under the proposal, is being eliminated.
    \494\ See paragraph (c)(1) of Rule 17g-8.
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    In the proposing release, the Commission asked whether the rule
should be more prescriptive in terms of how an NRSRO would be required
to determine whether to revise a credit rating by, for example,
requiring an NRSRO to apply a de novo review of the rated obligor,
security, or money market instrument using its rating procedures and
methodologies.\495\ Three NRSROs stated that the Commission should not
prescribe more requirements for how NRSROs must determine whether a
rating must be revised.\496\ Two of these NRSROs stated that doing so
may constitute regulating the substance of the credit ratings or the
procedures and methodologies by which an NRSRO determines credit
ratings in contravention of section 15E(c)(2) of the Exchange Act,\497\
and one of these NRSROs stated that the NRSRO ``should retain the
flexibility to conduct whatever analysis a particular situation calls
for.'' \498\ On the other hand, one commenter stated that the
Commission should be ``more prescriptive in this area'' and ``require
the NRSRO to apply de novo its procedures and methodologies'' to
determine whether a credit rating must be revised.\499\ Another
commenter stated that it is ``essential'' to require the NRSRO to
``conduct a de novo analysis of the credit rating using its
methodologies and procedures.'' \500\ In implementing section
15E(h)(4)(A)(i) of the Exchange Act through Rules 17g-8 and 17g-7, the
Commission has sought to strike an appropriate balance between adopting
a measure designed to address the employment conflict with the
prohibition in section 15E(c)(2) of the Exchange Act under which the
Commission may not regulate the substance of credit ratings or the
procedures and methodologies by which any NRSRO determines credit
ratings.\501\ To strike this balance, the Commission believes that the
rule should provide flexibility for the NRSRO to make this
determination by applying procedures and methodologies that it designs
to ensure that the credit rating is no longer influenced by the
conflict of interest. Such procedures and methodologies could but may
not necessarily require a de novo review of the rated obligor or
obligation.
---------------------------------------------------------------------------

    \495\ See Nationally Recognized Statistical Rating
Organizations, 76 FR at 33432.
    \496\ See DBRS Letter; Moody's Letter; S&P Letter.
    \497\ See Moody's Letter; S&P Letter.
    \498\ See DBRS Letter.
    \499\ See AFSCME Letter.
    \500\ See Better Markets Letter.
    \501\ See 15 U.S.C. 78o-7(c)(2).
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    Two NRSROs stated that a conflict of interest may impact a number
of other credit ratings, which would need to be revised and
published.\502\ Accordingly, one of these NRSROs suggested that the
words ``immediately'' and ``promptly'' in the proposed requirements be
replaced with ``as soon as practicable'' given that certain procedures
may have to be followed.\503\ The other NRSRO suggested that paragraph
(c)(2) of proposed Rule 17g-8 include a ``reasonableness standard'' for
the term ``promptly.'' \504\ A third NRSRO suggested that a
``reasonable amount of time'' be given to the NRSRO to ``investigate
the conflict and determine whether the rating must be revised.'' \505\
---------------------------------------------------------------------------

    \502\ See Moody's Letter; S&P Letter.
    \503\ See Moody's Letter.
    \504\ See S&P Letter.
    \505\ See Morningstar Letter.
---------------------------------------------------------------------------

    In response, the Commission believes it is important that the NRSRO
not delay completing the process that it will use to determine whether
the credit rating must be revised to ensure that it is solely a product
of the NRSRO's procedures and methodologies for determining credit
ratings (that is, not influenced by the conflict of interest). The
longer the determination takes the longer that investors and other
users of credit ratings will remain unaware of the important fact that
the credit rating was influenced by a conflict. Consequently, the final
rule retains the requirement that the NRSRO must ``promptly determine''
whether a credit rating must be revised.\506\ The Commission recognizes
that the amount of time necessary to complete the determination will
depend on facts and circumstances, including the number of credit
ratings impacted, the degree to which the conflict influenced the
credit ratings, and the complexity of the rating procedures and
methodologies used to determine the credit ratings.\507\ However, the
Commission expects that in each instance, the NRSRO will complete the
process promptly in order to satisfy the ``promptly determine''
requirement and that the process, in many cases, will be expedited by
the fact that much of the work to determine the impact, if any, and, if
necessary, revise the credit rating would already be accomplished at
the time an NRSRO determines that the credit rating was in

fact influenced by a conflict. In such cases, the Commission would
expect the revision or affirmation, as appropriate, to be issued
promptly after the existence of the conflict was determined. The
Commission notes that, as part of the annual examinations of each
NRSRO, Commission staff reviews the policies of the NRSRO governing the
post-employment activities of former staff of the NRSRO.
---------------------------------------------------------------------------

    \506\ See paragraph (c)(1) of Rule 17g-8.
    \507\ See Moody's Letter; Morningstar Letter; S&P Letter.
---------------------------------------------------------------------------

    The Commission is adopting the requirements in proposed paragraph
(c)(3) of Rule 17g-8 substantially as proposed, with technical
modifications, and is redesignating it as paragraph (c)(2)(i) of Rule
17g-8.\508\ As adopted, the final rule provides that the NRSRO must
promptly publish, based on the determination of whether a current
credit rating referred to in paragraph (c)(1) of Rule 17g-8 must be
revised: (1) A revised credit rating, if appropriate, and include with
the publication of the revised credit rating the information required
by paragraph (a)(1)(ii)(J)(3)(i) of Rule 17g-7; or (2) an affirmation
of the credit rating, if appropriate, and include with the publication
of the affirmation the information required by paragraph
(a)(1)(ii)(J)(3)(ii) of Rule 17g-7.\509\ As discussed below, the
Commission also is adopting the corresponding disclosure requirements
to accompany the publication of a revised credit rating and an
affirmation of a credit rating in paragraphs (a)(1)(ii)(J)(3)(i) and
(ii) of Rule 17g-7, respectively, with modifications in response to
comments.
---------------------------------------------------------------------------

    \508\ See paragraph (c)(2)(i) of Rule 17g-8. The final rule
modifies the proposal by re-designating paragraph (c)(3) as
paragraph (c)(2)(i) because, as discussed above, the requirement in
paragraph (c)(1) of Rule 17g-8, as proposed, is being eliminated. In
addition, the final rule modifies the proposal by revising the text
to specifically reference the credit rating ``in paragraph (c)(1)''.
    \509\ See paragraph (c)(2) of Rule 17g-8.
---------------------------------------------------------------------------

    One commenter stated that the NRSRO should publish a revised credit
rating or affirmation, as appropriate, ``as soon as practicable''
instead of ``promptly.'' \510\ As discussed above, paragraph (c)(1) of
Rule 17g-8, as adopted, requires the NRSRO to promptly determine
whether a credit rating discovered through a look-back review to have
been influenced by a conflict of interest must be revised so that it is
no longer influenced by the conflict and is solely a product of the
documented procedures and methodologies the NRSRO uses to determine
credit ratings. Having made the determination, paragraph (c)(2) of Rule
17g-8, as adopted, sets forth the next steps the NRSRO must take:
Promptly publish a revised credit rating or an affirmation of the
credit rating and provide users of the NRSRO's credit ratings
information about the reasons for taking either action. These steps are
an important component of the look-back review process. They are
designed to ensure that the NRSRO promptly addresses any impact the
conflict had on the credit rating and alerts the users of its credit
ratings about the existence of the conflict and its resolution. As
stated above, failing to act when a conflict has influenced a credit
rating creates the risk that investors and other users of credit
ratings will use a conflicted credit rating when making an investment
or other credit-related decision. Thus, paragraph (c)(2) of Rule 17g-8,
as adopted, retains the requirement that the NRSRO must act promptly.
---------------------------------------------------------------------------

    \510\ See Moody's Letter.
---------------------------------------------------------------------------

    Commenters addressed whether the NRSRO should be required to
publish a rating affirmation,\511\ including whether such a requirement
would constitute regulating the substance of credit ratings or the
procedures and methodologies by which an NRSRO determines credit
ratings in contravention of section 15E(c)(2) of the Exchange Act.\512\
The Commission does not expect (and the final rule does not require) an
NRSRO to revise a credit rating in every circumstance in which an
earlier rating action was influenced by a conflict of interest. Section
15E(h)(4)(A)(ii) of the Exchange Act provides that the NRSRO's policies
and procedures shall be reasonably designed to, among other things,
ensure that the NRSRO takes action to revise the credit rating ``if
appropriate.'' \513\ It is possible, for example, that in the period
since the NRSRO published the conflicted credit rating, events
unrelated to the conflict occurred that, when taken into account by the
NRSRO's procedures and methodologies for determining credit ratings,
would produce a credit rating at the same notch in the rating scale of
the NRSRO as the credit rating that was influenced by the
conflict.\514\ A requirement that the NRSRO nonetheless revise the
credit rating could interfere with the NRSRO's procedures and
methodologies for determining credit ratings in that it would force the
NRSRO to change the credit rating assigned to the obligor, security, or
money market instrument to a different notch in the rating scale than
would be the case if the credit rating were solely a product of the
NRSRO's procedures and methodologies. Consequently, a mandatory
revision requirement could, in effect, require the NRSRO to publish a
credit rating that was not consistent with those procedures and
methodologies. Accordingly, the final rule permits the NRSRO to publish
an affirmation of the credit rating as an alternative to revising the
credit rating, if appropriate. As discussed below, the Commission is
requiring that an NRSRO publish an affirmation if the credit rating is
not going to be revised because this will be the mechanism for
disclosing the fact that a conflict at one time influenced the credit
rating.
---------------------------------------------------------------------------

    \511\ See DBRS Letter; S&P Letter.
    \512\ See Moody's Letter. See also 15 U.S.C. 78o-7(c)(2).
    \513\ 15 U.S.C. 78o-7(h)(4)(A)(ii).
    \514\ For example, assume that nine months ago an analyst
upgraded the credit rating assigned to an issuer's securities from
the BBB to AA. The analyst leaves the NRSRO to work for the issuer.
The analyst's new employment triggers a look-back review of the
rating action upgrading the credit rating from BBB to AA pursuant to
section 15E(h)(4)(A)(i) of the Exchange Act. The look-back review
determines the credit rating should not have been upgraded from BBB
to AA at that point in time and the analyst's action in upgrading
the credit rating was influenced by the prospect of employment with
the issuer. The NRSRO performs a de novo review of the credit rating
assigned to the issuer by applying its procedures and methodologies
for determining credit ratings. This review--as required by the
procedures and methodologies--takes into consideration favorable
financial results the issuer reported three months ago.
Consequently, the process of re-rating the issuer's securities
determines that the current credit rating should remain AA.
---------------------------------------------------------------------------

