Commission, by rule, prescribes as necessary or appropriate in the 
public interest, for the protection of investors, or otherwise in 
furtherance of the purposes of [the Exchange Act].''\151\ The 
Commission preliminarily believes these proposed amendments are

[[Page 36236]]

necessary and appropriate in the public interest, for the protection of 
investors, or otherwise in furtherance of the purposes of the Exchange 
Act because they are designed to encourage investors to perform greater 
levels of internal risk assessment of structured finance products by 
putting them on notice that these products have different 
characteristics than other types of rated debt instruments. The 
Commission does acknowledge the risks related to these proposals as 
outlined above.
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    \151\ See Section 17(a)(1) of the Exchange Act (15 U.S.C. 
78q(a)(1)).
---------------------------------------------------------------------------

    The Commission generally requests comment on all aspects of this 
proposed rule. In addition, the Commission requests comment on the 
following questions related to the proposal.
     Would the use of different rating symbols for structured 
products impact automated securities trading, routing, settlement, 
clearance, trade confirmation, reporting, processing, and risk 
management systems and any other systems that are programmed to use 
standard credit rating symbols across all product classes? Commenters 
should describe how these systems may be impacted and associated costs 
to address the impacts on the firm such as costs to change or update 
the systems. Commenters also should describe how the impacts to these 
systems could impact trading activity in the markets for structured 
finance products.
     Is the proposed rule sufficiently clear about the types of 
securities and money market instruments to which it applies? Are there 
securities to which the proposal applies that should not be subject to 
the requirement of a report or a differentiated symbol?
     Would the use of different rating symbols have 
consequences for investment guidelines and covenants in legal documents 
that use credit ratings to distinguish finance instruments? Commenters 
should describe the potential consequences and associated costs to 
market participants and to the finance markets more broadly.
     Would the use of different rating symbols or reports 
dissuade purchases of structured finance products?
     Would the reports or differentiated symbols achieve the 
Commission's stated goal of encouraging investors to perform more 
internal risk assessments of structured finance products? Could the 
reports cause investors to ignore other relevant disclosures or lead to 
confusion?
     Should the rule be expanded to require reports or 
different ratings symbols for each class of credit ratings identified 
in Section 3(a)(62)(B) of the Exchange Act (15 U.S.C. 78c(a)(62)(B)); 
namely: (1) Financial institutions, brokers, or dealers; (2) insurance 
companies; (3) corporate issuers; (4) issuers of asset-backed 
securities; and (5) issuers of government securities, municipal 
securities or securities issued by a foreign government? Alternatively, 
should the rule be expanded to require reports or different ratings 
symbols for only certain of these classes or subclasses such as for 
municipal securities?
     Should the rule prohibit an NRSRO from using a common set 
of symbols (e.g., AAA, AA, A, BBB, BB, B, CCC, CC, C) to rate different 
types of obligors and debt securities (e.g., corporate debt and 
municipal debt) where the NRSRO uses different methodologies for 
determining such ratings? Would such a proposal raise any questions 
relating to the scope of the Commission's legal authority in this area?
     Should the rule allow the use of a common set of symbols 
only if the NRSRO determines additional types of ratings to distinguish 
the different risk characteristics of the different types of obligors 
and debt securities? For example, the rule could require the 
determination of ratings to distinguish the potential volatility of the 
credit ratings of different classes of obligors and debt securities or 
the differing levels of market and liquidity risk associated with 
different classes of debt securities. Would such disclosures raise any 
concerns regarding liability if they were found to be deficient?

IV. Paperwork Reduction Act

    Certain provisions of the proposed rule amendments contain a 
``collection of information'' within the meaning of the Paperwork 
Reduction Act of 1995 (``PRA'').\152\ The Commission is submitting 
these proposed amendments and proposed rule to the Office of Management 
and Budget (``OMB'') for review in accordance with the PRA. An agency 
may not conduct or sponsor, and a person is not required to comply 
with, a collection of information unless it displays a currently valid 
control number. The titles for the collections of information are:
---------------------------------------------------------------------------

    \152\ 44 U.S.C. 3501 et seq.; 5 CFR 1320.11.
---------------------------------------------------------------------------

    (1) Rule 17g-1, Application for registration as a nationally 
recognized statistical rating agency; Form NRSRO and the Instructions 
for Form NRSRO (OMB Control Number 3235-0625);
    (2) Rule 17g-2, Records to be made and retained by nationally 
recognized statistical rating organizations (OMB Control Number 3235-
0628);
    (3) Rule 17g-3, Annual reports to be furnished by nationally 
recognized statistical rating organizations (OMB Control Number 3235-
0626);
    (4) Rule 17g-5, Conflicts of interest (a proposed new collection of 
information); and
    (5) Rule 17g-7, Credit rating reports to be furnished by nationally 
recognized statistical rating organizations (a proposed new collection 
of information).

A. Collections of Information Under the Proposed Amendments

    The Commission is proposing for comment rule amendments to 
prescribe additional requirements for NRSROs to address concerns that 
have arisen with respect to their role in the credit market turmoil. 
These proposed amendments would modify rules the Commission adopted in 
2007 to implement registration, recordkeeping, financial reporting, and 
oversight rules under the Rating Agency Act. Additionally, the 
Commission is proposing a new rule under authority provided in the 
Rating Agency Act.\153\ Certain of the proposed amendments and the 
proposed new rule would contain recordkeeping and disclosure 
requirements that would be subject to the PRA. The collection of 
information obligations imposed by the proposed amendments and proposed 
new rule would be mandatory. The proposed amendments and proposed new 
rule, however, would apply only to credit rating agencies that are 
registered with the Commission as NRSROs. Such registration is 
voluntary.\154\
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    \153\ Proposed Rule 17g-7.
    \154\ See section 15E of the Exchange Act (15 U.S.C. 78o-7).
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    In summary, the proposed rule amendments and proposed new rule 
would require: (1) An NRSRO to provide enhanced disclosure of 
performance measurements statistics and the procedures and 
methodologies used by the NRSRO in determining credit ratings for 
structured finance products and other debt securities on Form NRSRO; 
(2) an NRSRO to make, keep and preserve additional records under Rule 
17g-2; \155\ (3) an NRSRO to make its rating actions and the date of 
such actions from the initial credit rating to the current credit 
rating publicly available in an XBRL Interactive Data File no later 
than six months after the date of the rating action; \156\ (4) an NRSRO 
to furnish the Commission with an additional annual report; \157\ (5) 
disclosure of certain information about securities being rated 
beginning on the date the issuer or depositor sets the offering price 
of the securities being rated ;\158\ and (6) an

[[Page 36237]]

NRSRO to attach a report to its credit ratings for structured finance 
products describing the rating methodology used and how it differs from 
the determination of ratings for other types of securities or use a 
symbol that identifies the rated security as a structured finance 
product.\159\
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    \155\ 17 CFR 240.17g-2.
    \156\ See proposed Rule 17g-2(a)(2)(iv) and (d).
    \157\ See proposed Rule 17g-3(a)(6).
    \158\ See proposed Rule 17g-5(a)(3) and (b)(9).
    \159\ See proposed Rule 17g-7.
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B. Proposed Use of Information

    The proposed amendments and new rule would enhance the framework 
for Commission oversight of NRSROs in response to the recent credit 
market turmoil.\160\ The collections of information in the proposed 
amendments and new rule are designed to assist the Commission in 
effectively monitoring, through its examination function, whether an 
NRSRO is conducting its activities in accordance with section 15E of 
the Exchange Act \161\ and the rules thereunder. In addition, these 
proposed amendments and the new rule are designed to assist users of 
credit ratings by proposing to require the disclosure of additional 
information with respect to an NRSRO that could be used to compare the 
credit ratings quality of different NRSROs, particularly with respect 
to structured finance products. The Commission believes that the 
information that NRSROs would have to make public as a result of the 
proposed amendments would advance one of the primary objectives of the 
Rating Agency Act, as noted in the accompanying Senate Report, to 
``facilitate informed decisions by giving investors the opportunity to 
compare ratings quality of different firms.'' \162\
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    \160\ See 17 CFR 17g-1 through 17g-6, and Form NRSRO.
    \161\ 15 U.S.C. 78o-7.
    \162\ See Senate Report, p. 8.
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C. Respondents

    In adopting the final rules under the Rating Agency Act, the 
Commission estimated that approximately 30 credit rating agencies would 
be registered as NRSROs.\163\ The Commission believes that this 
estimate continues to be appropriate for identifying the number of 
respondents for purposes of the proposed amendments and for proposed 
new Rule 17g-7. Since the initial set of rules under the Rating Agency 
Act became effective in June 2007, nine credit rating agencies have 
registered with the Commission as NRSROs.\164\ The registration program 
has been in effect for less than a year; consequently, the Commission 
expects additional entities will register. While 20 more entities may 
not ultimately register, the Commission believes the estimate is within 
reasonable bounds and appropriate given that it adds an element of 
conservatism as it increases paperwork burden estimates as well as cost 
estimates.
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    \163\ See Adopting Release, 72 FR at 33606-33607.
    \164\ A.M. Best Company, Inc.; DBRS Ltd.; Fitch.; Japan Credit 
Rating Agency, Ltd.; Moody's; Rating and Investment Information, 
Inc.; S&P LACE Financial Corp.; and Egan-Jones Rating Company.
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    In addition, proposed Rule 17g-5(a)(3) \165\ would require the 
disclosure of certain information provided to, and used by, an NRSRO in 
determining an initial rating for a security or money market instrument 
issued by an asset pool or as part of any asset-backed or mortgage-
backed securities transaction and for monitoring those ratings. The 
rule would not specify which party would disclose such information: The 
NRSRO, sponsor, issuer, depositor, trustee or some other person. The 
Commission believes that the most likely persons to disclose this 
information would be structured finance product arrangers, managers, or 
trustees as they are the entities that generate the information and 
provide it to the NRSROs. For purposes of the PRA estimate for proposed 
Rule 17g-5(a)(3), based on staff information gained from the NRSRO 
examination process, the Commission estimates that there would be 
approximately 200 respondents. As noted throughout the release, the 
number of arrangers bringing structured finance products to market is 
small relative to the number of deals.
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    \165\ See proposed Rule 17g-5(a)(3)(i) and (iii).
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    The Commission generally requests comment on all aspects of these 
proposed estimates for the number of respondents. In addition, the 
Commission requests specific comment on the following items related to 
these estimates.
     Should the Commission use the number of credit rating 
agencies currently registered as NRSROs rather the estimated number of 
30 ultimate registrants? Alternatively, is there a basis to estimate a 
different number of likely registrants?
     Is the Commission correct in believing that structured 
product arrangers, managers, and trustees would be the entities that 
disclose the information required under the proposed amendments to Rule 
17g-5(a)?
     Are there sources that could provide credible information 
that could be used to determine the number of credit rating agencies 
and other NRSROs that would be subject to the proposed paperwork 
burdens? Commenters should identify any such sources and explain how a 
given source could be used to either support the Commission's estimate 
or arrive at a different estimate.
    Commenters should provide specific data and analysis to support any 
comments they submit with respect to these burden estimates.

D. Total Annual Recordkeeping and Reporting Burden

    As discussed in further detail below, the Commission estimates the 
total recordkeeping burden resulting from the proposed amendments and 
proposed new rule would be approximately 1,434,690 hours on an annual 
basis \166\ and 64,500 hours on a one-time basis.\167\
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    \166\ This total is derived from the total annual hours set 
forth in the order that the totals appear in the text: 390 + 300 + 
4,000 + 150,000 + 1,280,000 = 1,434,690.
    \167\ This total is derived from the total one-time hours set 
forth in the order that the totals appear in the text: 900 + 900 + 
60,000 + 1,500 + 300 + 900 = 64,500.
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    The total annual and one-time hour burden estimates described below 
are averages across all types of NRSROs expected to be affected by the 
proposed amendment and new rule. The size and complexity of NRSROs 
range from small entities to entities that are part of complex global 
organizations employing thousands of credit analysts. Consequently, the 
burden hour estimates represent the average time across all NRSROs. The 
Commission further notes that, given the significant variance in size 
between the largest NRSROs and the smallest NRSROs, the burden 
estimates, as averages across all NRSROs, are skewed higher because the 
largest firms currently predominate in the industry.
1. Amendments to Form NRSRO
    The proposed amendments to Form NRSRO would change the instructions 
for the Form to require that NRSROs provide more detailed credit 
ratings performance statistics in Exhibit 1 and disclose with greater 
specificity information about the procedures and methodologies used to 
determine structured finance and other credit ratings in Exhibit 
2.\168\ The Commission expects these proposed amendments would not have 
a material effect on the respondents' hour burden. The Commission 
believes that the total annual burden hours of 2,100 currently approved 
by OMB would not change for Rule 17g-1 and Form NRSRO materially 
because the additional disclosures would be included within the overall 
preparation of the initial Form NRSRO for new applicants. Additionally, 
the Commission believes that the nine currently registered NRSROs could 
be

