Credit Rating Agencies

The Dodd-Frank Wall Street Reform and Consumer Protection Act creates an Office of Credit Ratings within the SEC, requires additional oversight of Nationally Recognized Statistical Ratings Organizations (NRSROs), creates new penalties and potential liabilities for credit rating agencies and NRSROs, attempts to reduce reliance on credit ratings, and requires the SEC to conduct numerous studies and prescribe a number of rules.

Additional Oversight of Credit Rating Agencies

Office of Credit Ratings. The Act creates an Office of Credit Ratings in the SEC to administer the SEC's rules, conduct annual exams of Nationally Recognized Statistical Ratings Organizations, and to have rulemaking authority.

Internal controls. NRSROs must create internal controls based on factors the SEC will prescribe by rule and submit annual reports on these controls.

Employee Transitions. The Act institutes a one year look-back on employee transitions where an employee of a company rated by a NRSRO was employed by a NRSRO in the prior year. Similarly, when certain employees of NRSROs move to a rated company, and the employee was associated with a NRSRO in the previous five years, the NRSRO must report this transition to the SEC.

Compliance Officers. Compliance officers at NRSROs will be required to provide annual reports and disclosure on compensation, conflicts of interest, and prohibited activities.

Transparency of Ratings Performance and Methodologies. NRSROs must disclose details on credit ratings to allow users of the ratings to better compare the performance of each NRSRO. In addition, the SEC will prescribe a form for the publication of each credit rating that discloses qualitative and quantitative content.

Rules on Credit Ratings Methodologies. The SEC will prescribe rules on procedures and methodologies for credit ratings.

Due Diligence Services for Asset-Backed Securities. Issuers and underwriters will make findings from third party due diligence reports publicly available, with a certification in a format to be prescribed by the SEC.

Boards of Directors of NRSROs. Each NRSRO must have a board of directors, at least 50 percent of whom must be independent, and the compensation of independent members cannot be linked to performance. The Act also creates additional duties for the boards of directors of NRSROs to monitor their internal controls.

Suspension and Revocation

The SEC may suspend or revoke a NRSRO's registration with regard to a class or subclass of securities if the NRSRO does not have adequate resources to consistently produce credit ratings with integrity. Similarly, the SEC can limit the activities of a person associated with a NRSRO who engaged in misconduct.

State of Mind in Private Actions

The enforcement and penalty provisions of Section 15E of the Securities and Exchange Act of 1934 now apply to statements by credit rating agencies in the same way they apply to statements made by accounting firms. In addition, a litigation complaint against a credit rating agency needs to state with particularity facts giving rise to a strong inference that the credit rating agency knowingly or recklessly failed to conduct a reasonable investigation or obtain reasonable verification of factual elements.

Rescission of Rule 436(g)

Under the Act, Rule 436(g) has no effect. As a result, NRSROs may be liable under Section 11 of the Exchange Act if they consent to be named as having prepared or certified any part of the registration statement or any report or valuation which is used in connection with the registration statement.

Referring Tips to Authorities

NRSROs shall inform the appropriate authorities of credible information from a third party that alleges an issuer of securities rated by the NRSRO has committed or is committing a material violation of law.

Qualification Standards for Credit Rating Analysts

Within one year from enactment, the SEC must prescribe rules to ensure that employees of NRSROs meet certain standards. Similarly, the Comptroller General must conduct a study on creating a professional organization for analysts that would establish independent standards for the profession, create a code of ethical conduct, and oversee the profession.

Removal of Statutory References to Credit Ratings

The Act replaces references to credit ratings with references to meeting standards of credit-worthiness as the SEC shall adopt in statutes such as the Federal Deposit Insurance Act, Federal Housing Enterprises Financial Safety and Soundness Act of 1992, Investment Company Act of 1940, and Securities Exchange Act of 1934.

Review Reliance on Ratings

Within one year of enactment, every federal agency must review its regulations that require the use of an assessment of credit-worthiness and then modify such regulations by removing references to credit-worthiness and substituting in standards that are appropriate for such regulations. Each agency will also provide a report to Congress summarizing any modifications to their regulations.

Elimination of Exemption from Regulation FD

Within 90 days of enactment, the SEC will revise Regulation FD to eliminate the exemption for entities who primarily issue credit ratings.

Assigned Credit Ratings for Structured Finance Products

The SEC must perform a study and, within two years of the Act's enactment, must establish a system for assigning NRSROs to determine the initial credit ratings of structured finance products that prevent the issuer, sponsor or underwriter from selecting the NRSRO.

Other Studies

The SEC must conduct a number of other studies on strengthening credit rating agency independence, standardizing credit rating terminology and other topics. The Comptroller General must conduct a study on alternative means for compensation of credit rating agencies.

Timing of Regulations

Unless otherwise provided, the SEC must issue final regulations within one year of the Act's enactment.

Conflicts of Interest

The SEC may use rulemaking authority under Section 15E of Exchange Act to prevent improper conflicts of interest.