    Commenters suggested that if the credit rating is not going to be
revised there should not be a requirement to publish an
affirmation.\515\ One commenter stated that such a requirement
constitutes regulating the substance of credit ratings or the
procedures and methodologies by which an NRSRO determines credit
ratings in contravention of section 15E(c)(2) of the Exchange Act.\516\
The Commission is not persuaded that the rule should require only the
publication of a revised credit rating. If the rule did not require
publication of an affirmation, the users of the NRSRO's credit ratings
would not learn of the existence of the conflict. One of the goals of
the registration and oversight program for NRSROs is to increase the
transparency of their activities so that users of credit ratings can
understand how they operate and can compare NRSROs. Disclosing the

existence of the conflict with the publication of the revised credit
rating or affirmation of the credit rating will provide users of the
NRSRO's credit ratings with information to assess the adequacy of the
NRSRO's policies, procedures, and controls designed to manage conflicts
of interest and, more generally, the integrity of the NRSRO's credit
rating process. Moreover, the required disclosures could be useful to
users of the NRSRO's credit ratings in considering the potential risk
of using the NRSRO's credit ratings to make investment or other credit-
based decisions. Furthermore, in light of the prohibition against
regulating the substance of credit ratings and rating procedures and
methodologies in section 15E(c)(2) of the Exchange Act, the final rule
has been carefully tailored to avoid interfering with the NRSRO's
analytical process.\517\ It is the NRSRO that will determine--using its
own procedures and methodologies--whether the credit rating should be
revised or affirmed. For these reasons, the Commission is adopting the
requirement to publish an affirmation of the credit rating if the
credit rating does not need to be revised.
---------------------------------------------------------------------------

    \515\ See, e.g., DBRS Letter (supporting the proposed
requirement that NRSROs ``promptly publish'' a revised rating, but
stating that an affirmation of a credit rating that was influenced
by a conflict of interest should be published ``only where the NRSRO
has determined . . . to place the existing rating on credit
watch''); S&P Letter (``we also support elimination of proposed Rule
17g-8(c)(3), to the extent that it would require NRSROs to publish
ratings affirmations or other actions following a CreditWatch action
required by proposed Rule 17g-8(c)(1).'').
    \516\ See Moody's Letter.
    \517\ See 15 U.S.C. 78o-7(c)(2).
---------------------------------------------------------------------------

    The Commission is adopting the disclosure requirements in proposed
paragraphs (a)(1)(ii)(J)(3)(ii) and (iii) of Rule 17g-7 with
modifications and is redesignating them as paragraphs
(a)(1)(ii)(J)(3)(i) and (ii).\518\ Commenters raised concerns about the
proposed requirement to disclose an estimate of the impact of the
conflict on each applicable prior credit rating.\519\ One commenter
stated that estimating the impact of a conflict on a credit rating may
``create inefficiencies.'' \520\ A second NRSRO stated that it may be
``unduly burdensome,'' delaying publication of a corrective
rating.\521\ A third NRSRO stated that it would be ``practically
impossible'' to estimate the impact of a conflict on a prior rating and
that the Commission should not require disclosure of the reasons for
revising or affirming a credit rating.\522\
---------------------------------------------------------------------------

    \518\ See paragraphs (a)(1)(ii)(J)(3)(i) and (ii) of Rule 17g-7.
Because the disclosure requirement with respect to placing a
conflicted credit rating on credit watch is being eliminated, the
final amendments modify the proposed rule text by re-designating
paragraph (a)(1)(ii)(J)(3)(ii) as paragraph (a)(1)(ii)(J)(3)(i), and
re-designating paragraph (a)(1)(ii)(J)(3)(iii) as paragraph
(a)(1)(ii)(J)(3)(ii). Further, because paragraph (c)(3) of Rule 17g-
8, as proposed, is being re-designated as paragraph (c)(2), the
final amendments modify the references in paragraphs
(a)(1)(ii)(J)(3)(ii) and (iii) of Rule 17g-7, as proposed, to refer
to paragraph (c)(2) of Rule 17g-8. The final amendments modify the
proposed rule text to make other minor changes to improve
readability.
    \519\ See DBRS Letter; Moody's Letter; S&P Letter.
    \520\ See S&P Letter.
    \521\ See DBRS Letter.
    \522\ See Moody's Letter.
---------------------------------------------------------------------------

    The Commission is persuaded by commenters that precisely
quantifying the impact of the conflict could be difficult and that a
more narrative disclosure would be appropriate. Consequently, the final
amendments to Rule 17g-7 require the NRSRO to provide a description of
the impact the conflict had on the prior rating action or actions.\523\
The Commission expects the description to be sufficient to provide
investors and users of credit ratings with insight into the nature of
the impact the conflict had on the credit rating. The Commission
recognizes that this may entail a degree of judgment on the part of the
NRSRO in terms of estimating the degree of the impact.
---------------------------------------------------------------------------

    \523\ See paragraphs (a)(1)(ii)(J)(3)(i) and (ii) of Rule 17g-7.
---------------------------------------------------------------------------

    In addition, the text of paragraph (a)(1)(ii)(J)(3)(iii) of Rule
17g-7, as proposed, has been modified to reflect that the requirement
to place the credit rating on watch and make a corresponding disclosure
has been eliminated.\524\ As proposed, this paragraph would govern the
disclosure to be made with an affirmation of the credit rating. The
disclosure requirement was intended to follow the initial disclosure
that would have been made when the credit rating was placed on watch.
The initial disclosure would have included an explanation that the
credit rating was placed on watch because of the discovery that the
credit rating was influenced by a conflict of interest. Because this
disclosure will not be required, the disclosure that accompanies an
affirmation of a credit rating will need to include an explanation that
the reason for the action is the discovery that a credit rating
assigned to the obligor, security, or money market instrument in one or
more prior rating actions was influenced by a conflict of
interest.\525\ This will provide context for why the NRSRO is issuing
the affirmation.\526\
---------------------------------------------------------------------------

    \524\ Id.
    \525\ Id.
    \526\ A similar modification is not necessary for the disclosure
that must accompany a revised credit rating because, as proposed,
that disclosure would have needed to include an explanation that the
reason for the action is the discovery that the credit rating was
influenced by a conflict of interest, thus providing the necessary
context. See Nationally Recognized Statistical Rating Organizations,
76 FR at 33541. The final amendments retain this disclosure
requirement. See paragraph (a)(1)(ii)(J)(3)(i) of Rule 17g-7.
---------------------------------------------------------------------------

    One commenter stated that the rule should require disclosure about
the nature of the conflict.\527\ In response, the Commission notes that
the rule requires the NRSRO to include with a revised credit rating an
explanation that the reason for the action is the discovery that a
credit rating assigned to the obligor, security, or money market
instrument in one or more prior rating actions was influenced by a
conflict of interest.\528\ Similarly, the rule requires an NRSRO to
include with an affirmation of a credit rating an explanation that the
credit rating was influenced by a conflict of interest.\529\ The
Commission agrees with the commenter that the disclosure should provide
some context for these explanations. Consequently, the Commission is
modifying the rule text from the proposal to provide that the
explanation of the conflict to be made with a revision of a credit
rating or an affirmation of a credit rating must include a description
of the nature of the conflict.\530\ For example, the description could
disclose that a former employee was unduly influenced by the prospect
of working for the issuer of the rated security and, as a consequence,
did not adhere to the NRSRO's rating methodology in order to make the
credit rating more favorable to the issuer.
---------------------------------------------------------------------------

    \527\ See Better Markets Letter.
    \528\ See paragraph (a)(1)(ii)(J)(3)(i) of Rule 17g-7.
    \529\ See paragraph (a)(1)(ii)(J)(3)(ii) of Rule 17g-7.
    \530\ See paragraphs (a)(1)(ii)(J)(3)(i) and (ii) of Rule 17g-7.
---------------------------------------------------------------------------

    Finally, two commenters stated that information regarding a credit
rating influenced by a conflict of interest should be provided to
former subscribers.\531\ As discussed above, the disclosures are
required to be made in the form to accompany a rating action under
paragraph (a) of Rule 17g-7, as amended.\532\ This form--as discussed
below in section II.G.1. of this release--must be published in the same
manner as the credit rating that is the result or subject of the rating
action and made available to the same persons who can receive or access
the credit rating that is the result or subject of the rating
action.\533\ This provision thereby accommodates both the issuer-pay
business model in which rating actions generally are made publicly
available and the subscriber-pay business model in which rating actions
generally are made available to current subscribers only.\534\
Consequently, if the NRSRO makes its rating actions available only to
current subscribers, former subscribers will not have access to the
form and the

disclosure it contains about the conflict of interest. In considering
the comments about disclosing the information to former subscribers,
the Commission balanced the interest in providing users of credit
ratings with information about a given NRSRO's credit ratings with the
interest in promulgating rules that accommodate and integrate with the
two predominant NRSRO business models. For example, since the final
amendments to Rule 17g-7 require the disclosure to be made in the same
manner as the disclosure of the credit rating that is the result or
subject of the rating action, a requirement that the disclosure must be
made to former subscribers (who normally would not have access to a
rating action that was published after their subscription expired)
would necessarily require a different process for the disclosure. For
example, the disclosure could be made through publication on the
NRSRO's Web site, but this method of disclosure may not be effective if
former subscribers no longer view the Web site. Alternatively, the
NRSRO could send the disclosure to former subscribers, but this could
be burdensome and present practical difficulties. Because former
subscribers are no longer using the NRSRO's credit ratings, the
Commission believes at this time that it is not necessary to add a
requirement that an NRSRO operating under the subscriber-pay model must
make this disclosure to former subscribers.
---------------------------------------------------------------------------

    \531\ See AFSCME Letter; DBRS Letter.
    \532\ See paragraph (a)(1)(ii)(J)(3) of Rule 17g-7.
    \533\ See paragraph (a) of Rule 17g-7.
    \534\ See 15 U.S.C 78c(a)(61) (defining a credit rating agency,
in pertinent part, as any person engaged in the business of issuing
credit ratings on the Internet or through another readily accessible
means, for free or a reasonable fee).
---------------------------------------------------------------------------

2. Amendment to Rule 17g-2
    The Commission proposed adding paragraph (a)(9) to Rule 17g-2 to
require NRSROs to make and retain a record documenting the policies and
procedures an NRSRO is required to establish, maintain, and enforce
pursuant to section 15E(h)(4)(A) of the Exchange Act and paragraph (c)
of proposed Rule 17g-8.\535\ As a result, the policies and procedures
would need to be documented and the record documenting them would be
subject to the record retention and production requirements in
paragraphs (c) through (f) of Rule 17g-2.\536\ One NRSRO stated that it
``supports the Commission's proposal to include look-back policies and
procedures as records that an NRSRO must retain under Rule 17g-
2(a)(9).'' \537\ The Commission is adding paragraph (a)(9) to Rule 17g-
2 as proposed.\538\ This will provide a means for the Commission to
monitor the NRSROs' compliance with section 15E(h)(4)(A) of the
Exchange Act and paragraph (c) of Rule 17g-8. The record must be
retained until three years after the date the record is replaced with
an updated record in accordance with the amendment to paragraph (c) of
Rule 17g-2 discussed above in section II.A.2. of this release.\539\
---------------------------------------------------------------------------

    \535\ See section 17(a)(1) of the Exchange Act, which 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. 15 U.S.C.
78q(a)(1).
    \536\ See 17 CFR 240.17g-2(c) through (f).
    \537\ See DBRS Letter.
    \538\ See paragraph (a)(9) of Rule 17g-2.
    \539\ See paragraphs (a)(9) and (c) of Rule 17g-2.
---------------------------------------------------------------------------