[[Page 36238]]

required to prepare and furnish an amended Form NRSRO to update their 
registration applications if the Commission were to adopt the proposed 
amendments (i.e., nine amended Form NRSROs). However, the Commission 
believes these potential nine furnishings of Form NRSRO are accounted 
for in the currently approved PRA collection for Rule 17g-1, which 
includes an estimate that each NRSRO would file two amendments to Form 
NRSRO per year.\169\
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    \168\ 17 CFR 240.17g-1 and Form NRSRO.
    \169\ See Adopting Release, 72 FR at 33609. To date, only one of 
the seven NRSROs that have been registered with the Commission since 
September 2007 has furnished the Commission with an amended Form 
NRSRO since registering with the Commission.
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    The Commission generally requests comment on all aspects of these 
proposed burden estimates for Rule 17g-1 and Form NRSRO, proposed to be 
amended. In addition, the Commission requests specific comment on the 
following items related to these estimates:
     Would the proposed additional disclosure requirements 
increase the burden hours from the amount currently budgeted for Rule 
17g-1 and Form NRSRO?
Commenters should provide specific data and analysis to support any 
comments they submit with respect to these burden estimates.
2. Amendments to Rule 17g-2
    Rule 17g-2 requires an NRSRO to make and keep current certain 
records relating to its business and requires an NRSRO to preserve 
those and other records for certain prescribed time periods.\170\ The 
Commission's current estimate for the average one-time burden of 
implementing a recordkeeping system to comply with Rule 17g-2 is 300 
hours.\171\ Additionally, the total annual burden currently approved by 
OMB for Rule 17g-2 is 7,620 hours, which represents the average annual 
amount of time an NRSRO will spend to make and maintain these records 
(254 hours per year) multiplied by 30 respondents.\172\
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    \170\ 17 CFR 240.17g-2.
    \171\ See Adopting Release, 72 FR at 33608.
    \172\ See Adopting Release, 72 FR at 33610.
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    The proposed amendments to Rule 17g-2 would require an NRSRO to 
make and retain two additional records and retain a third type of 
record. The records to be made and retained would be: (1) A record of 
the rationale for any material difference between the credit rating 
implied by the model and the final credit rating issued, if a 
quantitative model is a substantial component in the process of 
determining a credit rating;\173\ and (2) a record showing the history 
and dates of all previous rating actions with respect to each current 
credit rating.\174\ The proposed amendments to Rule 17g-2 would require 
an NRSRO to make the second set of records--rating actions related to 
current ratings--publicly available in an XBRL Interactive Data 
File.\175\ In addition, the proposed amendments would require an NRSRO 
to retain communications that contain any complaints by an obligor, 
issuer, underwriter, or sponsor about the performance of a credit 
analyst.\176\
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    \173\ Proposed paragraph (a)(2)(iii) of Rule 17g-2.
    \174\ Proposed paragraph (a)(8) of Rule 17g-2.
    \175\ Proposed amendment to Rule 17g-2(d).
    \176\ Proposed paragraph (b)(8) of Rule 17g-2.
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    With respect to the proposed amendments to Rule 17g-2, the 
Commission estimates, based on staff information gained from the NRSRO 
examination process, that the total one-time and annual record 
recordkeeping burdens would increase approximately 10% and 5%, 
respectively.\177\ Thus, the Commission estimates that the one-time 
burden that each NRSRO would spend implementing a recordkeeping system 
to comply with Rule 17g-2 as proposed to be amended would be 
approximately 330 hours,\178\ for a total one-time burden of 9,900 
hours for 30 NRSROs.\179\ The Commission estimates that an NRSRO would 
spend an average of 267 hours per year\180\ to make and retain records 
under Rule 17g-2 as proposed to be amended, for a total annual hour 
burden under Rule 17g-2 of 8,010 hours.\181\ This estimate would result 
in an increase in the currently approved PRA burden under Rule 17g-2 of 
390 annual burden hours.\182\ As discussed above, the increase in 
annual burden hours would result from the increase in the number of 
records an NRSRO would be required to make and retain under the 
proposed amendments to Rule 17g-2.
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    \177\ The Commission believes that the one-time burden to set up 
and/or modify a recordkeeping system to comply with the proposed 
amendments would be greater than the ongoing annual burden. Once an 
NRSRO has set up or modified its recordkeeping system to comply with 
the proposed amendments, its annual hour burden would be increased 
only to the extent it would be required to make and retain 
additional records.
    \178\ 300 hours x 1.10 = 330 hours. This would result in an 
increase of approximately 30 hours per NRSRO for the one-time hour 
burden.
    \179\ 330 hours x 30 respondents = 9,900 hours. The proposed 
amendments would result in an increase of 900 total one-time burden 
hours.
    \180\ 254 hours x 1.05 = 267 hours. The proposed amendments 
would result in an increase of approximately 13 annual burden hours 
per NRSRO for Rule 17g-2.
    \181\ 267 hours x 30 respondents = 8,010 hours.
    \182\ 8,010 hours - 7,620 hours = 390 hours.
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    In addition, the proposed amendments to Rule 17g-2 would require an 
NRSRO to make the records of its rating actions publicly available in 
an XBRL Interactive Data File.\183\
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    \183\ See proposed amendment to Rule 17g-2(d).
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    The Commission believes that an NRSRO would choose to make this 
information available through its Internet Web site and that each NRSRO 
already has, or would have, an Internet Web site. Therefore, based on 
staff information gained from the NRSRO examination process, the 
Commission estimates that, on average, an NRSRO would spend 
approximately 30 hours to publicly disclose the history of its rating 
actions for each credit rating in an XBRL Interactive Data File and, 
thereafter, 10 hours per year to update this information.\184\ 
Accordingly, the total aggregate one-time burden to the industry to 
make the history of rating actions publicly available in an XBRL 
Interactive Data File would be 900 hours,\185\ and the total aggregate 
annual burden hours would be 300 hours.\186\
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    \184\ The Commission also bases this estimate on the current 
one-time and annual burden hours for an NRSRO to publicly disclose 
its Form NRSRO. No alternatives to these estimates as proposed were 
suggested by commenters. See Adopting Release, 72 FR at 33609.
    \185\ 30 hours x 30 NRSROs = 900 hours.
    \186\ 10 hours x 30 NRSROs = 300 hours.
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    Under the currently approved PRA collection for Rule 17g-2, the 
Commission estimated that an NRSRO may need to purchase recordkeeping 
system software to establish a recordkeeping system in conformance with 
Rule 17g-2.\187\ The Commission estimated that the cost of the software 
would vary based on the size and complexity of the NRSRO. Also, the 
Commission estimated that some NRSROs would not need such software 
because they already have adequate recordkeeping systems or, given 
their small size, such software would not be necessary. Based on these 
estimates, the Commission estimated that the average cost for 
recordkeeping software across all NRSROs would be approximately $1,000 
per firm, with an aggregate one-time cost to the industry of $30,000. 
The Commission estimates that the proposed amendments to Rule 17g-2 
would not alter this estimate or that any increases in the cost would 
be de minimis.
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    \187\ See Adopting Release, 72 FR at 33609, 33610.
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    The Commission generally requests comment on all aspects of these 
proposed burden estimates for Rule 17g-2. In addition, the Commission 
requests specific comment on the following items related to these 
burden estimates:
     Are there publicly available reports or other data sources 
the Commission

[[Page 36239]]

should consider in arriving at these burden estimates?
     Are the estimates that these amendments would result in an 
increase to the current total one-time and annual recordkeeping burdens 
of approximately 10% and 5% accurate? If not, should they be higher or 
lower?
     Are the estimates that the requirement to make records of 
rating actions publicly available in an XBRL Interactive Data File 
would result in an increased one-time burden for each NRSRO of 
approximately 30 hours to publicly disclose the history of its rating 
actions for each credit rating in an XBRL Interactive Data File and, 
thereafter, 10 hours per year to update this information accurate? If 
not, should they be higher or lower?
     Is the estimate that the NRSROs would incur no additional 
costs (or that any additional costs would be de minimis) to update 
recordkeeping systems to comply with the proposed new recordkeeping 
requirements accurate? If not, what would the additional costs be?
Commenters should provide specific data and analysis to support any 
comments they submit with respect to these burden estimates.
3. Proposed Amendment to Rule 17g-3
    Rule 17g-3 requires an NRSRO to furnish certain financial reports 
to the Commission on an annual basis, including audited financial 
statements as well as other financial reports.\188\ The Commission is 
proposing to amend Rule 17g-3 to require an NRSRO to furnish the 
Commission with an additional report: an unaudited report of the number 
of credit ratings that were changed during the fiscal year in each 
class of credit ratings for which the NRSRO is registered with the 
Commission.\189\
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    \188\ 17 CFR 240.17g-3.
    \189\ See proposed Rule 17g-3(a)(6).
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    The total annual burden currently approved by OMB for Rule 17g-3 is 
6,000 hours, based on the fact that it would take an NRSRO, on average, 
approximately 200 hours to prepare for and file the annual 
reports.\190\ In addition, the total annual cost burden currently 
approved by OMB is $450,000 to engage the services of an independent 
public accountant to conduct the annual audit as part of the 
preparation of the first report required by Rule 17g-3.\191\ This 
estimate is based on 30 NRSROs hiring an independent public accountant 
on an annual basis for an average of $15,000.\192\
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    \190\ 200 hours x 30 NRSROs = 6,000 hours. See Adopting Release, 
72 FR at 33610.
    \191\ Rule 17g-3 currently requires five reports. Only the first 
report--financial statements--need be audited. The two new reports 
proposed to be required by the amendments would not need to be 
audited.
    \192\ $15,000 x 30 NRSROs = $450,000. See Adopting Release, 72 
FR at 33610.
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    The Commission believes that the proposed amendment to Rule 17g-3 
that would require a report on an NRSRO's rating changes during a 
fiscal year would have a de minimis effect on the annual hour burden 
for the current PRA collection for Rule 17g-3. The Commission 
preliminarily believes that an NRSRO already would have this 
information with respect to each class of credit ratings for which it 
is registered. In addition, the proposed amendment does not prescribe a 
format for the report. Consequently, the Commission estimates that 
proposed Rule 17g-3(a)(6) would not have a significant effect on the 
total annual hour burden currently approved for the PRA for Rule 17g-3.
    The Commission generally requests comment on all aspects of these 
proposed burden estimates for Rule 17g-3. In addition, the Commission 
requests specific comment on the following items related to these 
burden estimates:
     Are there publicly available reports or other data sources 
the Commission should consider in arriving at these burden estimates?
    Commenters should provide specific data and analysis to support any 
comments they submit with respect to these burden estimates.
4. Amendments to Rule 17g-5
    Rules 17g-5 requires an NRSRO to manage and disclose certain 
conflicts of interest.\193\ The rule also prohibits specific types of 
conflicts of interest.\194\ The proposed amendments to Rule 17g-5 would 
add an additional conflict to paragraph (b) of Rule 17g-5. This 
proposed conflict of interest would be issuing or maintaining a credit 
rating for a security or money market instrument issued by an asset 
pool or as part of an asset-backed or mortgage-backed securities 
transaction that was paid for by the issuer, sponsor, or underwriter of 
the security or money market instrument.\195\ Under the proposal, an 
NRSRO would be prohibited from issuing a credit rating for a structured 
finance product, unless certain information about the transaction and 
the assets underlying the structured finance product are 
disclosed.\196\ Specifically, the following information would need to 
be made publicly available beginning on the date the underwriter, 
issuer or depositor set the offering price of the securities being 
rated: (1) All information provided to the NRSRO that is used in 
determining the initial credit rating, including information about the 
characteristics of the assets underlying or referenced by the security 
or money market instrument, and the legal structure; and (2) all 
information provided to the NRSRO by the issuer, underwriter, sponsor, 
depositor or trustee that is used by the NRSRO in undertaking credit 
rating surveillance on the security or money market instrument.\197\ In 
a private offering, the above information would need to be made 
available on the date the underwriter and the issuer or depositor set 
the offering price of the securities being rated only to credit rating 
agencies and investors; it would need to be made publicly available, 
however, no later than one business day after the offering closes.
---------------------------------------------------------------------------

    \193\ 17 CFR 240.17g-5.
    \194\ 17 CFR 240.17g-5(c).
    \195\ See proposed Rule 17g-5(b)(9). The current paragraph 
(b)(9) would be renumbered as (b)(10).
    \196\ See proposed Rule 17g-5(a)(3).
    \197\ See proposed Rule 17g-5(a)(3)(i)-(iii).
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    The proposed rule would not specify which party would disclose the 
information: the NRSRO, sponsor, issuer, depositor or trustee. The 
Commission preliminarily believes that in order to avoid conflicts with 
Securities Act prohibitions on general solicitations as well as to 
avoid making the NRSRO liable for the accuracy of information that 
would originally be supplied by the arrangers and trustees of 
structured products, this information would likely be disclosed by 
those arrangers and trustees. The Commission estimates that there would 
be approximately 200 such entities. For purposes of this PRA, the 
Commission estimates that it would take a respondent approximately 300 
hours to develop a system, as well as policies and procedures, for the 
disclosures required by the proposed rule. This estimate is based on 
the Commission's experience with, and burden estimates for, the 
recordkeeping requirements for NRSROs.\198\ Accordingly, the Commission 
believes, based on staff experience, that a respondent would take 
approximately 300 hours on a one-time basis to implement a disclosure 
system to comply with the proposal in that a respondent would need a 
set of policies and procedures for disclosing the information, as well 
as a system for making the information publicly available. This would 
result in a total one-time hour burden of 60,000 hours for 200 
respondents.\199\
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    \198\ See Adopting Release, 72 FR at 33609.
    \199\ 300 hours x 200 respondents = 60,000 hours.

