
[Federal Register Volume 77, Number 48 (Monday, March 12, 2012)]
[Notices]
[Pages 14580-14581]
From the Federal Register Online via the Government Printing Office [www.gpo.gov]
[FR Doc No: 2012-5830]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-66514]


Order Granting Temporary Exemption of Morningstar Credit Ratings, 
LLC From the Conflict of Interest Prohibition in Rule 17g-5(c)(1) of 
the Securities Exchange Act of 1934

March 5, 2012.

I. Introduction

    Rule 17g-5(c)(1) of the Securities Exchange Act of 1934 (``Exchange 
Act'') prohibits a nationally recognized statistical rating 
organization (``NRSRO'') from issuing or maintaining a credit rating 
solicited by a person that, in the most recently ended fiscal year, 
provided the NRSRO with net revenue equaling or exceeding 10% of the 
total net revenue of the NRSRO for the fiscal year. In adopting this 
rule, the Commission stated that such a person would be in a position 
to exercise substantial influence on the NRSRO, which in turn would 
make it difficult for the NRSRO to remain impartial.\1\
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    \1\ Release No. 34-55857 (June 5, 2007), 72 FR 33564, 33598 
(June 18, 2007).
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II. Application and Exemption Request of Morningstar Credit Ratings, 
LLC

    Morningstar Credit Ratings, LLC (``Morningstar''), formerly known 
as Realpoint LLC (``Realpoint''), is a credit rating agency registered 
with the Commission as an NRSRO under Section 15E of the Exchange Act 
for the classes of credit ratings described in clauses (i) through (v) 
of Section 3(a)(62)(B) of the Exchange Act. Morningstar traditionally 
has operated mainly under the ``subscriber-paid'' business model, in 
which the NRSRO derives its revenue from restricting access to its 
ratings to paid subscribers. After Morningstar acquired Realpoint in 
the spring of 2010, Morningstar began to expand the scope of its 
business and initiated an issuer-paid ratings service for initial 
ratings on commercial mortgage-backed securities. In connection with 
this expansion, Morningstar has requested a temporary and limited 
exemption from Rule 17g-5(c)(1) on the grounds that the restrictions 
imposed by Rule 17g-5(c)(1) would pose a substantial constraint on the 
firm's ability to compete effectively with large rating agencies 
offering comparable ratings services. Specifically, Morningstar argues 
that because the fees typically associated with issuer-paid engagements 
tend to be relatively high when compared to the fees associated with 
its existing subscriber-based business, in the early stages of its 
expansion the fees associated with a single issuer-paid engagement have 
exceeded ten percent of its total net revenue for the fiscal year. 
Accordingly, Morningstar has requested that the Commission grant it an 
exemption from Rule 17g-5(c)(1) for any revenues derived from non-
subscription based business during calendar years 2012 and 2013, which 
are the end of Morningstar's 2011 and 2012 fiscal years, respectively.

[[Page 14581]]