3. Economic Analysis
    This section builds on the economic analysis in section I.B. of
this release by presenting a focused analysis of the potential economic
effects that may derive from the amendments and new rule with respect
to look-back reviews.\540\ The baseline that existed before today's
amendments and new rule was one in which section 15E(h)(4)(A)(i) of the
Exchange Act, added by the Dodd-Frank Act, required NRSROs to
establish, maintain, and enforce policies and procedures reasonably
designed to ensure that the NRSRO conducts look-back reviews in any
case in which an employee of a person subject to a credit rating of the
NRSRO or the issuer, underwriter, or sponsor of a security or money
market instrument subject to a credit rating of the NRSRO, was employed
by the NRSRO and participated in any capacity in determining credit
ratings for the person or the securities or money market instruments
during the one-year period preceding the date an action was taken with
respect to the credit rating.\541\ The Commission staff found during
its 2013 examinations of NRSROs that all NRSROs had established written
policies and procedures to address the look-back requirement.\542\
However, the staff found that two larger and six smaller NRSROs did not
consistently, in the staff's view, conduct adequate look-back searches
or did not have adequate policies governing the searches.\543\
---------------------------------------------------------------------------

    \540\ The economic analysis in section I.B. of this release
discusses the primary economic impacts that may derive from the
amendments and new rules being adopted today.
    \541\ See 15 U.S.C. 78o-7(h)(4)(A)(i).
    \542\ See 2013 Annual Staff Inspection Report, p. 22. The 2013
examinations generally focused on NRSRO activities for the period
October 1, 2011 through December 31, 2012.
    \543\ See 2013 Annual Staff Inspection Report, pp. 22-23.
---------------------------------------------------------------------------

    Section 15E(h)(4)(A)(ii) provides that an NRSRO must establish,
maintain, and enforce policies and procedures reasonably designed to
ensure that the NRSRO will take action to revise the credit rating if
appropriate, in accordance with such rules as the Commission shall
prescribe.\544\ Before today's amendments and new rule, if the NRSRO
found, after conducting the look-back review, that the credit rating
was influenced by a conflict, the NRSRO would have needed to ensure
that the credit rating was determined in accordance with the procedures
and methodologies the NRSRO uses to determine credit ratings. However,
the NRSRO was not required to ``promptly'' determine whether the
current credit rating must be revised or ``promptly'' publish a revised
credit rating or an affirmation of the credit rating, as appropriate.
Further, there was no requirement that the NRSRO disclose information
about the existence of the conflict with the publication of a revised
credit rating, affirmation of the existing credit rating, or placement
of the credit rating on watch or review if the credit rating is not
revised or affirmed within fifteen calendar days of the discovery that
the credit rating was influenced by a conflict. Finally, an NRSRO was
not required to make and retain a record documenting the policies and
procedures required under section 15E(h)(4)(A).
---------------------------------------------------------------------------

    \544\ See 15 U.S.C. 78o-7(h)(4)(A)(ii).
---------------------------------------------------------------------------

    The baseline that existed before today's amendments and new rule
was one in which, pursuant to paragraph (c)(4) of Rule 17g-5, an NRSRO
is prohibited from issuing or maintaining a credit rating where a
credit analyst who participated in determining the credit rating is an
officer or director of the person that is subject to the credit
rating.\545\ Also, section 15E(h)(1) of the Exchange Act and Rule 17g-5
require NRSROs to establish, maintain, and enforce written policies and
procedures reasonably designed to address and manage any conflicts of
interest that can arise from the business of the NRSRO.\546\
---------------------------------------------------------------------------

    \545\ See 17 CFR 240.17g-5(c)(4).
    \546\ See 15 U.S.C. 78o-7(h)(1).
---------------------------------------------------------------------------

    In addition, section 15E(h)(5)(A) of the Exchange Act requires
NRSROs to report to the Commission any case in which a person
associated with the NRSRO within the previous five years obtains
employment with a rated entity or the issuer, underwriter, or sponsor
of a rated instrument for which the NRSRO issued a credit rating during
the twelve-month period prior to the employment if the employee was a
senior officer of the NRSRO or participated, or supervised an employee
that participated, in determining credit

ratings for the new employer.\547\ Section 15E(h)(5)(B) requires that
the Commission make the reports publicly available.\548\ The Commission
received 244 of these reports between January 24, 2006 and December 31,
2013.\549\ One academic study examined these transition reports for
three NRSROs (Fitch, Moody's, and S&P), which submitted 167 of these
reports during that period.\550\ The study suggests that the credit
ratings assigned to the future employer by the NRSRO employing the
transitioning employee were more likely to be upgraded and less likely
to be downgraded than the ratings assigned to that future employer by
other NRSROs in the year prior to the transition.\551\
---------------------------------------------------------------------------

    \547\ See 15 U.S.C. 78o-7(h)(5)(A).
    \548\ See 15 U.S.C. 78o-7(h)(5)(B).
    \549\ The reports are available at http://www.sec.gov/divisions/
marketreg/nrsroetr.htm.
    \550\ See Jess Cornaggia, Kimberly J. Cornaggia, and Han Xia,
Revolving Doors on Wall Street (2014), available at http://
papers.ssrn.com/sol3/papers.cfm?abstractid=2150998.
    \551\ These authors state that ``the difference between the
ratings awarded by transitioning analysts and their benchmarks
changes by an average of 0.23 notches during the last five quarters
leading up to a transition.'' Id.
---------------------------------------------------------------------------

    Relative to this baseline, the amendments and new rule should
result in benefits. They are designed to require the NRSRO to evaluate
whether a credit rating has been influenced by a conflict of interest
and, if so, promptly address the conflicted credit rating. This could
limit the potential risk that users of credit ratings might make
investment or other credit-based decisions using incomplete, biased, or
inaccurate information. As stated above, the disclosures also will
increase transparency and provide users of NRSRO credit ratings with
information to assess an NRSRO's ability to address conflicts and to
compare NRSROs with respect to their ability to manage the conflicts.
Further, the amendments and new rule--because they are designed to
integrate with an NRSRO's existing policies and procedures for taking
rating actions--could mitigate potential inefficiencies associated with
the requirements. For example, the amendments and new rule are designed
to work within the existing framework of an NRSRO's policies and
procedures for taking rating actions but not to regulate the substance
of the credit rating or the procedures and methodologies for
determining credit ratings.
    The records NRSROs must make and keep under the amendment to Rule
17g-2 will be used by Commission examiners to assess whether a given
NRSRO's policies and procedures are reasonably designed and whether it
appears that the NRSRO is complying with them. Recordkeeping
requirements are integral to the Commission's investor protection
function because the preserved records are the primary means of
monitoring compliance with applicable securities laws.\552\ Compliance
by an NRSRO with its policies and procedures for look-back reviews and
the oversight exercised by the Commission may benefit users of credit
ratings by mitigating conflicts of interest, which may increase the
integrity and quality of credit ratings.
---------------------------------------------------------------------------

    \552\ See Oversight of Credit Rating Agencies Registered as
Nationally Recognized Statistical Rating Organizations, 72 FR at
33582.
---------------------------------------------------------------------------

    Relative to the baseline, the amendments and new rule relating to
look-back reviews will result in costs for NRSROs. NRSROs will need to
expend resources to establish, make a record of, enforce, and
periodically review and update (if necessary) the procedures they
establish pursuant to section 15E(h)(4)(A) of the Exchange Act to
ensure they comply with paragraph (c) of Rule 17g-8. They also will
need to develop and periodically modify processes and systems for
ensuring that, if the look-back review determines that a conflict of
interest influenced the credit rating, a revised credit rating or an
affirmation of the credit rating is promptly published (as appropriate)
along with the corresponding disclosures required under paragraph
(a)(1)(ii)(J)(3) of Rule 17g-7, or that the credit rating is placed on
watch or review if the credit rating is not revised or affirmed within
fifteen calendar days of the discovery that the credit rating was
influenced by a conflict of interest. Based on analysis for purposes of
the PRA, the Commission estimates that paragraph (c) of Rule 17g-8 will
result in total industry-wide one-time costs to NRSROs of approximately
$295,000 and total industry-wide annual costs to NRSROs of
approximately $71,000.\553\
---------------------------------------------------------------------------

    \553\ See section V.C. of this release (discussing
implementation and annual compliance considerations). These costs
are derived by monetizing internal hour burdens identified in the
PRA analysis in section IV.D.7. of this release. The one-time and
annual costs are determined by monetizing internal hour burdens and
adding external costs identified in the PRA analysis in section
IV.D.7. of this release.
---------------------------------------------------------------------------

    Relative to the baseline, the amendments to Rule 17g-2 prescribing
retention requirements for the documentation of the policies and
procedures will result in costs to NRSROs. NRSROs already have
recordkeeping systems in place to comply with the recordkeeping
requirements in Rule 17g-2 before today's amendments. Therefore, the
recordkeeping costs of this rule will be incremental to the costs
associated with these existing requirements. Specifically, the
incremental costs will consist largely of updating their record
retention policies and procedures and retaining and producing the
additional record. Based on analysis for purposes of the PRA, the
Commission estimates that paragraph (a)(9) of Rule 17g-2 and the
amendment to paragraph (c) of Rule 17g-2 will result in total industry-
wide one-time costs to NRSROs of approximately $12,000 and total
industry-wide annual costs to NRSROs of approximately $3,000.\554\
---------------------------------------------------------------------------

    \554\ See section V.C. of this release (discussing
implementation and annual compliance considerations). The one-time
and annual costs are determined by monetizing internal hour burdens
and adding external costs identified in the PRA analysis in section
IV.D.3. of this release.
---------------------------------------------------------------------------

    The amendments and new rule by increasing the scrutiny of the work
of former analysts could potentially decrease the quality of credit
ratings in circumstances where the subjective judgment of participants
in the rating process can improve the quality of ratings. In
particular, an NRSRO may establish credit rating methodologies that
diminish the ability of analysts to exercise subjective judgment in
order to minimize the chance that in exercising judgment an analyst may
be influenced by this conflict, which, in turn, will trigger the
requirements in the amendments and new rule, including the requirement
to disclose the existence of the conflict. If the ability to apply
subjective analysis is diminished, the credit ratings issued by an
NRSRO may not benefit fully from the expertise of the analysts.
    The amendments and new rule should have a number of effects related
to efficiency, competition, and capital formation.\555\ First, they
could improve the quality of credit-related information. As a result,
users of credit ratings may make more efficient investment decisions
based on this higher-quality information. Market efficiency also could
improve if this information is reflected in asset prices. Consequently,
capital formation could improve as capital may flow to more efficient
uses with the benefit of this enhanced information. Alternatively, the
quality of credit ratings may decrease in certain circumstances if an
NRSRO establishes credit rating methodologies that diminish the ability
of participants in the rating process to exercise subjective judgment.
In this case, the efficiency of investment decisions, market
efficiency,

and capital formation may also be adversely impacted if lower quality
information is reflected in asset prices, which may impede the flow of
capital to efficient uses. These amendments also will result in costs,
some of which may have a component that is fixed in magnitude across
NRSROs and does not vary with the size of the NRSRO. Therefore, the
operating costs per rating of smaller NRSROs may increase relative to
that of larger NRSROs, which could create adverse effects on
competition. As a result of these amendments, the barriers to entry for
credit rating agencies to register as NRSROs might be higher for credit
rating agencies, while some NRSROs, particularly smaller firms, may
decide to withdraw from registration as an NRSRO.
---------------------------------------------------------------------------