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[[Page 36240]]

    In addition to the one-time hour burden, disclosure would also be 
required under the proposed rule on a transaction by transaction basis 
when an initial rating is determined. Based on staff experience, the 
Commission estimates that each respondent would disclose information 
with respect to approximately 20 new transactions per year and that it 
would take approximately 1 hour per transaction to make the information 
publicly available. This estimate is based on the Commission's 
expectation that the respondent will have already implemented the 
system and policies and procedures for disclosure. The Commission 
estimates that a large NRSRO would have rated approximately 2,000 new 
RMBS and CDO transactions in a given year. The Commission is basing 
this estimate on the number of new RMBS and CDO deals rated in 2006 by 
two of the largest NRSROs which rated structured finance transactions. 
The Commission adjusted this number to approximately 4,000 transactions 
in order to include other types of structured finance products, 
including commercial MBS and other consumer assets. Therefore, the 
Commission estimates for purposes of the PRA that each respondent would 
arrange approximately 20 new transactions per year: 4,000 new 
transactions/200 arrangers = 20 new transactions. The Commission notes 
that the number of new transactions arranged per year would vary by the 
size of arranger and that this estimate would be an average across all 
respondents. Larger respondents may arrange in excess of 20 new deals 
per year, while a smaller entity may only arrange one or two new deals 
on an annual basis. Based on this analysis, the Commission estimates 
that it would take a respondent approximately 20 hours \200\ to 
disclose this information under the proposed rule, on an annual basis, 
for a total aggregate annual hour burden of 4,000 hours.\201\
---------------------------------------------------------------------------

    \200\ 20 transactions x 1 hour = 20 hours.
    \201\ 20 hours x 200 respondents = 4,000 hours.
---------------------------------------------------------------------------

    In addition, proposed Rule 17g-5(a)(ii) would require disclosure of 
information provided to an NRSRO that is used by an NRSRO in 
undertaking credit rating surveillance on a security or money market 
instrument. Because surveillance would cover more than just initial 
ratings, the Commission estimates based on staff information gained 
from the NRSRO examination process that monthly disclosure would be 
required with respect to approximately 125 transactions on an ongoing 
basis. Also based on staff information gained from the NRSRO 
examination process, the Commission estimates that it would take a 
respondent approximately 0.5 hours per transaction to disclose the 
information. Therefore, the Commission estimates that each respondent 
would spend approximately 750 hours \202\ on an annual basis disclosing 
information under proposed Rule 17g-5, for a total aggregate annual 
burden hours of 150,000 hours.\203\
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    \202\ 125 transactions x 30 minutes x 12 months = 45,000 
minutes/60 minutes = 750 hours.
    \203\ 750 hours x 200 respondents = 150,000 hours.
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    The Commission generally requests comment on all aspects of these 
proposed burden estimates for Rule 17g-5. In addition, the Commission 
requests specific comment on the following items related to these 
estimates:
     Are there publicly available reports or other data sources 
the Commission should consider in arriving at these burden estimates?
     Are the estimates of the one-time and recurring burdens of 
the proposed additional disclosures accurate? If not, should they be 
higher or lower?
Commenters should provide specific data and analysis to support any 
comments they submit with respect to these burden estimates.
5. Proposed Rule 17g-7
    The Commission is proposing a new rule--Rule 17g-7--which would 
address concerns that investors believe that the risk characteristics 
for a structured finance product are the same as for other types of 
obligors or debt securities. Proposed Rule 17g-7 would require an NRSRO 
to attach a report each time it publishes a credit rating for a 
structured finance product describing how the ratings procedures and 
methodologies differ from those for other types of obligors or debt 
securities.\204\ Proposed Rule 17g-7 would include an exemption to this 
requirement, however, if the NRSRO used credit rating symbols for 
structured finance products that identify the product as such as 
distinct from any other type of obligor or debt security. The 
Commission believes that proposed Rule 17g-7 \205\ would provide users 
of credit ratings with useful information either through the report or 
the differentiated symbol upon which to base their investment 
decisions.
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    \204\ See proposed Rule 17g-7.
    \205\ See proposed Rule 17g-7.
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    The Commission expects that most NRSROs already have documented 
their methodologies and procedures in place to determine credit ratings 
for structured finance products and corporate debt securities, and have 
disclosed such policies and procedures if they have registered with the 
Commission as an NRSRO. The Commission expects, however, that an NRSRO 
would have to compile and/or modify these documents to comply with the 
specific reporting requirements that would be mandated by the proposed 
rule. Based on staff information gained from the NRSRO examination 
process, the Commission estimates that it would take an NRSRO 
approximately 50 hours \206\ to draft the report required under the 
proposed rule for a total one-time hour burden of 1,500 hours.\207\
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    \206\ The Commission based this estimate on the estimated number 
of hours it would take an NRSRO to comply with Rule 17g-4 to develop 
policies and procedures to prevent the misuse of material nonpublic 
information. See Adopting Release, 72 FR at 33611.
    \207\ 50 hours x 30 NRSROs = 1,500 hours.
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    The Commission also estimates that it would take an NRSRO 
additional time to publish the report each time a credit rating for a 
structured finance product is published and to monitor the publications 
of structured finance credit ratings to ensure compliance with the 
proposed rule. Based on the average number of credit ratings of asset-
backed securities outstanding as of the latest fiscal year of the three 
largest NRSROs, the Commission estimates that an NRSRO would publish 
approximately 128,000 asset-backed credit ratings per year.\208\ The 
Commission notes that this number may not include all structured 
finance ratings, since some may not fit within the statutory definition 
of asset-backed security. However, the Commission also notes that the 
issuance of RMBS has dropped dramatically off recent highs. 
Accordingly, the Commission believes the number of asset-backed ratings 
reported in Form NRSRO is a reasonable proxy for the number of 
structured finance ratings. The Commission also notes that, as 
discussed below, the burden estimate identifies 30 respondents. 
However, most of the structured finance ratings are concentrated in the 
largest 3 or 4 NRSROs. Accordingly, the average number of structured 
finance ratings issued per NRSRO each year may be considerably lower 
than 128,000. For these reasons, the Commission believes the estimate 
is fairly conservative.
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    \208\ This estimate uses the average of the approximate number 
of credit ratings for asset-based securities as defined in 17 CFR 
229.1101(c) that S&P, Moody's and Fitch had outstanding as of the 
most recent calendar year end as reported in their annual 
certifications. (S&P: 197,700; Moody's: 110,000; and Fitch: 75,278).
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    The Commission estimates that an NRSRO would publish a rating 
action

[[Page 36241]]

with respect to a particular structured finance rating approximately 4 
times per year for a total of 512,000 publications.\209\ The Commission 
notes that this estimate would include publication of an initial 
rating, upgrades, downgrades and any affirmations published in a given 
year. Based on staff experience, the Commission estimates that an NRSRO 
would spend approximately 5 minutes ensuring that the required report 
was published along with the credit rating, for a total of 42,667 
annual burden hours \210\ per respondent, and a total of 1,280,000 
hours \211\ across 30 NRSROs. Finally, the Commission estimates, based 
on staff experience, that it would take an NRSRO approximately 10 hours 
per year to review and update the report to ensure that the disclosure 
was accurate and up-to-date for a total aggregate annual hour burden to 
the industry of 300 hours.\212\ The Commission believes, therefore, 
that the aggregate one-time and annual burden hours under proposed Rule 
17g-7(a) would be 1,280,000 and 1,800 hours,\213\ respectively.
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    \209\ 128,000 x 4 = 512,000 ratings publications.
    \210\ 512,000 x 5 minutes per report = 2,560,000 minutes/60 
minutes per hour = 42,667 hours.
    \211\ 42,667 hours x 30 NRSROs = 1,280,000 hours.
    \212\ This estimate is based on the number of hours it would 
take an NRSRO to complete an annual certification on Form NRSRO. See 
Adopting Release, 72 FR at 33609. 10 hours x 30 NRSROs = 300 hours.
    \213\ 1,500 + 300 hours.
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    The Commission believes, however, that most, if not all, NRSROs 
would opt to differentiate their ratings under paragraph (b) of 
proposed Rule 17g-7,\214\ rather than publish a report. The Commission 
believes that an NRSRO would likely choose to use a specific credit 
rating symbol to indicate that the particular credit rating relates to 
structured product as distinct from a credit rating for any other 
category of security or issuer. The Commission believes that an NRSRO 
would choose to employ this symbology approach because it would be more 
efficient and less burdensome than ensuring that the appropriate report 
was published along with the credit rating. The Commission believes 
that the implementation of a different rating symbol would entail a 
one-time burden of approximately 30 hours to develop the symbol for a 
total aggregate one-time burden to the industry of 900 hours.\215\
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    \214\ See proposed Rule 17g-7(b).
    \215\ 30 hours x 30 NRSROs.
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    Because the Commission believes that NRSROs will choose to 
differentiate their ratings under paragraph (b) of proposed Rule 17g-7 
rather than publish a report under paragraph (a) of the proposed new 
rule, the Commission believes that the appropriate estimate for the 
aggregate one-time burden to the industry under proposed Rule 17g-7 is 
900 hours. The Commission generally requests comment on all aspects of 
these proposed burden estimates for Rule 17g-7. In addition, the 
Commission requests specific comment on the following items related to 
these burden estimates:
     Is the Commission incorrect in its belief that NRSROs 
would opt to use a different rating symbol rather than to publish a 
report with each structured product rating? If so, what percentage of 
NRSROs would be likely to opt to publish a report?

Commenters should provide specific data and analysis to support any 
comments they submit with respect to these burden estimates.

E. Collection of Information Is Mandatory

    The recordkeeping and notice requirements for the proposed 
amendment and the proposed new rule would be mandatory.

F. Confidentiality

    The disclosures proposed to be required under the amendments to 
Rule 17g-1 and Form NRSRO would be made publicly available on Form 
NRSRO. The books and records information proposed to be collected under 
the proposed amendments to Rule 17g-2 would be stored by the NRSRO and 
made available to the Commission and its representatives as required in 
connection with examinations, investigations, and enforcement 
proceedings. However, an NRSRO would be required to make the record of 
rating actions under proposed Rule 17g-2(a)(8) publicly available in an 
XBRL Interactive Data File no later than six months after the date of 
the rating action.\216\ The information proposed to be collected under 
the proposed amendment to Rule 17g-3 would be generated from the 
internal records of the NRSRO and would be furnished to the Commission 
on a confidential basis, to the extent permitted by law.\217\ The 
information under Rule 17g-5(a)(3) would be made publicly available or 
available to certain permitted persons. The information proposed to be 
required under proposed new Rule 17g-7 would be made publicly 
available.
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    \216\ See proposed Rule 17g-2(a)(8) and (d).
    \217\ 15 U.S.C. 78o-7(k).
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G. Record Retention Period

    The records required under the proposed amendments to Rule 17g-1 
and Form NRSRO, Rule 17g-2, and 17g-3 would need to be retained by the 
NRSRO for at least three years.\218\
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    \218\ 17 CFR 240.17g-2(c).
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H. Request for Comment

    The Commission requests comment on the proposed collections of 
information in order to: (1) Evaluate whether the proposed collection 
of information is necessary for the proper performance of the functions 
of the Commission, including whether the information would have 
practical utility; (2) evaluate the accuracy of the Commission's 
estimates of the burden of the proposed collections of information; (3) 
determine whether there are ways to enhance the quality, utility, and 
clarity of the information to be collected; (4) evaluate whether there 
are ways to minimize the burden of the collection of information on 
those who respond, including through the use of automated collection 
techniques or other forms of information technology; and (5) evaluate 
whether the proposed rules would have any effects on any other 
collection of information not previously identified in this section.
    Persons who desire to submit comments on the collection of 
information requirements should direct their comments to the OMB, 
Attention: Desk Officer for the Securities and Exchange Commission, 
Office of Information and Regulatory Affairs, Washington, DC 20503, and 
should also send a copy of their comments to Secretary, Securities and 
Exchange Commission, 100 F Street, NE., Washington, DC 20549-1090, and 
refer to File No. S7-13-08. OMB is required to make a decision 
concerning the collections of information between 30 and 60 days after 
publication of this document in the Federal Register; therefore, 
comments to OMB are best assured of having full effect if OMB receives 
them within 30 days of this publication. Requests for the materials 
submitted to OMB by the Commission with regard to these collections of 
information should be in writing, refer to File No. S7-13-08, and be 
submitted to the Securities and Exchange Commission, Records Management 
Office, 100 F Street, NE., Washington, DC 20549-1110.