III. Discussion

    The Commission, when adopting Rule 17g-5(c)(1), noted that it 
intended to monitor how the prohibition operates in practice, 
particularly with respect to asset-backed securities, and whether 
exemptions may be appropriate.\2\ The Commission has previously granted 
three temporary exemptions from Rule 17g-5(c)(1), including one on June 
28, 2008 to Realpoint, as Morningstar was formerly known, in connection 
with its initial registration as an NRSRO (``Realpoint Exemptive 
Order'').\3\ The Commission noted several factors in granting that 
exemption, including the fact that the revenue in question was earned 
prior to the adoption of the rule, the likelihood of smaller firms such 
as Realpoint being more likely to be affected by the rule, Realpoint's 
expectation that the percentage of total revenue provided by the 
relevant client would decrease, and the increased competition in the 
asset-backed securities class that could result from Realpoint's 
registration. In granting the Realpoint Exemptive Order, the Commission 
also noted that an exemption would further the primary purpose of the 
Credit Rating Agency Reform Act of 2006 (``Rating Agency Act'') as set 
forth in the Report of the Senate Committee on Banking, Housing, and 
Urban Affairs accompanying the Rating Agency Act: 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''.\4\ Previously, on February 11, 2008, the Commission, 
citing the same factors it later set forth in the Realpoint Exemptive 
Order, issued a similar order granting LACE LLC (``LACE'') a temporary 
exemption from the requirements of Rule 17g-5(c)(1) in connection with 
LACE's registration as an NRSRO (``LACE Exemptive Order'').\5\ Most 
recently, the Commission issued an order granting Kroll Bond Rating 
Agency, Inc. (``Kroll''), formerly known as LACE, a temporary, limited 
and conditional exemption from Rule 17g-5(c)(1) allowing Kroll to enter 
the market for rating structured finance products (``Kroll Exemptive 
Order'').\6\ In this order, the Commission noted that an exemption is 
consistent with the Commission's goal of improving ratings quality for 
the protection of investors and in the public interest by fostering 
accountability, transparency, and competition in the credit rating 
industry.
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    \2\ Release No. 34-55857 (June 5, 2007), 72 FR 33564, 33598 
(June 18, 2007).
    \3\ Release No. 34-58001 (June 23, 2008), 73 FR 36362 (June 26, 
2008).
    \4\ See 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).
    \5\ Release No. 34-57301 (Feb. 11, 2008), 73 FR 8720 (Feb. 14, 
2008).
    \6\ Release No. 34-65339 (Sept. 14, 2011), 76 FR 58319 (Sept. 
20, 2011).
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    The Commission believes that a temporary, limited and conditional 
exemption allowing Morningstar to expand in the market for rating 
structured finance products on an issuer-paid basis is consistent with 
the Commission's goal of improving ratings quality for the protection 
of investors and in the public interest by fostering accountability, 
transparency, and competition in the credit rating industry. In order 
to maintain this exemption, Morningstar will be required to publicly 
disclose in Exhibit 6 to Form NRSRO, as applicable, that the firm 
received more than 10% of its net revenue in fiscal years 2011 and 2012 
from a client or clients that paid it to rate asset-backed securities. 
This disclosure is designed to alert users of credit ratings to the 
existence of this specific conflict and is consistent with exemptive 
relief the Commission has previously granted to Realpoint, LACE and 
Kroll. In addition to Morningstar's existing obligations as an NRSRO to 
maintain policies, procedures, and internal controls, by the terms of 
this order, Morningstar will also be required to maintain policies, 
procedures, and internal controls specifically designed to address the 
conflict created by exceeding the 10% threshold. Furthermore, the 
exemption would also require that revenue from a single client does not 
exceed 25% of Morningstar's total net revenue for either fiscal year 
2011 or 2012.
    Section 15E(p) of the Exchange Act, as added by Section 932(a)(8) 
of the Dodd-Frank Wall Street Reform and Consumer Protection Act, 
requires Commission staff to conduct an examination of each NRSRO at 
least annually. As part of this annual examination regimen for NRSROs, 
Commission staff will closely review Morningstar's activities with 
respect to managing this conflict and meeting the conditions set forth 
below and will consider whether to recommend that the Commission take 
additional action, including administrative or other action.
    The Commission therefore finds that a temporary, limited and 
conditional exemption allowing Morningstar to expand in the market for 
rating structured finance products on an issuer-paid basis is 
consistent with the Commission's goal, as established by the Rating 
Agency Act, of improving ratings quality by fostering accountability, 
transparency, and competition in the credit rating industry, and is 
necessary and appropriate in the public interest and is consistent with 
the protection of investors, subject to Morningstar's making public 
disclosure of the conflict created by exceeding the 10% threshold; its 
maintenance of policies, procedures and internal controls to address 
that conflict; and that revenue from a single client does not exceed 
25% of Morningstar's total net revenue for either the fiscal year 
ending December 31, 2011 or the fiscal year ending December 31, 2012.

IV. Conclusion

    Accordingly, pursuant to Section 36 of the Exchange Act,
    It is hereby ordered that Morningstar Credit Ratings, LLC, formerly 
known as Realpoint LLC, is exempt from the conflict of interest 
prohibition in Exchange Act Rule 17g-5(c)(1) until January 1, 2013, 
with respect to any revenue derived from issuer-paid ratings, provided 
that: (1) Morningstar Credit Ratings, LLC publicly discloses in Exhibit 
6 to Form NRSRO, as applicable, that the firm received more than 10% of 
its total net revenue in fiscal year 2011 or 2012 from a client or 
clients; (2) in addition to fulfilling its existing obligations as an 
NRSRO to maintain policies, procedures, and internal controls, 
Morningstar Credit Ratings, LLC also maintains policies, procedures, 
and internal controls specifically designed to address the conflict 
created by exceeding the 10% threshold; and (3) revenue from a single 
client does not exceed 25% of Morningstar's total net revenue for 
either the fiscal year ending December 31, 2011 or the fiscal year 
ending December 31, 2012.

    By the Commission.

Elizabeth M. Murphy,
Secretary.
[FR Doc. 2012-5830 Filed 3-9-12; 8:45 am]
BILLING CODE 8011-01-P