    \555\ See section I.B.3. of this release (providing a broader
discussion of the potential impacts of the amendments and new rules
on efficiency, competition, and capital formation).
---------------------------------------------------------------------------

    There are a number of reasonable alternatives to the amendments and
new rule, as adopted. First, the Commission could require that NRSROs
immediately place on credit watch or review credit ratings that are
determined by a look-back review to have been influenced by a conflict
of interest (as was proposed). This alternative might further benefit
users of credit ratings by alerting them sooner of conflicted credit
ratings, limiting the potential risk that investors and users of credit
ratings might make credit-based decisions using incomplete, biased, or
inaccurate information, and thereby reduce the risk of mispricing due
to the use of such incomplete, biased, or inaccurate information. It
also might increase the incentives of NRSROs to develop and adhere to
rating policies and procedures that further decrease the chance that
conflicts of interest may influence credit ratings. The quality of
credit ratings could increase as a result. This alternative also might
decrease the quality of credit ratings in certain circumstances if it
causes NRSROs to further reduce the use of subjective judgment in
rating methodologies relative to the amendments and new rule. This
alternative might also result in additional costs for NRSROs and users
of credit ratings. First, the NRSRO would need to expend resources to
develop, modify, and enforce policies and procedures ensuring that it
immediately places such conflicted ratings on credit watch or review in
addition to documenting and retaining these policies and procedures
pursuant to the amendments to Rule 17g-2. Second, if a look-back review
determined that a conflict influenced a credit rating, the NRSRO would
need to expend resources to place the credit rating on watch or review.
In addition, a number of academic studies indicate that both stock and
bond prices of an issuer react adversely when credit ratings are placed
on negative credit watch.\556\ Therefore, this alternative might also
create mispricing and confusion in the market. In particular, a
placement of a credit rating on credit watch creates uncertainty in the
credit rating that is resolved when the credit rating is either revised
or affirmed. As a result of unfamiliarity, users of credit ratings
might not react rationally in the short term to the uncertainty
introduced by placements of credit ratings on credit watch resulting
from look-back reviews. Consequently, this alternative might result in
costs for issuers and on market participants who may make non-optimal
investment decisions as a result of mispricing and confusion. Several
comment letters discussed these potential adverse consequences.\557\
However, these costs could arise if the NRSRO is required to place the
credit rating on credit watch or review because it does not revise or
affirm the credit rating within fifteen calendar days of the discovery
of the conflict.
---------------------------------------------------------------------------

    \556\ See Kee H. Chung, Carol Ann Frost, and Myungsun Kim,
Characteristics and Information Value of Credit Watches, Financial
Management 119-158 (2012); Sugato Chakravarty, Chiraphol N.
Chiyachantana, & Yen Teik Lee, On the Informativeness of Credit
Watch Placements (2009), available at http://papers.ssrn.com/sol3/
papers.cfm?abstractid=1252542; Christina E. Bannier and
Christian W. Hirsch, The Economic Function of Credit Rating
Agencies--What Does the Watchlist Tell Us?, J. of Banking and
Finance 3037-3049 (2010); John R.M. Hand, Robert W. Holthausen,
Richard W. Leftwich, The Effect of Bond Rating Agency Announcements
on Bond and Stock Prices, J. of Finance 733-752 (1992); Robert W.
Holthausen and Richard W. Leftwich, The Effect of Bond Rating
Changes on Common Stock Prices, J. of Fin. Economics 57-89 (1986).
    \557\ See A.M. Best Letter; DBRS Letter; FSR Letter; Morningstar
Letter; S&P Letter.
---------------------------------------------------------------------------

    Other alternatives include those that would apply standards other
than acting ``promptly'' with respect to the required timing of review
and rating actions after a rating is determined to have been conflicted
in a look-back review. For example, an NRSRO could be required to take
these actions ``as soon as practicable'' rather than ``promptly,'' as
suggested by one commenter.\558\ However, the Commission believes it is
important that the NRSRO not delay completing the process that it will
use to determine whether the credit rating must be revised to ensure
that it is solely a product of the NRSRO's procedures and methodologies
for determining credit ratings and to publish a revised credit rating
or an affirmation of the credit rating with the required disclosure of
information about the existence of the conflict. The longer the NRSRO
takes to complete these steps the greater the risk that investors and
other users of credit ratings will rely on a conflicted credit rating
when making an investment or credit-related decision. Consequently, the
final amendment retains the requirement that the NRSRO must ``promptly
determine'' whether a credit rating must be revised. At the same time,
the Commission recognizes that the amount of time necessary to complete
the determination will depend on the facts and circumstances, including
the number of credit ratings impacted, the degree to which the conflict
influenced the credit ratings, and the complexity of the rating
methodologies used to determine the credit ratings.\559\
---------------------------------------------------------------------------

    \558\ See Moody's Letter.
    \559\ See Moody's Letter; Morningstar Letter; S&P Letter.
---------------------------------------------------------------------------

    There are a number of other alternatives that would impose
additional requirements for addressing a credit rating that is found
through a look-back review to be influenced by a conflict of interest.
One alternative suggested by commenters would be to require a de novo
review of a credit rating that was determined through a look-back
review to have been influenced by a conflict of interest.\560\ This
alternative could produce higher-quality credit ratings because a de
novo review may provide a higher level of assurance that the credit
rating is no longer influenced by the conflict as the entire rating
process would be undertaken (this time without the conflicted analyst
participating). In other words, de novo reviews may be more likely to
result in credit ratings that are in accordance with the NRSRO's
procedures and methodologies for determining credit ratings.
---------------------------------------------------------------------------

    \560\ See AFSCME Letter; Better Markets Letter.
---------------------------------------------------------------------------

    On the other hand, this alternative might impose further costs as
NRSROs may be able to conduct a sufficient review without taking all
the steps necessary to perform a de novo review (for example, some of
the prior work could have been undertaken by a credit analyst that was
not influenced by the conflict). Requiring a de novo review also may
implicate the prohibition in section 15E(c)(2) of the Exchange Act
under which the Commission may not regulate the substance of credit
ratings or the procedures and methodologies by which any NRSRO
determines credit ratings.\561\ Further, this alternative might
decrease the quality of credit ratings in certain circumstances if it
caused NRSROs to eliminate or reduce the use of subjective judgment in
rating procedures or methodologies as

discussed earlier. In addition, the amendments and new rule provide
flexibility for the NRSRO to make this determination by applying
procedures and methodologies that it designs to ensure that the credit
rating is no longer influenced by the conflict of interest, which could
include procedures and methodologies that require a de novo review of
the rated obligor or obligation in all or certain cases.
---------------------------------------------------------------------------

    \561\ See 15 U.S.C. 78o-7(c)(2).
---------------------------------------------------------------------------

    Commenters also proposed alternatives which would make the
amendments and new rule less restrictive. One alternative suggested by
commenters would be to not require publication of an affirmation after
a credit rating has been determined to have been conflicted in a look-
back review if, for example, in the period since the NRSRO published
the credit rating, events unrelated to the conflict occurred that, when
taken into account by the NRSRO's procedures and methodologies for
determining credit ratings, would produce a credit rating at the same
notch in the rating scale as the credit rating that was influenced by
the conflict.\562\ This alternative could benefit NRSROs by reducing
the potential costs associated with publishing affirmations such as the
cost of composing text to appear in the NRSRO's publications and press
releases. This alternative also might increase the quality of credit
ratings in certain circumstances if not having to disclose the
existence of the conflict caused NRSROs to allow greater use of
subjective judgment in rating methodologies as discussed earlier.
---------------------------------------------------------------------------

    \562\ See DBRS Letter; S&P Letter.
---------------------------------------------------------------------------

    However, as discussed above, if the rule did not require
publication of an affirmation, it would result in costs as users of the
NRSRO's credit ratings would not learn of the existence of the
conflict. Disclosing the existence of the conflict with the publication
of the revised credit rating or affirmation of the credit rating will
provide users of the NRSRO's credit ratings with information to assess
the adequacy of the NRSRO's policies, procedures, and controls designed
to manage conflicts of interest and, more generally, the integrity of
the NRSRO's credit rating process. Moreover, the required disclosures
could be useful to users of the NRSRO's credit ratings in considering
the potential risk of using the NRSRO's credit ratings to make
investment or other credit-based decisions in comparison to other
NRSROs.

D. Fines and Other Penalties

1. Final Rule
    Section 932(a)(8) of the Dodd-Frank Act amended section 15E of the
Exchange Act to add subsection (p), which contains four paragraphs:
(1), (2), (3), and (4).\563\ Section 15E(p)(4)(A) provides that the
Commission shall establish, by rule, fines and other penalties
applicable to any NRSRO that violates the requirements of section 15E
of the Exchange Act and the rules under the Exchange Act.\564\
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    \563\ See Public Law 111-203, 932(a)(8); 15 U.S.C. 78o-7(p)(1)
through (4).
    \564\ See 15 U.S.C. 78o-7(p)(4)(A).
---------------------------------------------------------------------------

    The Exchange Act already provides a wide range of fines, penalties,
and other sanctions applicable to NRSROs for violations of any section
of the Exchange Act (including section 15E) and the rules under the
Exchange Act (including the rules under section 15E).\565\ For example,
section 15E(d)(1) of the Exchange Act provides that the Commission
shall censure an NRSRO, place limitations on the activities, functions,
or operations of an NRSRO, suspend an NRSRO for a period not exceeding
twelve months, or revoke the registration of an NRSRO if, among other
reasons, the NRSRO violates section 15E of the Exchange Act or the
Commission's rules under the Exchange Act.\566\ In addition, section
932(a)(3) of the Dodd-Frank Act amended section 15E(d) to explicitly
provide additional potential sanctions.\567\ First, it provided the
Commission with the authority to seek sanctions against persons
associated with, or seeking to become associated with, an NRSRO.\568\
The Commission can censure such persons, place limitations on the
activities or functions of such persons, suspend such persons for a
period not exceeding one year, or bar such persons from being
associated with an NRSRO.\569\ Second, section 932(a)(3) of Dodd-Frank
Act amended section 15E(d) to provide the Commission with explicit
authority to temporarily suspend or permanently revoke the registration
of an NRSRO in a particular class or subclass of credit ratings if the
NRSRO does not have adequate financial and managerial resources to
consistently produce credit ratings with integrity.\570\ Furthermore,
sections 21, 21A, 21B, 21C, and 32 of the Exchange Act provide
additional sanctions if an NRSRO violates the Exchange Act, including
the self-executing provisions in section 15E of the Exchange Act, or
rules under the Exchange Act.\571\
---------------------------------------------------------------------------