V. Costs and Benefits of the Proposed Rules

    The Commission is sensitive to the costs and benefits that result 
from its rules. The Commission has identified

[[Page 36242]]

certain costs and benefits of the proposed amendments and the proposed 
new rule and requests comment on all aspects of this cost-benefit 
analysis, including identification and assessment of any costs and 
benefits not discussed in the analysis.\219\ The Commission seeks 
comment and data on the value of the benefits identified. The 
Commission also welcomes comments on the accuracy of its cost estimates 
in each section of this cost-benefit analysis, and requests those 
commenters to provide data so the Commission can improve the cost 
estimates, including identification of statistics relied on by 
commenters to reach conclusions on cost estimates. Finally, the 
Commission seeks estimates and views regarding these costs and benefits 
for particular types of market participants, as well as any other costs 
or benefits that may result from the adoption of these proposed rule 
amendments.
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    \219\ For the purposes of this cost/benefit analysis, the 
Commission is using salary data from the Securities Industry and 
Financial Markets Association (``SIFMA'') Report on Management and 
Professional Earnings in the Securities Industry 2007, which 
provides base salary and bonus information for middle-management and 
professional positions within the securities industry. The 
Commission believes that the salaries for these securities industry 
positions would be comparable to the salaries of similar positions 
in the credit rating industry. Finally, the salary costs derived 
from the report and referenced in this cost benefit section, are 
modified to account for an 1800-hour work year and multiplied by 
5.35 to account for bonuses, firm size, employee benefits and 
overhead. The Commission used comparable assumptions in adopting the 
final rules implementing the Rating Agency Act in 2007, requested 
comments on such assumptions, and received no comments in response 
to its request. See Adopting Release, 72 FR at 33611, note 576. 
Hereinafter, references to data derived from the report as modified 
in the manner described above will be cited as ``SIFMA 2007 Report 
as Modified.''
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A. Benefits

    The purposes of the Rating Agency Act, as stated in the 
accompanying Senate Report, are to improve ratings quality for the 
protection of investors and in the public interest by fostering 
accountability, transparency, and competition in the credit rating 
industry.\220\ As the Senate Report states, the Rating Agency Act 
establishes ``fundamental reform and improvement of the designation 
process'' to further the belief that ``eliminating the artificial 
barrier to entry will enhance competition and provide investors with 
more choices, higher quality ratings, and lower costs. \221\
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    \220\ Senate Report, p. 2.
    \221\ Id, p. 7.
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    The proposed amendments and new rule would be issued pursuant to 
specific grants of rulemaking authority in the Rating Agency Act as 
well as the Commission's authority under the Exchange Act. The 
amendments are designed to further the goals of the Rating Agency Act 
and to enhance the Commission's oversight of NRSROs, in light of the 
recent credit market turmoil. Since the adoption of the final rules 
implementing the Rating Agency Act in 2007,\222\ and in response to the 
recent concerns about the role of credit rating agencies in the credit 
market turmoil, the Commission has identified a number of areas where 
it would be appropriate to enhance the current regulatory program for 
NRSROs.
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    \222\ See Adopting Release.
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    Consequently, the Commission is proposing amendments and a new rule 
that are designed to address concerns raised about the role NRSROs 
played in the credit turmoil by proposing to enhance the disclosure of 
credit ratings performance measurement statistics; increase the 
disclosure of information about the assets underlying structured 
finance products; require more information about the procedures and 
methodologies used to determine structured finance ratings; and address 
conflicts of interest arising from the structured finance rating 
process. As discussed below, the Commission believes that these 
proposed amendments and proposed new rule would further the purpose of 
the Rating Agency Act to improve the quality of credit ratings by 
fostering accountability, transparency, and competition in the credit 
rating industry, particularly with respect to credit ratings for 
structured finance products.\223\
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    \223\ See Senate Report, p. 2.
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    Rule 17g-1 prescribes a process for a credit rating agency to 
register with the Commission as an NRSRO using Form NRSRO, \224\ and 
requires that a credit rating agency provide information required under 
Section 15E(a)(1)(B) of the Exchange Act and certain additional 
information.\225\ Form NRSRO is also the means by which NRSROs update 
the information they must publicly disclose. The proposed amendments to 
the instructions to Exhibit 1 to Form NRSRO would require NRSROs to 
provide more detailed performance statistics and, thereby, make it 
easier for users of credit ratings to compare the ratings performance 
of the NRSROs.\226\ In addition, these proposed amendments could make 
it easier for an NRSRO to demonstrate that it has a superior ratings 
methodology or competence and, thereby, attract clients.
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    \224\ See Rule 17g-1.
    \225\ See Section 15E(a)(1)(B) of the Exchange Act. 15 U.S.C. 
78o-7(a)(1)(B).
    \226\ 17 CFR 240.17g-1 and Form NRSRO.
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    The proposed amendments to the instructions to Exhibit 2 of Form 
NRSRO are designed to provide greater clarity around three areas of the 
NRSROs' rating processes for structured finance products that have 
raised concerns in the context of the recent credit market turmoil: the 
level of verification performed on information provided in loan 
documents; the quality of loan originators; and the on-going 
surveillance of existing ratings and how changes made to a model used 
for initial ratings are applied to existing ratings. The additional 
information provided by the proposed amendments would assist users of 
credit ratings in making more informed decisions about the quality of 
an NRSRO's ratings processes, particularly with regard to structured 
finance products.
    The Commission preliminarily believes that these proposed enhanced 
disclosures in the Exhibits to Form NRSRO could make it easier for 
market participants to select the NRSROs that are performing best and 
have the highest quality processes for determining credit ratings. The 
potential result could be increased competition and the promotion of 
capital formation through a restoration of confidence in credit 
ratings.
    The proposed amendments to Rule 17g-2 are designed to assist the 
Commission in its examination function and provide greater information 
to users of credit ratings about the performance of an NRSRO's credit 
ratings. The additional records would be: (1) A record of the rationale 
for any material difference between the credit rating implied by the 
model and the final credit rating issued, if a quantitative model is a 
substantial component in the process of determining a credit 
rating;\227\ (2) a record showing the history and dates of all previous 
rating actions with respect to each current credit rating;\228\ and (3) 
any complaints regarding the performance of a credit analyst in 
determining credit ratings.\229\ These proposed records would assist 
the Commission in monitoring whether an NRSRO is complying with 
provisions of Section 15E of the Exchange Act and the rules thereunder. 
This would include monitoring whether an NRSRO is operating 
consistently with the methodologies and procedures it establishes (and 
discloses) to determine credit ratings and its policies and procedures 
designed to ensure the

[[Page 36243]]

impartiality of its credit ratings, including its ratings of structured 
finance products.
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    \227\ Proposed paragraph (a)(2)(iii) of Rule 17g-2.
    \228\ Proposed paragraph (a)(8) of Rule 17g-2.
    \229\ Proposed paragraph (b)(8) of Rule 17g-2.
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    In addition, the proposed amendments to Rule 17g-2, which would 
require an NRSRO to make its rating actions history publicly available 
in an XBRL Interactive Data File, would allow the marketplace to 
develop performance measurement statistics that would supplement those 
already required to be published by NRSROs in Exhibit 1 to Form NRSRO. 
This proposed amendment is designed to leverage the expertise of the 
marketplace and, thereby, provide users of credit ratings with 
innovative and potentially more useful metrics with which to compare 
NRSROs. This could make NRSROs more accountable for their ratings by 
enhancing the transparency of their ratings performance. By proposing 
to require an XBRL Interactive Data File the Commission also believes 
the proposed amendment would allow investors, analysts, and the 
Commission staff to capture and analyze the ratings action data more 
quickly and at less of a cost than is possible using another format.
    The Commission preliminarily believes that the proposed amendments 
to Rule 17g-2 would enhance the Commission's oversight of NRSROs and, 
with respect to the public disclosure of ratings history, provide the 
marketplace with the raw materials to develop metrics for comparing the 
ratings performance of NRSROs. This could, in turn, help in restoring 
confidence in credit ratings and, thereby, promote capital formation. 
Increased disclosure of ratings history could make the ratings 
performance of the NRSROs more transparent to the marketplace and, 
thereby, highlight those firms that do a better job analyzing credit 
risk. This could benefit smaller NRSROs to the extent they have 
performed better than others by alerting the market to their superior 
competence.
    The proposed amendment to Rule 17g-3 would require an NRSRO to 
furnish an additional annual report to the Commission: An unaudited 
report of the number of credit ratings that were changed during the 
fiscal year in each class of credit ratings for which the NRSRO is 
registered with the Commission.\230\ The proposed new report is 
designed to enhance the Commission's oversight of NRSROs by providing 
the Commission with additional information to assist in the monitoring 
of NRSROs for compliance with their stated policies and procedures. For 
example, the proposed new report would allow examiners to target 
potential problem areas in an NRSRO's rating processes by highlighting 
spikes in rating actions within a particular class of credit rating.
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    \230\ See proposed Rule 17g-3(a)(6).
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    The proposed amendments to Rule 17g-5 would prohibit an NRSRO from 
issuing a rating for a structured product unless information about the 
assets underlying the rated security is made available to certain 
persons.\231\ These proposed rule amendments would prohibit an NRSRO 
from issuing or maintaining a credit rating where the NRSRO or an 
affiliate provided recommendations on the structure of the transaction 
being rated; a credit analyst or person involved in the ratings process 
participated in fee negotiations; or a credit analyst or a person 
responsible for approving a credit rating received gifts from the 
obligor being rated, or from the issuer, underwriter, or sponsor of the 
securities being rated, other than items provided in the context of 
normal business activities such as meetings that have an aggregate 
value of no more than $25.\232\ The Commission believes that the 
proposed amendments to Rule 17g-5 would promote the disclosure and 
management of conflicts of interest and mitigate potential undue 
influences on an NRSRO's credit rating process, particularly with 
respect to credit ratings for structured finance products.\233\ This 
would in turn increase confidence in the integrity of NRSRO ratings 
and, thereby, promote capital formation. In addition, the proposed 
disclosure of additional information regarding the assets underlying a 
structured finance transaction \234\ would allow for unsolicited 
ratings that could help address ratings shopping by exposing an NRSRO 
whose ratings methodologies are less conservative in order to gain 
business. It also could mitigate the impact of rating shopping, since 
NRSROs not hired to rate a deal could nonetheless issue a credit 
rating. These potential impacts of the rule proposal could help to 
restore confidence in credit ratings and, thereby, promote capital 
formation. Also, by creating a mechanism for determining unsolicited 
ratings, they could increase competition by allowing smaller NRSROs to 
demonstrate proficiency in rating structured products.
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    \231\ See proposed Rule 17g-5(a)(3) and (b)(9).
    \232\ See proposed Rule 17 CFR 240.17g-5(c)(5)-(7).
    \233\ See 15 U.S.C. 78o-7(a)(1)(B)(vi) and (h).
    \234\ See proposed Rule 17 CFR 240.17g-5(a)(3).
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    Proposed Rule 17g-7 would address concerns that investors may 
believe that the risk characteristics for a structured finance product 
are the same as for other types of obligors or debt securities by 
requiring an NRSRO to attach a report each time it publishes a credit 
rating for a structured finance product describing how the ratings 
procedures and methodologies differ from those ratings for other types 
of obligors or debt securities.\235\ Alternatively, an NRSRO would be 
permitted to use rating symbols for structured finance products that 
differentiate them from its other credit ratings. The Commission 
believes this proposed rule would address potential confusion by 
investors as to the different characteristics of structured finance 
products when compared to other types of obligors or debt securities 
and help them in assessing the risks involved with different types of 
securities and promote better informed investment decisions.
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    \235\ See proposed Rule 17g-7.
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    The Commission generally requests comment on all aspects of these 
proposed benefits. In addition, the Commission requests specific 
comment on the following items related to these benefits.
     Are there metrics available to quantify these benefits and 
any other benefits the commenter may identify, including the 
identification of sources of empirical data that could be used for such 
metrics.

Commenters should provide specific data and analysis to support any 
comments they submit with respect to these benefit estimates.

B. Costs

    The cost of compliance with the proposed amendments and new rule to 
a given NRSRO would depend on its size and the complexity of its 
business activities. The size and complexity of NRSROs vary 
significantly. Therefore, the cost could vary significantly across 
NRSROs. Instead, the Commission is providing estimates of the average 
cost per NRSRO, as a result of the proposed amendments, taking into 
consideration the range in size and complexity of NRSROs and the fact 
that many already may have established policies, procedures and 
recordkeeping systems and processes that would comply substantially 
with the proposed amendments. Additionally, the Commission notes that 
nine credit rating agencies are currently registered with the 
Commission as NRSROs and subject to the Act and its implementing 
regulations. The cost of compliance would also vary depending on which 
classes of credit ratings an NRSRO issues. NRSROs which issue credit 
ratings for structured finance products would incur higher compliance 
costs

[[Page 36244]]

than those NRSROs which do not issue such credit ratings or issue very 
few credit ratings in that class.
    For these reasons, the cost estimates represent the average cost 
across all NRSROs and take into account that some firms would only need 
to augment existing policies, procedures and recordkeeping systems and 
processes to come into compliance with the proposed amendments.
1. Proposed Amendments to Form NRSRO
    As discussed above, the Commission is proposing to amend the 
instructions to Exhibit 1 to Form NRSRO to provide more detailed 
performance statistics. Currently, the instructions require the 
disclosure of performance measurement statistics of the credit ratings 
of the ``Applicant/NRSRO over the short-term, mid-term and long-term 
periods (as applicable) through the most recent calendar year end.'' 
The proposed amendments would augment these instructions to require the 
disclosure of separate sets of default and transition statistics for 
each class of credit ratings. In addition, the class-by-class 
disclosures would need to be broken out over 1, 3 and 10 year 
periods.\236\
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    \236\ See proposed instructions to Exhibit 1, Form NRSRO.
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    The proposed amendments would also amend the instructions to 
Exhibit 2 to Form NRSRO to require enhanced disclosures about the 
procedures and methodologies an NRSRO uses to determine credit ratings, 
including whether and, if so, how information about verification 
performed on assets underlying a structured finance transaction is 
relied on in determining credit ratings; whether and, if so, how 
assessments of the quality of originators of assets underlying a 
structured finance transaction factor into the determination of credit 
ratings; and how frequently credit ratings are reviewed, whether 
different models are used for ratings surveillance than for determining 
credit ratings, and whether changes made to models and criteria for 
determining initial ratings are applied retroactively to existing 
ratings. As discussed above, the Commission estimates that for PRA 
purposes the total one-time and annual hour burdens and the cost would 
have a neutral effect, resulting in no overall change in hours or cost 
for the currently approved PRA collection.
    The Commission preliminarily believes, however, NRSROs may incur a 
cost of compliance in updating their performance metric statistics to 
conform to the new requirements set forth in the proposed rule 
amendments. Under the current instructions to Exhibit 1 to Form NRSRO, 
an NRSRO must disclose its performance metrics over short, mid, and 
long-term periods. Thus, the current Form NRSRO instructions to Exhibit 
1 allow an NRSRO to use its own definitions of ``short, mid, and long-
term periods'' and to include all credit ratings, regardless of class 
of rating, in one set of metrics. Under the proposed amendments, an 
NRSRO would be required to break out on a class-by-class basis 
performance statistics over 1, 3 and 10-year periods. The Commission 
believes that existing NRSROs would incur costs to conform their 
current performance statistics with the requirements of this proposed 
amendment to Exhibit 1.
    The Commission estimates that it would take each NRSRO currently 
registered with the Commission approximately 50 hours to review its 
performance measurement statistics and to develop and implement any 
changes necessary to comply with the proposed amendment. The Commission 
is basing this estimate on the amount of time the Commission estimated 
that it would take an NRSRO to establish procedures in conformance with 
Rule 17g-4 and on information gained from the NRSRO examination 
process.\237\ For these reasons, the Commission estimates that the 
average one-time cost to an NRSRO would be $12,740 \238\ and the total 
aggregate cost to the currently registered NRSROs would be 
$114,660.\239\
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    \237\ See 17 CFR 240.17g-4; Adopting Release, 72 FR at 33616.
    \238\ The Commission estimates that a Compliance Attorney (40 
hours) and a Programmer Analyst (10 hours) would perform these 
responsibilities. The SIFMA 2007 Report as Modified indicates that 
the average hourly rates for a Compliance Attorney and a Programmer 
Analyst are $270 and $194 per hour, respectively. Therefore, the 
average one-time cost to an NRSRO would be $12,740 [(40 hours x 
$270) + (10 hours x $194)].
    \239\ $12,740 x 9 NRSROs = $114,660.
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    The Commission generally requests comment on all aspects of these 
proposed cost estimates for the proposed amendments to Form NRSRO. In 
addition, the Commission requests specific comment on the following 
items related to these cost estimates:
     Would these proposals impose costs on other market 
participants, including persons who use credit ratings to make 
investment decisions or for regulatory purposes, and persons who 
purchase services and products from NRSROs?