    \565\ See 15 U.S.C. 78o-7(d); 15 U.S.C. 78u; 15 U.S.C. 78u; 15
U.S.C. 78u-2; 15 U.S.C. 78u-3; 15 U.S.C. 78ff.
    \566\ See section 15E(d)(1)(A) through (F) of the Exchange Act
(15 U.S.C. 78o-7(d)(1)(A) through (F)), as amended by the Dodd-Frank
Act.
    \567\ See Public Law 111-203, 932(a)(3); 15 U.S.C. 78o-7(d).
    \568\ 15 U.S.C. 78o-7(d)(1).
    \569\ Id.
    \570\ See Public Law 111-203, 932(a)(3); 15 U.S.C. 78o-7(d)(2).
Prior to this amendment, the Commission had the authority to suspend
or revoke the registration of an NRSRO if it failed to maintain
adequate financial and managerial resources to consistently produce
credit ratings with integrity. See section 15E(d)(5) of the Exchange
Act (15 U.S.C 78o-7(d)(5)) before being amended by the Dodd-Frank
Act, which re-designated paragraph (d)(5) of section 15E as
paragraph (d)(1)(E) (15 U.S.C 78o-7(d)(1)(E)). Section 15E(d)(2) of
the Exchange Act, however, provides explicit authority to target a
suspension or registration revocation to a specific class or
subclass of security. See 15 U.S.C. 78o-7(d)(2).
    \571\ See 15 U.S.C. 78o-7; 15 U.S.C. 78u; 15 U.S.C. 78u-1; 15
U.S.C. 78u-2; 15 U.S.C. 78u-3; 15 U.S.C. 78ff. In fact, the Dodd-
Frank Act amended section 21B of the Exchange Act (15 U.S.C. 78u-2)
to provide the Commission with the authority to assess money
penalties in cease-and-desist proceedings under section 21C (15
U.S.C. 78u-3). See section 929P(a)(2) of the Dodd-Frank Act.
---------------------------------------------------------------------------

    In the proposing release, the Commission stated its preliminarily
belief that these provisions of the Exchange Act, as amended by the
Dodd-Frank Act, provide a sufficiently broad range of means to impose
fines, penalties, and other sanctions on an NRSRO for violations of
section 15E of the Exchange Act and the rules under the Exchange
Act.\572\ For example, the fines, penalties, and sanctions applicable
to NRSROs are similar in scope to the fines, penalties, and sanctions
applicable to other registrants under the Exchange Act, such as broker-
dealers. Moreover, since enactment of the Rating Agency Act of 2006,
the Commission has not identified a specific need for a fine or penalty
applicable to NRSROs not otherwise provided for in the Exchange Act.
Consequently, in the proposing release, the Commission stated its
preliminary belief that it would be appropriate at that time to defer
establishing new fines or penalties in addition to those provided for
in the Exchange Act.\573\ However, the Commission stated that, in the
future, it may use the authority in section 15E(p)(4)(A) of the
Exchange Act if a specific need to do so is identified.\574\
---------------------------------------------------------------------------

    \572\ See Nationally Recognized Statistical Rating
Organizations, 76 FR at 33433.
    \573\ Id.
    \574\ Id.
---------------------------------------------------------------------------

    For the foregoing reasons, to implement section 15E(p)(4)(A) of the
Exchange Act, the Commission proposed to amend the instructions to Form
NRSRO by adding Instruction

A.10.\575\ This instruction would provide notice to credit rating
agencies applying for registration as an NRSRO and to NRSROs that an
NRSRO is subject to applicable fines, penalties, and other available
sanctions set forth in sections 15E, 21, 21A, 21B, 21C, and 32 of the
Exchange Act (15 U.S.C. 78o-7, 78u, 78u-1, 78u-2, 78u-3, and 78ff,
respectively) for violations of the securities laws.\576\
---------------------------------------------------------------------------

    \575\ Id. at 33552.
    \576\ See Nationally Recognized Statistical Rating
Organizations, 76 FR at 33552.
---------------------------------------------------------------------------

    Several comment letters addressed the proposal.\577\ Most
commenters generally supported the Commission's proposal to defer
establishing new fines or penalties in addition to those currently
provided for in the Exchange Act,\578\ with one commenter specifically
noting that it supports the Commission's proposal to add the new
instruction to Form NRSRO.\579\ Commenters stated that the fines,
penalties, and other sanctions currently applicable to NRSROs under the
Exchange Act are ``sufficient,'' \580\ and that no other additional
fines or penalties are necessary or warranted.\581\ However, one
commenter suggested that, while other sections of the Exchange Act
provide for appropriate penalties and sanctions, it is not appropriate
to consider suspension or revocation of an NRSRO's registration under
section 21C of the Exchange Act.\582\
---------------------------------------------------------------------------

    \577\ See A.M. Best Letter; DBRS Letter; Morningstar Letter; S&P
Letter.
    \578\ See A.M. Best Letter; DBRS Letter; Morningstar Letter; S&P
Letter.
    \579\ See DBRS Letter.
    \580\ See Morningstar Letter.
    \581\ See A.M. Best Letter; DBRS Letter; Morningstar Letter; S&P
Letter.
    \582\ See A.M. Best Letter. As discussed above in section
II.B.3. of this release, the Commission has modified the final
amendments relating to suspending or revoking an NRSRO's
registration from the proposal so that it no longer incorporates
section 21C of the Exchange Act.
---------------------------------------------------------------------------

    The Commission is adopting Instruction A.10 to Form NRSRO \583\ as
proposed. As stated above, certain commenters agreed that the fines,
penalties, and other sanctions currently applicable to NRSROs under the
Exchange Act are sufficient and that additional fines, penalties, or
other sanctions are not necessary or appropriate. Consequently,
commenters supported the Commission's proposal to add Instruction A.10
to Form NRSRO. While the Commission is adopting Instruction A.10 to
Form NRSRO, it is deferring establishing new fines or penalties in
addition to those provided for in the Exchange Act. The Commission may
choose to use the authority to establish new fines or penalties in the
future.\584\
---------------------------------------------------------------------------

    \583\ See Nationally Recognized Statistical Rating
Organizations, 76 FR at 33552.
    \584\ One commenter recommended the Commission re-propose the
rules and, in doing so, invoke its authority under section 15E(p)(4)
of the Exchange Act to seek fines and the disgorgement of profits
when an NRSRO persistently ``issues non-standardized'' credit
ratings. See CFA II Letter.
---------------------------------------------------------------------------

2. Economic Analysis
    The final amendments should not create any costs for NRSROs and may
provide some benefits. It could benefit credit rating agencies applying
for registration as NRSROs and NRSROs because it should notify them of
the potential consequences of violating provisions of the Exchange Act
and Commission rules.

E. Disclosure of Information About the Performance of Credit Ratings

    Section 932(a)(8) of the Dodd-Frank Act added subsection (q) to
section 15E of the Exchange Act.\585\ Section 15E(q)(1) provides that
the Commission shall, by rule, require NRSROs to publicly disclose
information on the initial credit ratings determined by the NRSRO for
each type of obligor, security, and money market instrument, and any
subsequent changes to such credit ratings, for the purpose of allowing
users of credit ratings to evaluate the accuracy of credit ratings and
compare the performance of credit ratings by different NRSROs.\586\
Section 15E(q)(2) provides that the Commission's rules shall require,
at a minimum, disclosures that:
---------------------------------------------------------------------------

    \585\ See Public Law 111-203, 932(a)(8); 15 U.S.C. 78o-7(q).
    \586\ See 15 U.S.C. 78o-7(q)(1).
---------------------------------------------------------------------------

     are comparable among NRSROs, to allow users of credit
ratings to compare the performance of credit ratings across NRSROs;
\587\
---------------------------------------------------------------------------

    \587\ See 15 U.S.C. 78o-7(q)(2)(A).
---------------------------------------------------------------------------

     are clear and informative for investors having a wide
range of sophistication who use or might use credit ratings; \588\
---------------------------------------------------------------------------

    \588\ See 15 U.S.C. 78o-7(q)(2)(B).
---------------------------------------------------------------------------

     include performance information over a range of years and
for a variety of types of credit ratings, including for credit ratings
withdrawn by the NRSRO; \589\
---------------------------------------------------------------------------

    \589\ See 15 U.S.C. 78o-7(q)(2)(C).
---------------------------------------------------------------------------

     are published and made freely available by the NRSRO, on
an easily accessible portion of its Web site, and in writing, when
requested; \590\
---------------------------------------------------------------------------

    \590\ See 15 U.S.C. 78o-7(q)(2)(D).
---------------------------------------------------------------------------

     are appropriate to the business model of an NRSRO; \591\
and
---------------------------------------------------------------------------

    \591\ See 15 U.S.C. 78o-7(q)(2)(E).
---------------------------------------------------------------------------

     require an NRSRO to include an attestation with any credit
rating it issues affirming that no part of the credit rating was
influenced by any other business activities, that the credit rating was
based solely on the merits of the instruments being rated, and that
such credit rating was an independent evaluation of the risks and
merits of the instrument.\592\
---------------------------------------------------------------------------

    \592\ See 15 U.S.C. 78o-7(q)(2)(F). As discussed in section
II.G.4. of this release, the Commission is including this
attestation requirement in the rule the Commission is adopting to
implement section 15E(s) of the Exchange Act, which requires, among
other things, that the Commission adopt rules requiring an NRSRO to
generate a form to be included with the publication of a credit
rating. See 15 U.S.C. 78o-7(s); paragraph (a)(1)(iii) of Rule 17g-7.
---------------------------------------------------------------------------

    The rules in existence before today's amendments require NRSROs to
publish two types of information about the performance of their credit
ratings: (1) Performance statistics \593\ and (2) rating
histories.\594\ The Commission proposed to implement the rulemaking
mandated in section 15E(q) of the Exchange Act, in substantial part, by
significantly enhancing the requirements for generating and disclosing
this information by amending the instructions to Form NRSRO as they
relate to Exhibit 1 and the disclosure of transition and default
statistics, and by amending Rule 17g-1, Rule 17g-2, and Rule 17g-7 with
respect to the disclosure of rating histories.\595\ The Commission is
adopting the amendments substantially as proposed, with modifications,
in part, in response to comments received.
---------------------------------------------------------------------------

    \593\ See Nationally Recognized Statistical Rating
Organizations, 76 FR at 33434. This type of disclosure shows the
performance of an NRSRO's credit ratings in the aggregate through
statistics. Specifically, it provides the percent of credit ratings
assigned to obligors, securities, and money market instruments in
each category of credit rating in a rating scale (for example, AAA,
AA, A, BBB, BB, B, CCC, CC, and C) that over a given time period
were downgraded or upgraded to another credit rating category
(``transition rates'') or classified as a default (``default
rates''). The goal is to provide a mechanism for users of credit
ratings to compare the performance statistics of credit ratings in
each category across NRSROs.
    \594\ See Nationally Recognized Statistical Rating
Organizations, 76 FR at 33434. This type of disclosure shows the
credit rating history of a given rated obligor, security, or money
market instrument. Specifically, it shows the initial credit rating
and all subsequent modifications to the credit rating (such as
upgrades and downgrades) and the dates of such actions. The goal is
to allow users of credit ratings to compare how different NRSROs
rated an individual obligor, security, or money market instrument
and how and when those ratings were changed over time. The
disclosure of rating histories also is designed to provide ``raw
data'' that can be used by third parties to generate independent
performance statistics such as transition and default rates.
    \595\ See Nationally Recognized Statistical Rating
Organizations, 76 FR at 33433-33452.

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1. Amendments to Instructions for Exhibit 1 to Form NRSRO
a. Proposal
    Exhibit 1 is part of the registration application a credit rating
agency seeking to be registered as an NRSRO must submit to the
Commission and that an NRSRO must file with the Commission, keep up-to-
date, and publicly disclose.\596\ Section 15E(a)(1)(B)(i) of the
Exchange Act requires that an application f or registration as an NRSRO
include performance measurement statistics over short-term, mid-term,
and long-term periods (as applicable).\597\ The Commission implemented
this requirement, in large part, through Exhibit 1 to Form NRSRO and
the instructions for Exhibit 1.\598\ Section 15E(b)(1)(A) of the
Exchange Act provides that the performance measurement statistics must
be updated annually in the annual certification required by section
15E(b)(2).\599\ Paragraph (i) of Rule 17g-1 provides, among other
things, that the NRSRO must make the annual certification publicly
available within ten business days of furnishing the annual
certification to the Commission.\600\
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    \596\ In particular, section 15E(a)(1)(A) of the Exchange Act
requires an applicant to furnish an application for registration to
the Commission, in such form as the Commission shall require, by
rule or regulation. See 15 U.S.C. 78o-7(a)(1)(A). Section
15E(a)(1)(B) of the Exchange Act identifies information that must be
included in the application for registration. See 15 U.S.C. 78o-
7(a)(1)(B)(i) through (x). The Commission implemented sections
15E(a)(1)(A) and (B) of the Exchange Act by adopting Form NRSRO. See
Form NRSRO available at http://www.sec.gov/about/forms/formnrsro.pdf; see also Oversight of Credit Rating Agencies
Registered as Nationally Recognized Statistical Rating
Organizations, 72 FR at 33569-33582. Section 15E(a)(3) of the
Exchange Act provides that the Commission, by rule, shall require an
NRSRO, upon being granted registration, to make the information and
documents in its completed application for registration, or in any
amendment to its application, publicly available on its Web site, or
through another comparable, readily accessible means, except for
certain information that is submitted on a confidential basis. See
15 U.S.C. 78o-7(a)(3). The Commission implemented this provision by
adopting paragraph (i) of Rule 17g-1. See 17 CFR 240.17g-1(i); see
also Oversight of Credit Rating Agencies Registered as Nationally
Recognized Statistical Rating Organizations, 72 FR at 33569. Section
15E(b)(1) requires an NRSRO to promptly amend its application for
registration if any information or document provided therein becomes
materially inaccurate; however, (as discussed below) certain
information does not have to be updated and other information must
be updated only on an annual basis. See 15 U.S.C. 78o-7(b)(1); 15
U.S.C. 78o-7(b)(1); 15 U.S.C. 78o-7(a)(1)(B)(ix). The Commission
implemented this provision by adopting Form NRSRO and paragraph (e)
of Rule 17g-1. See Form NRSRO; 17 CFR 240.17g-1(e). See also
Oversight of Credit Rating Agencies Registered as Nationally
Recognized Statistical Rating Organizations, 72 FR at 33567, 33569-
33582.
    \597\ See 15 U.S.C. 78o-7(a)(1)(B)(i).
    \598\ See Oversight of Credit Rating Agencies Registered as
Nationally Recognized Statistical Rating Organizations, 72 FR at
33628, 33634.
    \599\ See 15 U.S.C. 78o-7(b)(1) and (2). In particular, section
15E(b) of the Exchange Act provides that not later than ninety days
after the end of each calendar year, an NRSRO shall file with the
Commission an amendment to its registration application, in such
form as the Commission, by rule, may prescribe: (1) Certifying that
the information and documents in the application for registration
continue to be accurate; (2) listing any material change that
occurred to such information and documents during the previous
calendar year; and (3) updating its credit ratings performance
measurement statistics. See 15 U.S.C. 78o-7(b). The Commission
implemented these provisions by adopting Form NRSRO and paragraph
(f) of Rule 17g-1. See Instruction F to Form NRSRO; 17 CFR 240.17g-
1(f). See also Oversight of Credit Rating Agencies Registered as
Nationally Recognized Statistical Rating Organizations, 72 FR at
33567, 33569-33582.
    \600\ See 17 CFR.240.17g-1(i).
---------------------------------------------------------------------------

    Before today's amendments, the instructions for Exhibit 1 required
the applicant or NRSRO to provide performance statistics for the credit
ratings of the applicant or NRSRO, including performance statistics for
each class of credit ratings for which the applicant is seeking
registration or the NRSRO is registered.\601\ The classes of credit
ratings for which an NRSRO can be registered are enumerated in the
definition of nationally recognized statistical rating organization in
section 3(a)(62) of the Exchange Act: (1) Financial institutions,
brokers, or dealers; \602\ (2) insurance companies; \603\ (3) corporate
issuers; \604\ (4) issuers of asset-backed securities (as that term is
defined in section 1101(c) of part 229 of Title 17, Code of Federal
Regulations, ``as in effect on the date of enactment of this
paragraph''); \605\ and (5) issuers of government securities, municipal
securities, or securities issued by a foreign government.\606\
---------------------------------------------------------------------------

    \601\ As used throughout this release, the term category of a
credit rating scale refers to a distinct level in a rating scale
represented by a unique symbol, number, or score. For example, if a
rating scale consists of symbols (for example, AAA, AA, A, BBB, BB,
B, CCC, CC, and C), each unique symbol would represent a category in
the rating scale. Similarly, if a rating scale consists of numbers
(for example, 1, 2, 3, 4, 5, 6, 7, 8, and 9), each number would
represent a category in the rating scale. Each category also
represents a notch in the rating scale. In addition, some NRSRO
rating scales attach additional symbols or numbers to the symbols
representing categories in order to denote gradations within a
category. For example, a rating scale may indicate gradations within
a category by attaching a plus or a minus or a number to a rating
symbol. For example, AA+, AA, and AA- or AA1, AA2, and AA3 would be
three gradations within the AA category. If a rating scale has
gradations within a category, each category and gradation within a
category would constitute a notch in the rating scale. For example,
the following symbols would each represent a notch in the rating
scale in descending order: AAA, AA+, AA, AA-, A+, A, A-, BBB+, BBB,
BBB-, BB+, BB, BB-, CCC+, CCC, CCC-, CC, C, and D. Furthermore, for
the purposes of this release, changing a credit rating (for example,
upgrading or downgrading the credit rating) means assigning a credit
rating at a different notch in the rating scale (for example,
downgrading an obligor assigned an AA rating to an AA- rating or an
A+ rating).
    \602\ See 15 U.S.C. 78c(a)(62)(A)(i).
    \603\ See 15 U.S.C. 78c(a)(62)(A)(ii).
    \604\ See 15 U.S.C. 78c(a)(62)(A)(iii).
    \605\ See 15 U.S.C. 78c(a)(62)(A)(iv). The instructions for
Exhibit 1 in existence before today's amendments broadened this
class of credit rating to include a credit rating of any security or
money market instrument issued by an asset pool or as part of any
asset-backed or mortgage-backed securities transaction. The intent
of the instruction was to include in the class (and, therefore, in
the performance statistics for the class) credit ratings for
structured finance products that are outside the scope of the
definition referenced in section 3(a)(62)(A)(iv) of the Exchange
Act. See 15 U.S.C. 78c(a)(62)(A)(iv); Amendments to Rules for
Nationally Recognized Statistical Rating Organizations, 74 FR at
6458. As discussed below, the final amendments to the instructions
for Exhibit 1 continue to use this broadened definition.
    \606\ See 15 U.S.C. 78c(a)(62)(A)(v). With respect to this class
of credit ratings, the instructions for Exhibit 1 in existence
before today's amendments required the applicant or NRSRO to provide
performance measurement statistics for the following three
subclasses (as opposed to the class as a whole): Sovereigns, U.S.
public finance, and international public finance. As discussed
below, the final amendments to the instructions for Exhibit 1
continue to require performance statistics for these subclasses.
---------------------------------------------------------------------------

    In addition, the instructions required that the performance
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 and default rates within each of the
credit rating categories,\607\ notches, grades, or rankings used by the
applicant or NRSRO as an indicator of the assessment of the
creditworthiness of an obligor, security, or money market instrument in
each class of credit rating.''
---------------------------------------------------------------------------

    \607\ The transition rate is the percent of credit ratings at a
given rating notch that transition to another specified rating notch
over a given time period. Only credit ratings that were outstanding
at the beginning of the time period are used in the calculation of
the transition rate. Transition rates are generally used to measure
the stability of credit ratings. The default rate is the percent of
credit ratings at a given rating notch that have defaulted over a
given time period. Only the credit ratings that were outstanding at
the beginning of the time period are used in the calculation.
---------------------------------------------------------------------------

    Before today's amendments, the instructions for Exhibit 1 did not
prescribe the methodology an applicant or NRSRO must use to calculate
the performance statistics or the format by which they must be
disclosed; nor did the instructions limit the type of information that
can be disclosed in Exhibit 1.\608\ Consequently, as stated in

a 2010 report of the GAO, NRSROs at that time used different techniques
to produce performance statistics, which limited the ability of
investors and other users of credit ratings to compare the performance
of credit ratings across NRSROs.\609\ In addition, several NRSROs
included substantial amounts of information in Exhibit 1 about
performance statistics, in addition to transition and default rates.
---------------------------------------------------------------------------

    \608\ When adopting Form NRSRO, the Commission explained that
the instructions would not prescribe how NRSROs must calculate
transition rates and default rates, noting that commenters had
opposed a standard approach because NRSROs use different
methodologies to determine credit ratings. See Oversight of Credit
Rating Agencies Registered as Nationally Recognized Statistical
Rating Organizations, 72 FR at 33574. The Commission stated that it
intended to 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
performance between NRSROs.'' Id. The Commission took an incremental
step toward standardizing the disclosure requirements in Exhibit 1
by amending the Form in 2009 to require an NRSRO to disclose
transition and default rates for each class of credit rating for
which it was registered and for 1-year, 3-year, and 10-year periods.
See Amendments to Rules for Nationally Recognized Statistical Rating
Organizations 74 FR at 6457-6459.
    \609\ See, e.g., GAO, Securities and Exchange Commission: Action
Needed to Improve Rating Agency Registration Program and Performance
Related Disclosures, Report 10-782 (Sept. 2010) (``GAO Report 10-
782''). Section 7 of the Rating Agency Act required the GAO to
review the implementation of the Rating Agency Act of 2006. See
Public Law 109-291, 7. Among other things, the report evaluated the
performance-related NRSRO disclosures required by Commission rules
under the Exchange Act. See GAO Report 10-782, pp. 24-46.
---------------------------------------------------------------------------

    As noted above, NRSROs have produced and presented performance
statistics in various ways. For example, for the calendar year 2009
performance statistics published by the NRSROs, some NRSROs used a
``single cohort approach'' to determine transition rates for their
credit ratings.\610\ Under this approach, an NRSRO would calculate
transition rates for the most recent 1-year, 3-year, or 10-year period.
For example, for its 2009 3-year transition rates for corporate issuers
using the single cohort approach, an NRSRO would calculate transition
rates for the class of corporate issuers for the period December 31,
2006 through December 31, 2009. Other NRSROs used an ``average cohort
approach.'' \611\ Under this approach, an NRSRO would calculate
transition rates for multiple 1-year, 3-year, or 10-year periods and
then average them. For example, for its 2009 3-year transition rates
for corporate issuers using the average cohort approach, an NRSRO would
calculate 3-year transition rates for the class of corporate issuers
for multiple 3-year periods (for example, 3-year periods from 1981 to
2009) and then average them. Two NRSROs also published ``Lorenz
curves,'' which are ``visual tools for assessing the accuracy of the
rank ordering of creditworthiness that a set of ratings provides.''
\612\ The GAO found that the variability in how NRSROs produce
performance statistics limited the ability of investors and other users
of credit ratings to compare the performance of credit ratings across
NRSROs.\613\
---------------------------------------------------------------------------