Commenters should provide specific data and analysis to support any 
comments they submit with respect to these burden estimates.
2. Proposed Amendments to Rule 17g-2
Rule 17g-2 requires an NRSRO to make and preserve specified records 
related to its credit rating business.\240\ As discussed above, the 
proposed amendments to Rule 17g-2 would require an NRSRO to make and 
retain two additional records and retain a third type of record. The 
records to be made and retained would be: (1) A record of the rationale 
for any material difference between the credit rating implied by the 
model and the final credit rating issued, if a quantitative model is a 
substantial component in the process of determining a credit rating; 
\241\ and (2) a record showing the history and dates of all previous 
rating actions with respect to each current credit rating.\242\ The 
proposed amendments to Rule 17g-2 would require an NRSRO to make the 
second record-rating actions related to current ratings publicly 
available in an XBRL Interactive Data File.\243\ In addition, the 
proposed amendments would require an NRSRO to retain communications 
that contain any complaints by an obligor, issuer, underwriter, or 
sponsor about the performance of a credit analyst.\244\
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    \240\ 17 CFR 240.17g-2.
    \241\ Proposed paragraph (a)(2)(iii) of Rule 17g-2.
    \242\ Proposed paragraph (a)(8) of Rule 17g-2.
    \243\ Proposed amendment to Rule 17g-2(d).
    \244\ Proposed paragraph (b)(8) of Rule 17g-2.
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    As discussed with respect to the PRA, the Commission estimates 
that, based on staff experience, the total one-time and annual 
recordkeeping burdens would increase approximately 10% and 5%, 
respectively. Thus, the Commission estimates that the one-time hour 
burden that each NRSRO would spend implementing a recordkeeping system 
to comply with Rule 17g-2 would be approximately 330 hours (an increase 
of 30 hours) \245\ for a total one-time burden of 9,900 hours (an 
increase of 900 hours).\246\
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    \245\ 300 hours x 1.10 = 330 hours.
    \246\ 330 hours x 30 respondents = 9,900 hours.
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    The Commission estimates that an NRSRO would spend an average of 
267 hours per year (an increase of 13 hours) \247\ to make and maintain 
records under Rule 17g-2, for a total annual hour burden of 8,010 
hours.\248\ This estimate would increase the currently approved PRA 
burden under Rule 17g-2 by 390 hours.\249\ For these reasons, the 
Commission estimates that an NRSRO would incur an average one-time cost 
of $7,350 and the average annual cost of $3,185, as a result of the 
proposed

[[Page 36245]]

amendments.\250\ Consequently, the total aggregate one-time cost 
attributable to the proposed amendments would be $220,500 \251\ and the 
total aggregate annual cost to the industry would be $95,550.\252\
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    \247\ 254 hours x 1.05 = 267 hours.
    \248\ 267 hours x 30 respondents = 8,010 hours.
    \249\ 8,010 hours-7,620 hours = 390 hours.
    \250\ The Commission estimates that an NRSRO will have a 
Compliance Manager perform these responsibilities. Based on the 
average hourly rate for a Compliance Manager of $245, the average 
one time cost will be $7,350 (30 hours x $245 per hour) and the 
average annual cost will be $3,185 (13 hours x $245 per hour).
    \251\ $7,350 x 30 NRSROs = $220,500.
    \252\ $3,185 x 30 NRSROs = $95,550.
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    In addition, the proposed amendments to Rule 17g-2 would require an 
NRSRO to make the records of its rating actions publicly available in 
an XBRL Interactive Data File.\253\ As discussed with respect to the 
PRA, the Commission estimates that, on average, an NRSRO would spend 
approximately 30 hours to publicly disclose this ratings history 
information in an XBRL Interactive Data File and, thereafter, 10 hours 
per year to update its rating action history.\254\ Accordingly, the 
total aggregate one-time burden to the industry to make the history of 
its rating actions publicly available in an XBRL Interactive Data File 
would be 900 hours \255\ and the total aggregate annual burden hours 
would be 300 hours.\256\ Furthermore, as discussed in the PRA the 
Commission estimates there will be 30 NRSROs. For these reasons, the 
Commission estimates that an NRSRO would incur an average one-time cost 
of $8,670 and an average annual cost of $2,890, as a result of the 
proposed amendment.\257\ Consequently, the total aggregate one-time 
cost to the industry would be $260,100 \258\ and the total aggregate 
annual cost to the industry would be $86,700.\259\
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    \253\ See proposed amendment to Rule 17g-2(d).
    \254\ The Commission also bases this estimate on the estimated 
one-time and annual burden hours it would take an NRSRO to publicly 
disclose its Form NRSRO on its Web site. No comments were received 
on these estimates in the final rule release. See Adopting Release, 
72 FR at 33609.
    \255\ 30 hours x 30 NRSROs = 900 hours.
    \256\ 10 hours x 30 NRSROs = 300 hours.
    \257\ The Commission estimates that an NRSRO would have a Senior 
Programmer perform these responsibilities. The SIFMA 2007 Report as 
Modified indicates that the average hourly cost for a Senior 
Programmer is $289. Therefore, the average one-time cost would be 
$8,670 [(30 hours) x ($289 per hour)] and the average annual cost 
would be $2,890 [(10 hours per year) x ($289 per hour)].
    \258\ 900 hours x $289 per hour.
    \259\ 300 hours x $289 per hour.
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    As discussed with respect to the PRA, the Commission estimated that 
an NRSRO may have to purchase recordkeeping software to establish a 
recordkeeping system in conformance with Rule 17g-2. The Commission 
estimated that the cost of the software will vary based on the size and 
complexity of the NRSRO. Also, the Commission estimated that some 
NRSROs would not need such software because they already have adequate 
recordkeeping systems or, given their small size, such software would 
not be necessary. Based on these estimates, the Commission estimated 
that the average cost for recordkeeping software across all NRSROs 
would be approximately $1,000 per firm. Therefore, the estimated one-
time cost to the industry would be $30,000. The Commission estimates 
that the proposed amendments to Rule 17g-2 would not alter this 
estimate or that any increases in the cost would be de minimis.
    Finally, proposed paragraph (a)(8) to Rule 17g-2 would require an 
NRSRO to create and maintain a record showing all rating actions and 
the date of such actions from the initial rating to the current rating 
identified by the name or rated security or obligor, and, if 
applicable, the CUSIP of the rated security or the Central Index Key 
(CIK) number of the rated obligor.\260\ The Commission estimates that 
an NRSRO could be required to purchase a license from the CUSIP Service 
Bureau in order to access CUSIP numbers for the securities it rates. 
The CUSIP Service Bureau's operations are covered by fees paid by 
issuers and licensees of the CUSIP Service Bureau's data. Issuers pay a 
one-time fee for each new CUSIP assigned, and licensees pay a renewable 
subscription or a license fee for access and use of the CUSIP Service 
Bureau's various database services. The CUSIP Service Bureau's license 
fees vary based on usage, i.e., how many securities or by type of 
security or business line.\261\ The Commission estimates that the 
license fees incurred by an NRSRO would vary depending on the size of 
the NRSRO and the number of credit ratings it issues. For purposes of 
this cost estimate, the Commission estimates that an NRSRO would incur 
a fee of $100,000 to obtain access to the CUSIP numbers for the 
securities it rates. Consequently, the estimated total one-time cost to 
the industry would be $3,000,000.\262\
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    \260\ See proposed Rule 17g-2(a)(8). The Central Index Key (CIK) 
is used on the Commission's computer systems to identify 
corporations and individual people who have filed disclosure with 
the Commission. Anyone may search http://www.edgarcompany.sec.gov 
for a company, fund, or individual CIK. There is no fee for this 
service. CUSIP stands for Committee on Uniform Securities 
Identification Procedures. A CUSIP number identifies most 
securities, including: Stocks of all registered U.S. and Canadian 
companies, U.S. government and municipal bonds, as well as 
structured finance issuances. The CUSIP system--owned by the 
American Bankers Association and operated by Standard & Poor's--
facilitates the clearing and settlement process of securities. The 
CUSIP number consists of nine characters (including letters and 
numbers) that uniquely identify a company or issuer and the type of 
security.
    \261\ See https://www.cusip.com/static/html/webpage/service_
fees.html#lic_fees.
    \262\ $100,000 x 30 NRSROs = $3,000,000.
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    The Commission generally requests comment on all aspects of these 
cost estimates for the proposed amendments to Rule 17g-2. In addition, 
the Commission requests specific comment on the following items related 
to these cost estimates:
     Would these proposals impose costs on other market 
participants, including persons who use credit ratings to make 
investment decisions or for regulatory purposes, and persons who 
purchase services and products from NRSROs?

Commenters should provide specific data and analysis to support any 
comments they submit with respect to these burden estimates.
3. Proposed Amendment to Rule 17g-3
    Rule 17g-3 requires an NRSRO to furnish audited annual financial 
statements to the Commission, including certain specified 
schedules.\263\ The proposed amendment to Rule 17g-3 would require an 
NRSRO to furnish the Commission with an additional annual report: An 
unaudited report of the number of credit ratings that were changed 
during the fiscal year in each class of credit ratings for which the 
NRSRO is registered with the Commission. The Commission believes that 
the annual costs to NRSROs to comply with the proposed amendment to 
Rule 17g-3 would be de minimis, as the Commission preliminarily 
believes that a credit rating agency already would have this 
information with respect to each class of credit ratings for which it 
is registered. In addition, the proposed amendment does not prescribe a 
format for the report. Consequently, the Commission estimates that 
proposed Rule 17g-3(a)(6) would not have a significant effect on the 
total average annual cost burden currently estimated for Rule 17g-3.
---------------------------------------------------------------------------

    \263\ 17 CFR 240.17g-3.
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    The Commission generally requests comment on all aspects of these 
cost estimates for the proposed amendment to Rule 17g-3. In addition, 
the Commission requests specific comment on the following items related 
to these cost estimates:
     Would this proposal impose costs on other market 
participants, including persons who use credit ratings to make 
investment decisions or for regulatory

[[Page 36246]]

purposes, and persons who purchase services and products from NRSROs?