    \610\ See GAO Report 10-782, p. 28.
    \611\ Id.
    \612\ Id. at 25, note 38 (``[Lorenz curves] are considered
useful for comparing the relative accuracy of different rating
systems or the relative accuracy of a single rating system measured
at different points of time for different cohorts.'').
    \613\ Id. at 27-37.
---------------------------------------------------------------------------

    As described by the GAO, the single cohort approach uses
information from the most recent time periods, while the average cohort
approach uses information from multiple time periods. The GAO stated
that the single cohort approach may be useful to predict the
performance of credit ratings under similar circumstances, while the
average cohort approach may be useful to predict future transition
rates under different economic and other conditions.\614\ The GAO also
found that ``[b]oth approaches are valid, depending on the needs of the
user, but they do not yield comparable information.'' \615\
---------------------------------------------------------------------------

    \614\ Id. at 27.
    \615\ Id. at 27.
---------------------------------------------------------------------------

    As indicated above, before today's amendments, the instructions for
Exhibit 1 permitted NRSROs to use differing methods to calculate
performance statistics and to include additional information in Exhibit
1. This created the potential that the presentation of information in
the exhibits would be inconsistent across NRSROs. To address this issue
and to implement section 15E(q) of the Exchange Act, the Commission
proposed significant amendments to the instructions for Exhibit 1.\616\
The proposed amendments would standardize the calculation of the
performance statistics by requiring the applicant or NRSRO to calculate
1-year, 3-year, and 10-year transition and default rates for each
applicable class and subclass of credit rating using a single cohort
approach.\617\ Further, the results would need to be presented in
tabular form using a standardized format (a ``Transition/Default
Matrix'').\618\ Finally, the proposed amendments would specify that an
applicant or NRSRO must not disclose information in the Exhibit that is
not required to be disclosed.\619\
---------------------------------------------------------------------------

    \616\ See Nationally Recognized Statistical Rating
Organizations, 76 FR at 33434-33444. See also 15 U.S.C. 78o-
7(q)(2)(A) (requiring that the Commission's rules require
disclosures that are comparable among NRSROs, to allow users of
credit ratings to compare the performance of credit ratings across
NRSROs).
    \617\ See Nationally Recognized Statistical Rating
Organizations, 76 FR at 33556-33558.
    \618\ See id. at 33557.
    \619\ See id. at 33556-33557.
---------------------------------------------------------------------------

    Under the proposal, the ``issuers of asset-backed securities''
class of credit ratings would be divided into the following subclasses:
RMBS; CMBS; collateralized loan obligations (``CLOs''); CDOs; asset-
backed commercial paper (``ABCP''); other asset-backed securities
(``other ABS''); and other structured finance products (``other
SFPs'').\620\
---------------------------------------------------------------------------

    \620\ See id. at 33556.
---------------------------------------------------------------------------

    As stated above, under the proposal the applicant or NRSRO would be
required to use the single cohort approach to calculate transition and
default rates in order to determine the percent of credit ratings at
each notch in the rating scale for a given class or subclass and for
the applicable time period (one, three, or ten years) that were rated
at the same notch or transitioned to another notch as of the end of the
period, and the percent of credit ratings at each notch that were
classified as a default or paid off, or had been withdrawn for reasons
other than being classified as a default or paid off during the
period.\621\ For example, a matrix containing 3-year transition and
default rates for the class of corporate issuers would disclose the
number of credit ratings of corporate issuers the applicant or NRSRO
had outstanding as of the period start date that is three years prior
to the most recent calendar year end at each notch in the rating scale
used by the applicant or NRSRO, the percent of those credit ratings
that were rated at the same notch and the percent that transitioned to
each other notch in the rating scale as of the end of the 3-year
period, and the percent that were classified as a default or paid off,
or had been withdrawn at any time during the 3-year period.\622\
---------------------------------------------------------------------------

    \621\ See id. at 33556-33558.
    \622\ See id. at 33556-33558.
---------------------------------------------------------------------------

    The Commission proposed that an applicant or NRSRO must classify
the credit rating assigned to an obligor, security, or money market
instrument as a default if, during the applicable period, either: (1)
The obligor failed to timely pay principal or interest due according to
the terms of an obligation or the issuer of the security or money
market instrument failed to timely pay principal or interest due
according to the terms of the security or money market instrument; or
(2) the applicant or NRSRO classified the obligor, security, or money
market instrument as having gone into default using its own

definition of default.\623\ The applicant or NRSRO would need to
classify an obligor, security, or money market instrument as having
gone into default even if the applicant or NRSRO assigned a credit
rating to the obligor, security, or money market instrument at a notch
above default in its rating scale on or after the event of default or
withdrew the credit rating on or after the event of default.\624\
---------------------------------------------------------------------------

    \623\ See id. at 33557-33558.
    \624\ See id. at 33441-33442, 33557-33558.
---------------------------------------------------------------------------

    As proposed, an applicant or NRSRO would classify a credit rating
assigned to an obligor, security, or money market instrument as paid
off if, during the applicable period: (1) An obligor extinguished the
obligation by paying in full all outstanding principal and interest due
on the obligation according to the terms of the obligation (for
example, because the obligation matured, was called, or was prepaid)
and the applicant or NRSRO withdrew the credit rating because the
obligation was extinguished; or (2) the issuer of a security or money
market instrument extinguished its obligation with respect to the
security or money market instrument by paying in full all outstanding
principal and interest due according to the terms of the security or
money market instrument (for example, because the security or money
market instrument matured, was called, or was prepaid) and the
applicant or NRSRO withdrew the credit rating for the security or money
market instrument because the obligation was extinguished.\625\
---------------------------------------------------------------------------

    \625\ See id. at 33557-33558.
---------------------------------------------------------------------------

    The proposal would require the applicant or NRSRO to determine and
disclose the number of obligors, securities, and money market
instruments assigned a credit rating as of the period start date for
which the applicant or NRSRO withdrew a credit rating at any time
during the applicable time period for a reason other than that the
credit rating assigned to the obligor, security, or money market
instrument was classified as a default or paid-off.\626\ The applicant
or NRSRO would have to classify the credit rating assigned to the
obligor, security, or money market instrument as withdrawn even if the
applicant or NRSRO assigned a credit rating to the obligor, security,
or money market instrument after withdrawing the credit rating.\627\
---------------------------------------------------------------------------

    \626\ See 15 U.S.C. 78o-7(q)(2)(C) (requiring that the
disclosures include information for credit ratings withdrawn by the
NRSRO).
    \627\ See Nationally Recognized Statistical Rating
Organizations, 76 FR at 33557-33558.
---------------------------------------------------------------------------

    Finally, the performance statistics would need to be presented in a
``Transition/Default Matrix'' in a format specified in the
instructions, which included a sample matrix.\628\
---------------------------------------------------------------------------

    \628\ See id. at 33557.
---------------------------------------------------------------------------

b. Final Rule
    Paragraph (1) of the instructions for Exhibit 1. The Commission is
adopting paragraph (1) of the instructions for Exhibit 1 with two
technical modifications from the proposal.\629\ This paragraph requires
the applicant or NRSRO to provide performance statistics for each class
of credit ratings for which the applicant is seeking registration as an
NRSRO or the NRSRO is registered and for the applicable subclasses of
credit ratings listed in the paragraph.\630\ Specifically, it requires
the applicant or NRSRO to provide transition and default rates for 1-
year, 3-year, and 10-year periods for each applicable class or subclass
of credit rating.\631\ It further requires the applicant or NRSRO to
produce and present three separate transition and default statistics
for each applicable class or subclass of credit rating; namely, for 1-
year, 3-year, and 10-year time periods through the most recent calendar
year end. In addition, the applicant or NRSRO must present the
transition and default rates for each time period together in tabular
form using a standard format (a ``Transition/Default Matrix'').\632\
---------------------------------------------------------------------------

    \629\ See paragraph (1) of the instructions for Exhibit 1. One
commenter stated that the phrase ``up-to-date Exhibit 1'' as used in
proposed paragraph (1) of the instructions for Exhibit 1 was
ambiguous. See Moody's Letter. Specifically, as proposed, paragraph
(1) of the instructions for Exhibit 1 would provide that the
performance measurement statistics must be updated yearly in the
NRSRO's annual certification in accordance with section 15E(b)(1)(A)
of the Exchange Act and paragraph (f) of Rule 17g-1 (in particular,
a Form NRSRO with updated performance measurement statistics--the
annual certification--must be filed with the Commission no later
than ninety days after the end of the calendar year). The proposed
instructions also would remind an NRSRO that, pursuant to paragraph
(i) of Rule 17g-1, the annual certification with the updated
performance measurement statistics must be made publicly and freely
available on an easily accessible portion of the NRSRO's corporate
Internet Web site within ten business days after the filing and that
the NRSRO must make its ``up-to-date'' Exhibit 1 freely available in
writing to any individual who requests a copy of the Exhibit. The
Commission agrees with the comment and is replacing the phrase ``up-
to-date Exhibit 1'' with the phrase ``most recently filed Exhibit
1'' as suggested by the commenter. Further, as proposed, the
instructions referenced the ``classes and subclasses'' for which an
applicant is seeking registration or for which an NRSRO is
registered. As discussed in section II.I.1. of this release, a
commenter noted that applicants and NRSROs do not register in
``subclasses'' of credit ratings. See DBRS Letter. Paragraph (1) of
the instructions for Exhibit 1 has therefore been modified to make
this clear. See paragraph (1) of the Instructions for Exhibit 1.
    \630\ See paragraph (1) of the instructions for Exhibit 1.
    \631\ See id.
    \632\ See id.
---------------------------------------------------------------------------

    Paragraph (1) of the instructions for Exhibit 1 specifies the
classes and subclasses of credit ratings for which the applicant or
NRSRO must produce Transition/Default Matrices, as applicable.\633\ The
identified classes reference the classes of credit ratings for which an
NRSRO can be registered as enumerated in the definition of nationally
recognized statistical rating organization in section 3(a)(62)(A) of
the Exchange Act.\634\ As was the case prior to today's amendments, the
class of credit ratings enumerated in section 3(a)(62)(A)(iv) of the
Exchange Act (issuers of certain asset-backed securities) is expanded
to include a broader range of structured finance products than are
within the scope of the definition in section 3(a)(62)(A)(iv).\635\
Moreover, this class has been divided into the following subclasses:
RMBS; \636\ CMBS; \637\ CLOs; \638\ CDOs; \639\ ABCP; \640\ other

ABS; \641\ and other structured finance products.\642\
---------------------------------------------------------------------------