Commenters should provide specific data and analysis to support any 
comments they submit with respect to these burden estimates.
4. Proposed Amendments to Rule 17g-5
    Rule 17g-5 requires an NRSRO to manage and disclose certain 
conflicts of interest.\264\ The proposed amendments would add an 
additional conflict to paragraph (b) of Rule 17g-5. This proposed 
conflict of interest would be issuing or maintaining a credit rating 
for a security or money market instrument issued by an asset pool or as 
part of an asset-backed or mortgage-backed securities transaction that 
was paid for by the issuer, sponsor, or underwriter of the security or 
money market instrument.\265\ Unlike the other conflicts of interest in 
paragraph (b) of Rule 17g-5, NRSROs would be prohibited from issuing a 
rating, unless certain information about the transaction and the assets 
underlying the structured product being rated were disclosed, pursuant 
to proposed Rule 17g-5(a)(3)(i) and (ii).\266\
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    \264\ 17 CFR 240.17g-5.
    \265\ See proposed Rule 17g-5(b)(9). The current paragraph 
(b)(9) would be renumbered as (b)(10).
    \266\ See proposed Rule 17g-5(a)(3).
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    Specifically, proposed Rule 17g-5(a)(3)(i) and (ii) would require 
the disclosure of certain information about the assets underlying a 
structured product that is provided to an NRSRO and used in determining 
an initial rating and monitoring the rating. While the proposed rule 
would require disclosure of certain information, the rule would not 
specify which party would disclose the information. For purposes of 
this PRA, the Commission estimates that it would take a respondent 
approximately 300 hours to develop a system, as well as policies and 
procedures to disclose the information as required under the proposed 
rule. This would result in a total one-time hour burden of 60,000 hours 
for 200 respondents.\267\ For these reasons, the Commission estimates 
that the average one-time cost to each respondent would be $65,850 
\268\ and the total aggregate one-time cost to the industry would be 
$13,116,000.\269\
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    \267\ 300 hours x 200 respondents = 60,000 hours.
    \268\ The Commission estimates an NRSRO would have a Compliance 
Manager and a Programmer Analyst perform these responsibilities, and 
that each would spend 50% of the estimated hours performing these 
responsibilities. The SIFMA 2007 Report as Modified indicates that 
the average hourly cost for a Compliance Manager is $245 and the 
average hourly cost for a Programmer Analyst is 194. Therefore, the 
average one-time cost to an NRSRO would be $[150 hours x $245) + 
(150 hours x $194)] = $65,850.
    \269\ $65,580 x 200 respondents = $13,116,000.
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    As discussed with respect to the PRA, in addition to the one-time 
hour burden, respondents also would be required to disclose the 
required information under proposed Rule 17g-5(a)(3)(i) on a 
transaction by transaction basis. Based on staff information gained 
from the NRSRO examination process, the Commission estimates that the 
proposed amendments would require each respondent to disclose 
information with respect to approximately 20 new transactions per year 
and that it would take approximately 1 hour per transaction to make the 
information publicly available.\270\ Therefore, as discussed with 
respect to the PRA, the Commission estimates that it would take a 
respondent approximately 20 hours \271\ to disclose this information 
under proposed Rule 17g-5(a)(i) and (ii), on an annual basis, for a 
total aggregate annual hour burden of 4,000.\272\ For these reasons, 
the Commission estimates that the average annual cost to a respondent 
would be $4,100 \273\ and the total annual cost to the industry would 
be $820,000.\274\
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    \270\ This estimate assumes the respondent has already 
implemented the system and policies and procedures for disclosure. 
The Commission cannot estimate the number of initial transactions 
per year with certainty. The Commission believes that the number of 
deals that each respondent will disclose information on will vary 
widely based on the size of the entity. In addition, the Commission 
preliminarily believes that the number of asset-backed or mortgaged-
backed issuances being rated by NRSROs in the next few years would 
be difficult to predict given the recent credit market turmoil.
    \271\ 20 transactions x 1 hour = 20 hours.
    \272\ 20 hours x 200 respondents = 4,000 hours.
    \273\ The Commission estimates an NRSRO would have a Webmaster 
perform these responsibilities. The SIFMA 2007 Report as Modified 
indicates that the average hourly cost for a Webmaster is $205. 
Therefore, the average one-time cost to a respondent would be 20 
hours x $205 = $4,100.
    \274\ $4,100 x 200 respondents = $820,000.
---------------------------------------------------------------------------

    Proposed Rule 17g-5(a)(ii) would require respondents to disclose 
information provided to an NRSRO that is used by an NRSRO in 
undertaking credit rating surveillance on a structured product. Because 
surveillance would cover more than just initial ratings, the Commission 
estimates that a respondent would be required to disclose information 
with respect to approximately 125 transactions on an ongoing basis and 
that the information would be provided to the NRSRO on a monthly basis. 
As discussed with respect to the PRA, the Commission estimates that 
each respondent would spend approximately 750 hours \275\ on an annual 
basis disclosing the information for a total aggregate annual burden 
hours of 150,000 hours.\276\ For these reasons, the Commission 
estimates that the average annual cost to a respondent would be 
$153,750 \277\ and the total annual cost to the industry would be 
$30,750,000.\278\
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    \275\ 125 transactions x 30 minutes x 12 months = 45,000 
minutes/60 minutes = 750 hours.
    \276\ 750 hours x 200 respondents = 150,000 hours.
    \277\ The Commission estimates an NRSRO would have a Webmaster 
perform these responsibilities. The SIFMA 2007 Report as Modified 
indicates that the average hourly cost for a Webmaster is $205. 
Therefore, the average one-time cost to a respondent would be 750 
hours x 205 = $153,750.
    \278\ $153,750 x 200 respondents = $30,750,000.
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    The Commission is also proposing to amend paragraph (c) to Rule 
17g-5 to add three additional prohibited conflicts of interest.\279\ 
The Commission estimates that the amendments to paragraph (c) to Rule 
17g-5 generally would impose de minimis costs on an NRSRO. However, the 
Commission recognizes that an NRSRO may incur costs related to training 
employees about the requirements with respect to these proposed 
amendments. It also is possible that the proposed amendments could 
require some NRSROs to restructure their business models or activities, 
in particular with respect to their consulting services.
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    \279\ See proposed Rule 17g-5(c)(5)-(7).
---------------------------------------------------------------------------

    The Commission generally requests comment on all aspects of these 
cost estimates for the proposed amendments to Rule 17g-5. In addition, 
the Commission requests specific comment on the following items related 
to these cost estimates:
     Would the proposals for additional disclosure impose costs 
on issuers, underwriters, sponsors, depositors, or trustees?
     Would these proposals impose costs on other market 
participants, including persons who use credit ratings to make 
investment decisions or for regulatory purposes, and persons who 
purchase services and products from NRSROs?
     Would there be costs in addition to those identified 
above, such as costs arising from systems changes and restructuring 
business practices to account for the new reporting requirement?
     Would the proposed amendments to paragraph (c) of Rule 
17g-5 impose training and restructuring costs?
     Would the proposed amendments to paragraph (c) of Rule 
17g-5 impose personnel costs?
     Would the proposed amendments to paragraph (c) of Rule 
17g-5 impose any additional costs on an NRSRO that is part of a large 
conglomerate related to monitoring the business activities of persons 
associated with the NRSRO, such as affiliates located in other

[[Page 36247]]

countries, to comply with the proposed requirement?

Commenters should provide specific data and analysis to support any 
comments they submit with respect to these burden estimates.
5. Proposed Rule 17g-7
    The Commission is proposing a new rule--proposed Rule 17g-7--which 
would require an NRSRO to attach a report each time it publishes a 
credit rating for a structured finance product describing how the 
ratings procedures and methodologies differ from those for corporate 
debt.\280\ Alternatively, an NRSRO would be permitted to use rating 
symbols for structured finance products that differentiate them from 
its other credit ratings. The Commission expects that most NRSROs 
already have methodologies in place to determine credit ratings for 
structured finance products and corporate debt securities, and 
disclosed such policies and procedures if they have registered as an 
NRSRO. The Commission expects, however, that an NRSRO would have to 
conform these disclosures into a report to comply with the specific 
requirements in the proposed rule. As discussed above with respect to 
PRA, the Commission estimates that it would take approximately 50 hours 
for an NRSRO to compile and write disclosures to comply with the 
proposed rule and that there would be 30 NRSROs. For these reasons, the 
Commission estimates that the average one-time cost to an NRSRO would 
be $12,250 \281\ and the total aggregate one-time cost to the industry 
would be $367,500.\282\
---------------------------------------------------------------------------

    \280\ See proposed Rule 17g-3A.
    \281\ The Commission estimates an NRSRO would have a Compliance 
Manager perform these responsibilities. The SIFMA 2007 Report as 
Modified indicates that the average hourly cost for a Compliance 
Manager is $245. Therefore, the average one-time cost to an NRSRO 
would be $12,250 (50 hours x $245).
    \282\ 30 NRSROs x $12,250 = $367,500.
---------------------------------------------------------------------------

    As discussed above with respect to the PRA, the Commission also 
estimates that it would take an NRSRO additional time to attach the 
report to each credit rating for a structured finance product and to 
monitor the report on an ongoing basis to ensure that the disclosure 
was accurate. Based on staff experience staff information gained from 
the NRSRO examination process, the Commission estimates that an NRSRO 
would spend approximately 5 minutes to attach each proposed report to 
the estimated 128,000 asset-backed credit ratings per NRSRO, four times 
per year, as discussed above, for a total of 42,667 annual burden hours 
\283\ per respondent, and a total of 1,280,010 annual burden hours 
\284\ for 30 NRSROs. For these reasons, the Commission estimates that 
the average annual cost to an NRSRO would be $4,373,265 \285\ and the 
total aggregate annual cost to the industry would be $131,197,950.\286\
---------------------------------------------------------------------------

    \283\ 128,000 x 4 = 512,000 reports x 5 minutes per report = 
2,560,000 minutes/60 minutes per hour = 42,667 hours.
    \284\ 42,667 hours x 30 NRSROs = 1,280,010 hours.
    \285\ The Commission estimates an NRSRO would have a Webmaster 
perform these responsibilities. The SIFMA 2007 Report as Modified 
indicates that the average hourly cost for a Webmaster is $205. 
Therefore, the average one-time cost to an NRSRO would be $4,373,265 
(21,333 hours x $205).
    \286\ $4,373,265 x 30 NRSROs = $131,197,950.
---------------------------------------------------------------------------

    Finally, as discussed with respect to the PRA, the Commission 
estimates, based on staff experience, that it would take an NRSRO 
approximately 10 hours per year to review and update the report to 
ensure the disclosure was accurate and up-to-date for a total aggregate 
annual hour burden to the industry of 300 hours.\287\ For these 
reasons, the Commission estimates that the average annual cost to an 
NRSRO would be $2,700 \288\ and the total aggregate annual cost to the 
industry would be $81,000.\289\
---------------------------------------------------------------------------

    \287\ This estimate is based on the number of hours it would 
take an NRSRO to complete an annual certification on Form NRSRO. See 
Exchange Act Release No. 55857 (June 5, 2007), 72 FR 33564, 33609 
(June 18, 2007). 10 hours x 30 NRSROs = 300 hours.
    \288\ The Commission estimates an NRSRO would have a Compliance 
Attorney perform these responsibilities. The SIFMA 2007 Report as 
Modified indicates that the average hourly cost for a Compliance 
Attorney is $270. Therefore, the average one-time cost to an NRSRO 
would be $2,700 (10 hours x $270).
    \289\ $2,700 x 30 NRSROs = $81,000.
---------------------------------------------------------------------------

    The Commission generally requests comment on all aspects of these 
cost estimates for the proposed amendments to Rule 17g-7. In addition, 
the Commission requests specific comment on the following items related 
to these cost estimates:
     Would the use of different rating symbols for structured 
products impact automated securities trading, routing, settlement, 
clearance, trade confirmation, reporting, processing, and risk 
management systems and any other systems that are programmed to use 
standard credit rating symbols across all product classes?
     Would the use of different rating symbols have 
consequences for investment guidelines and covenants in legal documents 
that use credit ratings to distinguish finance instruments?
     Would these proposals impose costs on other market 
participants, including persons who use credit ratings to make 
investment decisions or for regulatory purposes, and persons who 
purchase services and products from NRSROs?
     Would there be costs in addition to those identified 
above, such as costs arising from systems changes and restructuring 
business practices to account for the new reporting requirement?
Commenters should provide specific data and analysis to support any 
comments they submit with respect to these burden estimates.

C. Total Estimated Costs and Benefits of This Rulemaking

    As discussed above, the proposed amendments and new rules are 
expected to have both benefits and costs for investors and the credit 
rating industry as a whole. The Commission believes the benefits to 
investors and other users of credit ratings, especially with respect to 
investments in structured finance products would be quite substantial, 
but are difficult to quantify. Similarly difficult to quantify are the 
expected benefits to the Commission's oversight over NRSROs due to the 
enhanced recordkeeping, disclosure and reporting requirements. 
Moreover, not all the costs the Commission anticipates would result 
from this rulemaking are quantifiable. Based on the figures discussed 
above, however, the Commission estimates that the first year 
quantifiable costs related to this proposed rulemaking would be 
approximately $180,175,810.\290\
---------------------------------------------------------------------------

    \290\ $17,078,760 (total one-time costs) + $163,097,810 (total 
annual costs) = $180,175,810.
---------------------------------------------------------------------------

VI. Consideration of Burden on Competition and Promotion of Efficiency, 
Competition, and Capital Formation

    Under Section 3(f) of the Exchange Act,\291\ the Commission shall, 
when engaging in rulemaking that requires the Commission to consider or 
determine if an action is necessary or appropriate in the public 
interest, consider whether the action will promote efficiency, 
competition, and capital formation. Section 23(a)(2) of the Exchange 
Act \292\ requires the Commission to consider the anticompetitive 
effects of any rules the Commission adopts under the Exchange Act. 
Section 23(a)(2) prohibits the Commission from adopting any rule that 
would impose a burden on competition not necessary or appropriate in 
furtherance of the purposes of the Exchange Act. As discussed below, 
the Commission's preliminary view is that the proposed amendments and 
new

[[Page 36248]]

rules should promote efficiency, competition, and capital formation.
---------------------------------------------------------------------------

    \291\ 15 U.S.C. 78c(f).
    \292\ 15 U.S.C. 78w(a)(2).
---------------------------------------------------------------------------

    The proposed amendments to the Instructions to Exhibit 1 to Form 
NRSRO would require NRSROs to make more comparable disclosures about 
the performance of their credit ratings. These could make it easier for 
an NRSRO to demonstrate that it has a superior ratings methodology or 
competence and, thereby, attract clients. In addition, the proposed 
amendments to the instructions to Exhibit 2 are designed to enhance the 
disclosures NRSROs make with respect to their methodologies for 
determining credit ratings. The Commission believes these enhanced 
disclosures would make it easier for users of credit ratings to compare 
the quality of the NRSRO's procedures and methodologies for determining 
credit ratings. The greater transparency that would result from all 
these enhanced disclosures could make it easier for market participants 
to select the NRSROs that are performing best and have the highest 
quality processes for determining credit ratings. This could increase 
competition and promote capital formation by restoring confidence in 
the credit ratings, which are an integral part of the capital formation 
process.
    The proposed amendments to Rule 17g-2 are designed to enhance the 
Commission's oversight of NRSROs and, with respect to the public 
disclosure of ratings history, provide the marketplace with the raw 
materials to develop metrics for comparing the ratings performance of 
NRSROs. Enhancing the Commission's oversight could help in restoring 
confidence in credit ratings and, thereby, promote capital formation. 
Increased disclosure of ratings history could make the ratings 
performance of the NRSROs more transparent to the marketplace and, 
thereby, highlight those firms that do a better job analyzing credit 
risk. This could benefit smaller NRSROs to the extent they have 
performed better than others by alerting the market to their superior 
competence.
    The proposed amendment to Rule 17g-3 is designed to enhance the 
Commission's oversight of NRSROs. Enhancing the Commission's oversight 
could help in restoring confidence in credit ratings and, thereby, 
promote capital formation.
    The proposed amendments to paragraphs (a) and (b) of Rule 17g-5 
would enhance the disclosures made about assets underlying structured 
finance products. The goal of these proposals is to provide a mechanism 
for NRSROs to determine unsolicited credit ratings and other market 
participants and observers to independently assess the creditworthiness 
of structured finance products. This could expose NRSROs whose 
procedures and methodologies for determining credit ratings are less 
conservative in order to gain business. It also could mitigate the 
impact of rating shopping, since NRSROs not hired to rate a deal could 
nonetheless issue a credit rating. These potential impacts of the rule 
proposal could help to restore confidence in credit ratings and, 
thereby, promote capital formation. Also, by creating a mechanism for 
determining unsolicited ratings, they could increase competition by 
allowing smaller NRSROs to demonstrate proficiency in rating structured 
products.
    The proposed amendments to paragraph (c) of Rule 17g-5 would 
prohibit NRSROs and their affiliates from providing consulting or 
advisory services, prohibit analysts from participating in fee 
negotiations, and prohibit credit analysts or persons responsible for 
approving a credit rating receiving gifts from the obligor being rated, 
or from the issuer, underwriter, or sponsor of the securities being 
rated, other than items provided in the context of normal business 
activities such as meetings that have an aggregate value of no more 
than $25. These proposals could increase confidence in the integrity of 
NRSROs and the credit ratings they issue. This could help to restore 
confidence in credit ratings and, thereby, promote capital formation.
    Proposed new Rule 17g-7 would provide users of credit ratings with 
useful information about structured product ratings. This could help 
them in assessing the risk of securities and promote better informed 
investment decisions. This could increase the efficiency of the capital 
markets by making structured finance ratings more transparent.
    The Commission generally requests comment on all aspects of this 
analysis of the burden on competition and promotion of efficiency, 
competition, and capital formation. In addition, the Commission 
requests specific comment on the following items related to this 
analysis:
     Would the proposed amendments have an adverse effect on 
efficiency, competition, and capital formation that is neither 
necessary nor appropriate in furtherance of the purposes of the 
Exchange Act?
Commenters should provide specific data and analysis to support any 
comments they submit with respect to these burden estimates.

VII. Consideration of Impact on the Economy

    For purposes of the Small Business Regulatory Enforcement Fairness 
Act of 1996, or ``SBREFA,'' \293\ the Commission must advise OMB 
whether a proposed regulation constitutes a major rule. Under SBREFA, a 
rule is ``major'' if it has resulted in, or is likely to result in:
---------------------------------------------------------------------------

    \293\ Pub. L. 104-121, Title II, 110 Stat. 857 (1996) (codified 
in various sections of 5 U.S.C., 15 U.S.C. and as a note to 5 U.S.C. 
601).
---------------------------------------------------------------------------

     An annual effect on the economy of $100 million or more;
     A major increase in costs or prices for consumers or 
individual industries; or
     A significant adverse effect on competition, investment, 
or innovation.
    If a rule is ``major,'' its effectiveness will generally be delayed 
for 60 days pending Congressional review. The Commission requests 
comment on the potential impact of each of the proposed amendments on 
the economy on an annual basis. Commenters are requested to provide 
empirical data and other factual support for their view to the extent 
possible.

VIII. Initial Regulatory Flexibility Analysis

    The Commission has prepared the following Initial Regulatory 
Flexibility Analysis (``IRFA''), in accordance with the provisions of 
the Regulatory Flexibility Act,\294\ regarding proposed amendments to 
Form NRSRO, Rule 17g-2, Rule 17g-3, and Rule 17g-5 and regarding 
proposed Rule 17g-7 under the Exchange Act.
---------------------------------------------------------------------------

    \294\ 5 U.S.C. 603.
---------------------------------------------------------------------------

    The Commission encourages comments with respect to any aspect of 
this IRFA, including comments with respect to the number of small 
entities that may be affected by the proposed amendments. Comments 
should specify the costs of compliance with the proposed amendments and 
suggest alternatives that would accomplish the goals of the amendments. 
Comments will be considered in determining whether a Final Regulatory 
Flexibility Analysis is required and will be placed in the same public 
file as comments on the proposed amendments. Comments should be 
submitted to the Commission at the addresses previously indicated.

A. Reasons for the Proposed Action

    The proposed amendments would prescribe additional requirements for 
NRSROs to address concerns raised about the role of credit rating 
agencies in the recent credit market turmoil. The proposed amendments 
are designed to enhance and strengthen the rules the

[[Page 36249]]

Commission adopted in 2007 to implement specific provisions of the 
Rating Agency Act.\295\ The Rating Agency Act defines the term 
``nationally recognized statistical rating organization'' as a credit 
rating agency registered with the Commission, provides authority for 
the Commission to implement registration, recordkeeping, financial 
reporting, and oversight rules with respect to registered NRSROs.
---------------------------------------------------------------------------

    \295\ Pub. L. 109-291 (2006); see also Exchange Act Release No. 
55857 (June 5, 2007), 72 FR 33564, 33609 (June 18, 2007).
---------------------------------------------------------------------------

B. Objectives

    The proposed amendments and new rules would enhance and strengthen 
the rules the Commission adopted in 2007 to implement specific 
provisions of the Rating Agency Act. The objectives of the Rating 
Agency Act are ``to improve ratings quality for the protection of 
investors and in the public interest by fostering accountability, 
transparency, and competition in the credit rating industry.'' \296\ 
The proposed amendments and new rules are designed to further enhance 
these objectives and assist the Commission in monitoring whether an 
NRSRO complies with the provisions of the Rating Agency Act and rules 
thereunder, consistent with the Commission's statutory mandate to adopt 
rules to implement the NRSRO regulatory program, and provide 
information regarding NRSROs to the public and to users of credit 
ratings. These proposed amendments would also prescribe additional 
requirements for NRSROs to address concerns raised about the role of 
credit rating agencies in the recent credit market turmoil, including 
concerns with respect to the determination of credit ratings for 
structured finance products.
---------------------------------------------------------------------------

    \296\ See Senate Report.
---------------------------------------------------------------------------

C. Legal Basis

    Pursuant to the Sections 3(b), 15E, 17(a), 23(a) and 36 of the 
Exchange Act.\297\
---------------------------------------------------------------------------

    \297\ 15 U.S.C. 78c(b), 78o-7, 78q(a), and 78w.
---------------------------------------------------------------------------

D. Small Entities Subject to the Rule

    Paragraph (a) of Rule 0-10 provides that for purposes of the 
Regulatory Flexibility Act, a small entity ``[w]hen used with reference 
to an `issuer' or a `person' other than an investment company'' means 
``an `issuer' or `person' that, on the last day of its most recent 
fiscal year, had total assets of $5 million or less.'' \298\ The 
Commission believes that an NRSRO with total assets of $5 million or 
less would qualify as a ``small'' entity for purposes of the Regulatory 
Flexibility Act.
---------------------------------------------------------------------------

    \298\ 17 CFR 240.0-10(a).
---------------------------------------------------------------------------

    As noted in the Adopting Release,\299\ the Commission believes that 
approximately 30 credit rating agencies ultimately would be registered 
as an NRSRO. Of the approximately 30 credit rating agencies estimated 
to be registered with the Commission, the Commission estimates that 
approximately 20 may be ``small'' entities for purposes of the 
Regulatory Flexibility Act.\300\
---------------------------------------------------------------------------

    \299\ Adopting Release, 72 FR at 33618.
    \300\ See 17 CFR 240.0-10(a).
---------------------------------------------------------------------------

E. Reporting, Recordkeeping, and Other Compliance Requirements

    The proposals would amend Form NRSRO to elicit certain additional 
information regarding the performance data for the credit ratings and 
the methods used by a credit rating agency for issuing credit 
ratings.\301\
---------------------------------------------------------------------------

    \301\ See proposed amendments to Form NRSRO.
---------------------------------------------------------------------------

    The proposals would amend Rule 17g-2 to establish additional 
recordkeeping requirements.\302\ The proposed amendments would require 
an NRSRO to make and retain two additional records and retain a third 
type of record. The records would be: (1) A record of the rationale for 
any material difference between the credit rating implied by the model 
and the final credit rating issued, if a quantitative model is a 
substantial component in the process of determining a credit rating; 
\303\ (2) a record showing the history and dates of all previous rating 
actions with respect to each current credit rating; \304\ and (3) any 
complaints about the performance of a credit analyst.\305\ These 
records would assist the Commission, through its examination process, 
in monitoring whether the NRSRO continues to maintain adequate 
financial and managerial resources to consistently produce credit 
ratings with integrity (as required under the Rating Agency Act) and 
whether the NRSRO was complying with the provisions of the Exchange Act 
including the provisions of the Rating Agency Act, the rules adopted 
thereunder, and the NRSRO's disclosed policies and procedures.
---------------------------------------------------------------------------

    \302\ See proposed amendments to Rule 17g-2.
    \303\ Proposed paragraph (a)(2)(iii) of Rule 17g-2.
    \304\ Proposed paragraph (a)(8) of Rule 17g-2.
    \305\ Proposed paragraph (b)(8) of Rule 17g-2.
---------------------------------------------------------------------------

    The proposals would amend Rule 17g-3 to require an NRSRO to furnish 
the Commission with an additional annual report: the number of 
downgrades in each class of credit ratings for which it is registered 
and the description of the findings from an independent review.\306\ 
This requirement is designed to assist the Commission in its 
examination function and to require an NRSRO to assess the integrity of 
its rating process. It also is designed to assist the Commission in 
monitoring whether the NRSRO is complying with provisions of the Rating 
Agency Act and the rules adopted thereunder.
---------------------------------------------------------------------------

    \306\ See proposed amendment to Rule 17g-3.
---------------------------------------------------------------------------

    The proposals would amend paragraphs (a) and (b) of Rule 17g-5 to 
prohibit an NRSRO from issuing a credit rating for a structured product 
unless certain information about the assets underlying the product are 
disclosed. The proposals would amend paragraph (c) of Rule 17g-5 to 
prohibit NRSROs and their affiliates from providing consulting or 
advisory services, prohibit analysts from participating in fee 
negotiations, and prohibit credit analysts or persons responsible for 
approving a credit rating received gifts from the obligor being rated, 
or from the issuer, underwriter, or sponsor of the securities being 
rated, other than items provided in the context of normal business 
activities such as meetings that have an aggregate value of no more 
than $25.\307\
---------------------------------------------------------------------------

    \307\ See proposed amendment to Rule 17g-5.
---------------------------------------------------------------------------

    The proposals would amend Rule 17g-7 to require an NRSRO to attach 
a report each time it publishes a credit rating for a structured 
finance product describing how the ratings procedures and methodologies 
and credit risk characteristics for structured products differ from 
those for other types of obligors and debt securities. An NRSRO could 
avoid having to attach the report if it used ratings symbols for 
structured products that differentiate them from its other types of 
credit ratings.\308\
---------------------------------------------------------------------------

    \308\ See proposed Rule 17g-7.
---------------------------------------------------------------------------

F. Duplicative, Overlapping, or Conflicting Federal Rules

    The Commission believes that there are no federal rules that 
duplicate, overlap, or conflict with the proposed amendments or new 
rule.

G. Significant Alternatives

    Pursuant to Section 3(a) of the RFA,\309\ the Commission must 
consider certain types of alternatives, including: (1) The 
establishment of differing compliance or reporting requirements or 
timetables that take into account the resources available to small 
entities; (2) the clarification, consolidation, or simplification of 
compliance and reporting requirements under the rule for small 
entities; (3) the use of

[[Page 36250]]

performance rather than design standards; and (4) an exemption from 
coverage of the rule, or any part of the rule, for small entities.
---------------------------------------------------------------------------

    \309\ 5 U.S.C. 603(c).
---------------------------------------------------------------------------

    The Commission is considering whether it is necessary or 
appropriate to establish different compliance or reporting requirements 
or timetables; or clarify, consolidate, or simplify compliance and 
reporting requirements under the rule for small entities. Because the 
proposed amendments and proposed new rule are designed to improve the 
overall quality of ratings and enhance the Commission's oversight, the 
Commission is not proposing to exempt small entities from coverage of 
the rule, or any part of the rule. The proposed amendments and new 
rules allow NRSROs the flexibility to develop procedures tailored to 
their specific organizational structure and business models. The 
Commission also does not believe that it is necessary at this time to 
consider whether small entities should be permitted to use performance 
rather than design standards to comply with the proposed amendments as 
the amendments already propose performance standards and do not dictate 
for entities of any size any particular design standards that must be 
employed to achieve the Act's objectives.

H. Request for Comments

    The Commission encourages the submission of comments to any aspect 
of this portion of the IRFA. Comments should specify costs of 
compliance with the proposed amendments and suggest alternatives that 
would accomplish the objective of the proposed amendments

IX. Statutory Authority

    The Commission is proposing amendments to Form NRSRO and Rules 17g-
2, 17g-3, and 17g-5 and is proposing new rule 17g-7 pursuant to the 
authority conferred by the Exchange Act, including Sections 3(b), 15E, 
17, 23(a) and 36.\310\
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    \310\ 15 U.S.C. 78c(b), 78o-7, 78q, 78w, and 78mm.
---------------------------------------------------------------------------

Text of Proposed Rules

List of Subjects in 17 CFR Parts 240 and 249b

    Brokers, Reporting and recordkeeping requirements, Securities.
    In accordance with the foregoing, the Commission proposes to amend 
Title 17, Chapter II of the Code of Federal Regulations as follows.

PART 240--GENERAL RULES AND REGULATIONS, SECURITIES EXCHANGE ACT OF 
1934

    1. The authority citation for part 240 continues to read in part as 
follows:

    Authority: 15 U.S.C. 77c, 77d, 77g, 77j, 77s, 77z-2, 77z-3, 
77eee, 77ggg, 77nnn, 77sss, 77ttt, 78c, 78d, 78e, 78f, 78g, 78i, 
78j, 78j-1, 78k, 78k-1, 78l, 78m, 78n, 78o, 78p, 78q, 78s, 78u5, 
78w, 78x, 78ll, 78mm, 80a-20, 80a-23, 80a-29, 80a-37, 80b-3, 80b-4, 
80b-11, and 7201 et seq.; and 18 U.S.C. 1350, unless otherwise 
noted.
* * * * *
    2. Section 240.17g-2 is amended by:
    a. Removing paragraph (a)(2)(iv);
    b. Redesignating paragraph (a)(2)(iii) as paragraph (a)(2)(iv);
    c. In newly redesignated paragraph (a)(2)(iv), removing ``; and'' 
and in its place adding a period;
    d. Adding new paragraph (a)(2)(iii);
    e. Adding paragraph (a)(8);
    f. In paragraph (b)(7), revising the phrase ``maintaining, 
changing,'' to read ``maintaining, monitoring, changing,'';
    g. Redesignating paragraphs (b)(8), (b)(9), and (b)(10) as 
paragraphs (b)(9), (b)(10), and (b)(11), respectively;
    h. Adding new paragraph (b)(8); and
    i. In paragraph (d), adding a sentence to the end of the paragraph.
    The additions read as follows:


Sec.  240.17g-2  Records to be made and retained by nationally 
recognized statistical rating organizations.

    (a) * * *
    (2) * * *
    (iii) If a quantitative model was a substantial component in the 
process of determining the credit rating, a record of the rationale for 
any material difference between the credit rating implied by the model 
and the final credit rating issued; and
* * * * *
    (8) A record 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.
    (b) * * *
    (8) Any communications that contain complaints about the 
performance of a credit analyst in initiating, determining, 
maintaining, monitoring, changing, or withdrawing a credit rating.
* * * * *
    (d) * * * In addition, the records required to be retained pursuant 
to paragraph (a)(8) of this section must be made publicly available on 
the corporate Web site of the NRSRO in an XBRL Interactive Data File 
that uses a machine-readable computer code that presents information in 
eXtensible Business Reporting Language in electronic format no later 
than six months after the date of the rating action.
* * * * *
    3. Section 240.17g-3 is amended by:
    a. Adding paragraph (a)(6); and
    b. Revising paragraph (b).
    The additions and revision read as follows:


Sec.  240.17g-3  Annual financial reports to be furnished by nationally 
recognized statistical rating organizations.

    (a) * * *
    (6) The number of credit ratings actions taken during the fiscal 
year in each class of credit ratings identified in section 3(a)(62)(B) 
of the Act (15 U.S.C. 78c(a)(62)(B)) for which the nationally 
recognized statistical rating organization is registered with the 
Commission.

    Note to paragraph (a)(6): A nationally recognized statistical 
rating organization registered in the class of credit ratings 
described in section 3(a)(62)(B)(iv) of the Act (15 U.S.C. 
78c(a)(62)(B)(iv)) must include credit ratings actions taken on 
credit ratings of any security or money market instrument issued by 
an asset pool or as part of any asset-backed or mortgage-backed 
securities transaction for purposes of reporting the number of 
credit ratings actions in this class.

    (b) The nationally recognized statistical rating organization must 
attach to the financial reports furnished pursuant to paragraphs (a)(1) 
through (a)(6) of this section a signed statement by a duly authorized 
person associated with the nationally recognized statistical rating 
organization stating that the person has responsibility for the 
financial reports and, to the best knowledge of the person, the 
financial reports fairly present, in all material respects, the 
financial condition, results of operations, cash flows, revenues, 
analyst compensation, and credit rating actions of the nationally 
recognized statistical rating organization for the period presented.
* * * * *
    4. Section 240.17g-5 is amended by:
    a. Removing the word ``and'' at the end of paragraph (a)(1);
    b. Removing the period at the end of paragraph (a)(2) and in its 
place adding ``; and'';
    c. Adding paragraph (a)(3);
    d. Redesignating paragraph (b)(9) as paragraph (b)(10);
    e. Adding new paragraph (b)(9);
    f. Removing the word ``or'' at the end of paragraph (c)(3);
    g. Removing the period at the end of paragraph (c)(4) and in its 
place adding a semi-colon; and

[[Page 36251]]

    h. Adding paragraphs (c)(5), (c)(6), and (c)(7).
    The additions read as follows:


Sec.  240.17g-5  Conflicts of interest.

    (a) * * *
    (3) In the case of the conflict of interest identified in paragraph 
(b)(9) of this section, the following information is disclosed through 
a means designed to provide reasonably broad dissemination:
    (i) (A) All information provided to the nationally recognized 
statistical rating organization by the issuer, underwriter, sponsor, 
depositor, or trustee that is used in determining the initial credit 
rating for the security or money market instrument, including 
information about the characteristics of the assets underlying or 
referenced by the security or money market instrument, and the legal 
structure of the security or money market instrument, with such 
information to disclosed publicly in an offering registered under the 
Securities Act of 1933 (15 U.S.C. 77a et seq.) on the date the 
underwriter and the issuer or depositor set the offering price of the 
securities being rated;
    (B) In offerings that are not registered under the Securities Act 
of 1933 (15 U.S.C. 77a et seq.), the information in paragraph 
(a)(3)(i)(A) of this section must be disclosed to investors and credit 
rating agencies on the date the underwriter and the issuer or depositor 
set the offering price of the securities being rated, and disclosed 
publicly on the first business day after the transaction closes; and
    (ii) All information provided to the nationally recognized 
statistical rating organization by the issuer, underwriter, sponsor, 
depositor, or trustee that is used by the nationally recognized 
statistical rating organization in undertaking credit rating 
surveillance on the security or money market instrument, including 
information about the characteristics and performance of the assets 
underlying or referenced by the security or money market instrument, 
with such information to be disclosed publicly at the time such 
information is provided to the nationally recognized statistical rating 
organization.
    (b) * * *
    (9) Issuing or maintaining a credit rating for a security or money 
market instrument issued by an asset pool or as part of any asset-
backed or mortgage-backed securities transaction that was paid for by 
the issuer, sponsor, or underwriter of the security or money market 
instrument.
* * * * *
    (c) * * *
    (5) The nationally recognized statistical rating organization 
issues or maintains a credit rating with respect to an obligor or 
security where the nationally recognized statistical rating 
organization or a person associated with the nationally recognized 
statistical rating organization 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 of the security;
    (6) The nationally recognized statistical rating organization 
issues or maintains a credit rating where the fee paid for the rating 
was negotiated, discussed, or arranged by a person within the 
nationally recognized statistical rating organization who has 
responsibility for participating in determining credit ratings or for 
developing or approving procedures or methodologies used for 
determining credit ratings, including qualitative and quantitative 
models; or
    (7) The nationally recognized statistical rating organization 
issues or maintains 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, other 
than items provided in the context of normal business activities such 
as meetings that have an aggregate value of no more than $25.
* * * * *
    5. Section 240.17g-7 is added to read as follows:


Sec.  240.17g-7  Credit rating reports to be furnished by nationally 
recognized statistical rating organizations.

    (a) A nationally recognized statistical rating organization must 
attach a report each time it publishes a credit rating for a security 
or money market instrument issued by an asset pool or as part of any 
asset-backed or mortgage-backed securities transaction that describes 
the rating methodology used to determine such credit rating and how it 
differs from the determination of ratings for any other type of obligor 
or debt security and how the credit risk characteristics associated 
with a security or money market instrument issued by an asset pool or 
as part of any asset-backed or mortgage-backed securities transaction 
differ from those of any other type of obligor or debt security.
    (b) Exemption from attaching report. A nationally recognized 
statistical rating organization is not required to attach the report 
each time it publishes a credit rating as prescribed by paragraph (a) 
of this section if the credit rating symbol used by the nationally 
recognized statistical rating organization to indicate the credit 
rating identifies the credit rating as relating to a security or money 
market instrument issued by an asset pool or as part of any asset-
backed or mortgage-backed securities transaction as distinct from a 
credit rating for any other type of obligor or debt security.

PART 249b--FURTHER FORMS, SECURITIES EXCHANGE ACT OF 1934

    6. The authority citation for part 249b continues to read in part 
as follows:

    Authority: 15 U.S.C. 78a et seq., unless otherwise noted;
* * * * *
    7. Form NRSRO (referenced in Sec.  249b.300) is amended by revising 
Exhibits 1 and 2 in section H, Item 9 of the Form NRSRO Instructions to 
read as follows:

    Note: The text of Form NRSRO and this amendment does not appear 
in the Code of Federal Regulations.

Form NRSRO

* * * * *

Form NRSRO Instructions

* * * * *

H. Instructions for Specific Line Items

* * * * *
    Item 9. Exhibits. * * *
    Exhibit 1. Provide in this Exhibit performance measurement 
statistics of the credit ratings of the Applicant/NRSRO, including 
performance measurement statistics of the credit ratings seperately for 
each class of credit rating for which the Applicant/NRSRO is seeking 
registration or is registered (as indicated in Item 6 and/or 7 of Form 
NRSRO) and any other broad class of credit rating issued by the 
Applicant/NRSRO. For the purposes of this Exhibit, an Applicant/NRSRO 
registered in the class of credit ratings described in Section 
3(a)(62)(B)(iv) of the Act (15 U.S.C. 78c(a)(62)(B)(iv)) must include 
credit ratings of any security or money market instrument issued by an 
asset pool or as part of any asset-backed or mortgage-backed securities 
transaction for purposes of reporting the performance measurement 
statistics for this class. The performance measurement statistics must 
at a minimum show the performance of credit ratings in each class over 
1 year, 3 year, and 10 year periods (as applicable) through the most 
recent calendar year-end, including, as applicable: historical ratings 
transition

[[Page 36252]]

and default rates within each of the credit rating categories, notches, 
grades, or rankings used by the Applicant/NRSRO as an indicator of the 
assessment of the creditworthiness of an obligor, security, or money 
market instrument in each class of credit rating. The default 
statistics must include defaults relative to the initial rating and 
must incorporate defaults that occur after a credit rating is 
withdrawn. As part of this Exhibit, define the credit rating 
categories, notches, grades, and rankings used by the Applicant/NRSRO 
and explain the performance measurement statistics, including the 
inputs, time horizons, and metrics used to determine the statistics. 
Also provide in this Exhibit the Web site address where the records of 
credit rating actions required under 17 CFR 240.17g-2(a)(8) are, or 
will be, made publicly available in an XBRL Interactive Data File 
pursuant to the requirements of 17 CFR 240.17g-2(d).
    Exhibit 2. Provide in this Exhibit a general description of the 
procedures and methodologies used by the Applicant/NRSRO to determine 
credit ratings, including unsolicited credit ratings within the classes 
of credit ratings for which the Applicant/NRSRO is seeking registration 
or is registered. The description must be sufficiently detailed to 
provide users of credit ratings with an understanding of the processes 
employed by the Applicant/NRSRO in determining credit ratings, 
including, as applicable, descriptions of: policies for determining 
whether to initiate a credit rating; a description of the public and 
non-public sources of information used in determining credit ratings, 
including information and analysis provided by third-party vendors; 
whether and, if so, how information about verification performed on 
assets underlying or referenced by a security or money market 
instrument issued by an asset pool or as part of any asset-backed or 
mortgage-backed securities transaction is relied on in determining 
credit ratings; the quantitative and qualitative models and metrics 
used to determine credit ratings, including whether and, if so, how 
assessments of the quality of originators of assets underlying or 
referenced by a security or money market instrument issued by an asset 
pool or as part of any asset-backed or mortgage-backed securities 
transaction factor into the determination of credit ratings; the 
methodologies by which credit ratings of other credit rating agencies 
are treated to determine credit ratings for securities or money market 
instruments issued by an asset pool or as part of any asset-backed or 
mortgaged-backed securities transaction; the procedures for interacting 
with the management of a rated obligor or issuer of rated securities or 
money market instruments; the structure and voting process of 
committees that review or approve credit ratings; procedures for 
informing rated obligors or issuers of rated securities or money market 
instruments about credit rating decisions and for appeals of final or 
pending credit rating decisions; procedures for monitoring, reviewing, 
and updating credit ratings, including how frequently credit ratings 
are reviewed, whether different models or criteria are used for ratings 
surveillance than for determining initial ratings, 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; and procedures 
to withdraw, or suspend the maintenance of, a credit rating. An 
Applicant/NRSRO may provide in Exhibit 2 the location on its Web site 
where additional information about the procedures and methodologies is 
located.
* * * * *

    Dated: June 16, 2008.

    By the Commission.
Jill M. Peterson,
Assistant Secretary.
 [FR Doc. E8-13887 Filed 6-24-08; 8:45 am]

BILLING CODE 8010-01-P