    \633\ See id.
    \634\ Compare 15 U.S.C. 78c(a)(62)(A)(i) through (v), with
paragraphs (1)(A) through (E) of the instructions for Exhibit 1. As
was the case prior to today's amendments, paragraph (1) of the
instructions for Exhibit 1 divides the class of credit ratings
enumerated in section 3(a)(62)(A)(v) of the Exchange Act (issuers of
government securities, municipal securities, or securities issued by
a foreign government) into three subclasses: Sovereign issuers; U.S.
public finance; and international public finance. See paragraph (1)
of the instructions for Exhibit 1.
    \635\ See paragraph (1) of the instructions for Exhibit 1; 15
U.S.C. 78c(a)(62)(A)(iv). As was the case before today's amendments,
the instructions for Exhibit 1 broaden this class of credit rating
to include a credit rating of any security or money market
instrument issued by an asset pool or as part of any asset-backed or
mortgage-backed securities transaction.
    \636\ The instructions provide that RMBS means a securitization
of primarily residential mortgages. See paragraph (1)(D)(i) of the
instructions for Exhibit 1.
    \637\ The instructions provide that CMBS means a securitization
of primarily commercial mortgages. See paragraph (1)(D)(ii) of the
instructions for Exhibit 1.
    \638\ The instructions provide that CLO means a securitization
of primarily commercial loans. See paragraph (1)(D)(iii) of the
Instructions for Exhibit 1.
    \639\ The instructions provide that CDO means a securitization
primarily of other debt instruments such as RMBS, CMBS, CLOs, CDOs,
other ABS, and corporate bonds. See paragraph (1)(D)(iv) of the
instructions for Exhibit 1.
    \640\ The instructions provide that ABCP means short term notes
issued by a structure that securitizes a variety of financial assets
(for example, trade receivables, credit card receivables), which
secure the notes. See paragraph (1)(D)(v) of the instructions for
Exhibit 1.
    \641\ The instructions provide that other ABS means a
securitization primarily of auto loans, auto leases, floor plan
financings, credit card receivables, student loans, consumer loans,
equipment loans, or equipment leases. See paragraph (1)(D)(vi) of
the instructions for Exhibit 1.
    \642\ The instructions provide that other structured finance
product means a structured finance product that does not fit into
any of the other subclasses of structured products. See paragraph
(1)(D)(vii) of the instructions for Exhibit 1.
---------------------------------------------------------------------------

    Regarding the proposed seven subclasses of asset-backed securities,
one commenter stated that the proposed degree of granularity ``would
lead to the creation of sparse Transition/Default Matrices because many
NRSROs do not have enough ratings for each proposed subclass to produce
statistically significant results'' and that the class of ABS ratings
should be divided into three classes: RMBS, CMBS, and ``Other ABS.''
\643\ Another NRSRO stated that dividing the class of credit ratings
for structured finance products as proposed ``would tend to further
increase market transparency'' and that the proposed subclasses are
``suitable,'' but that ``greater stratification may in some cases
produce subclasses that are too small to generate meaningful
statistics.'' \644\
---------------------------------------------------------------------------

    \643\ See DBRS Letter.
    \644\ See S&P Letter.
---------------------------------------------------------------------------

    In response, the Commission notes that the reason for dividing the
broad class of structured finance products into these subclasses is to
provide investors and other users of credit ratings with more useful
information about the performance of an NRSRO's structured finance
credit ratings.\645\ Each subclass has characteristics that distinguish
it from the other subclasses. Consequently, the separation of
performance statistics into these subclasses will provide users of
credit ratings with additional information and allow them to compare
the performance of the credit ratings in each subclass among the
NRSROs. Further, the NRSRO must disclose the number of credit ratings
outstanding in each subclass at the beginning of the period, so users
of credit ratings will be aware of the number of credit ratings the
statistics are based upon.
---------------------------------------------------------------------------

    \645\ See, e.g., GAO Report 10-782, p. 36 (observing that the
various structured finance sectors have risk characteristics that
vary significantly and, therefore, presenting performance statistics
for the class as a whole ``may not be useful.''). During the recent
crisis, NRSROs assigned credit ratings to RMBS and CDOs that
performed far differently than credit ratings of some other types of
securitizations. See, e.g., S&P, A Global Cross-Asset Report Card of
Ratings Performance in Times of Stress (June 8, 2010).
---------------------------------------------------------------------------

    Paragraph (2) of the instructions for Exhibit 1. The Commission is
adopting paragraph (2) of the instructions for Exhibit 1 with
modifications.\646\ This paragraph prescribes how the applicant or
NRSRO must present the performance statistics and other required
information in the Exhibit.\647\ Specifically, it requires that the
Transition/Default Matrices for each applicable class and subclass of
credit ratings be presented in the order that the classes and
subclasses are identified in paragraphs (1)(A) through (E) of the
instructions for Exhibit 1.\648\ In addition, the order of the
Transition/Default Matrices for a given class or subclass must be: The
1-year matrix, the 3-year matrix, and then the 10-year matrix.\649\
Further, if the applicant or NRSRO did not issue credit ratings in a
particular class or subclass for the length of time necessary to
produce a Transition/Default Matrix for a 1-year, 3-year, or 10-year
period, it must explain that fact in the location where the Transition/
Default Matrix would have been presented in the Exhibit.\650\
---------------------------------------------------------------------------

    \646\ See paragraph (2) of the instructions for Exhibit 1.
    \647\ See id.
    \648\ See id.
    \649\ See id.
    \650\ See id. For example, if an NRSRO is registered in the
corporate issuer class but has been issuing credit ratings for only
seven years in that class, it could not produce a 10-year
Transition/Default Matrix for the class. Instead, the NRSRO must
provide an explanation in the location where a 10-year Transition/
Default Matrix would have been located (namely, after the 3-year
matrix) that it had not been issuing credit ratings in that class
for a sufficient amount of time to produce a 10-year Transition/
Default Matrix.
---------------------------------------------------------------------------

    The instructions require the applicant or NRSRO to clearly define
in Exhibit 1, after the presentation of all applicable Transition/
Default Matrices, each symbol, number, or score in the rating scale
used by the applicant or NRSRO to denote a credit rating category and
notches within a category for each class and subclass of credit ratings
in any Transition/Default Matrix presented in the Exhibit.\651\ The
instructions also require the applicant or NRSRO to clearly explain the
conditions under which it classifies obligors, securities, or money
market instruments as being in default.\652\ Further, the instructions
require that the applicant or NRSRO provide in Exhibit 1 the uniform
resource locator (``URL'') of its corporate Internet Web site where the
credit rating histories required to be disclosed pursuant to paragraph
(b) of Rule 17g-7 would be located (in the case of an applicant) or are
located (in the case of an NRSRO).\653\
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    \651\ See paragraph (2) of the instructions for Exhibit 1. As
discussed in section II.J.2. of this release, the Commission is
implementing section 938(a)(2) of the Dodd-Frank Act through
paragraph (b)(2) of Rule 17g-8, which requires an NRSRO to have
policies and procedures reasonably designed to clearly define each
symbol, number, or score in the rating scale used by the NRSRO to
denote a credit rating category and notches within a category for
each class of credit ratings for which the NRSRO is registered,
including in Exhibit 1 to Form NRSRO. See Public Law 111-203,
938(a)(2); paragraph (b)(2) of Rule 17g-8.
    \652\ See paragraph (2) of the instructions for Exhibit 1.
    \653\ See id. As discussed below in section II.E.3. of this
release, the Commission is amending Rule 17g-2 and Rule 17g-7 to
enhance the rating histories disclosure requirements currently
codified in Rule 17g-2. Among other things, the amendments relocate
the credit rating history disclosure requirements from Rule 17g-2 to
Rule 17g-7.
---------------------------------------------------------------------------

    Finally, as proposed, the instructions provided that the Exhibit
must contain no performance statistics or information other than as
described in, and required by, the instructions for Exhibit 1; except
that the applicant or NRSRO would be permitted to provide, after the
presentation of all required Transition/Default Matrices and other
required disclosures, Internet Web site URLs where other information
relating to performance statistics of the applicant or NRSRO is
located.\654\ This provision was intended to address the fact that some
NRSROs included substantial amounts of information in Exhibit 1 about
performance statistics, in addition to transition and default
rates.\655\ As discussed in more detail below, some commenters stated
that there are advantages and limitations to using the single cohort
approach as compared to the average cohort approach to calculate the
performance statistics.\656\ While the instructions for Exhibit 1
mandate the use of the single cohort approach, the Commission believes
that, if an NRSRO also calculates performance statistics using the
average cohort approach, it would be appropriate to disclose that fact
in Exhibit 1 and provide an Internet URL where the performance
statistics are located. This will provide additional information to
evaluate the performance of the NRSRO's credit ratings. For these
reasons, paragraph (2) of the instructions for Exhibit 1 has been
modified to provide that Exhibit 1 must contain no performance
measurement statistics or information other than as described in, and
required by, the Instructions for Exhibit 1; except that

the NRSRO may provide after the presentation of all required
Transition/Default Matrices and other disclosures:
---------------------------------------------------------------------------

    \654\ See paragraph (2) of the instructions for Exhibit 1. To
the extent that an NRSRO wishes to include other information that it
believes is relevant for the purposes of drawing comparisons among
credit ratings, the NRSRO could use an Internet Web site URL as a
channel to provide the reader with additional information the NRSRO
believes to be relevant.
    \655\ See Nationally Recognized Statistical Rating
Organizations, 76 FR at 33437.
    \656\ The advantages and limitations of the single cohort
approach as compared to the average cohort approach are also
discussed in section II.E.4. of this release.
---------------------------------------------------------------------------

     A short statement describing the required method of
calculating the performance measurement statistics in Exhibit 1 (the
single cohort approach) and any advantages or limitations to the single
cohort approach the NRSRO believes would be appropriate to disclose;
     A short statement that the NRSRO has calculated and
published on an Internet Web site performance measurement statistics
using the average cohort approach (if applicable), a description of the
differences between the single cohort approach and the average cohort
approach used to calculate the performance measurement statistics, and
the Internet Web site URL where the performance measurements statistics
calculated using the average cohort approach are located; and
     The Internet Web site URLs where any other information
relating to performance measurement statistics of the NRSRO is
located.\657\
---------------------------------------------------------------------------

    \657\ See paragraph (2) of the instructions for Exhibit 1.
---------------------------------------------------------------------------

    Paragraph (3) of the instructions for Exhibit 1. The Commission is
adopting paragraph (3) of the instructions for Exhibit 1 with
modifications to make the disclosures more understandable to users of
credit ratings.\658\ This paragraph prescribes the format for a
Transition/Default Matrix and includes a sample matrix.\659\
Specifically, the prescribed format is designed to allow the applicant
or NRSRO to show in the matrix the number of outstanding credit ratings
in the class or subclass at each notch in the applicable rating scale
at the period start-date, and the percent of those credit ratings that
were rated at the same notch at the end of the period, the percent of
those credit ratings that were rated at each different notch in the
rating scale at the end of the period, and the percent of those credit
ratings that were classified as a default or paid off or were withdrawn
at any time during the period.\660\ The prescribed format also is
designed so that this information will be displayed in Exhibit 1 in a
standard manner across the NRSROs to make it easier for users of NRSRO
credit ratings and others to understand and compare the statistics.
---------------------------------------------------------------------------

    \658\ See paragraph (3) of the instructions for Exhibit 1.
    \659\ See id.
    \660\ See id.
---------------------------------------------------------------------------

    One commenter suggested adding the heading ``Status of those
ratings at the end of the time period'' to the Transition/Default
Matrix because ``less sophisticated investors'' may not understand the
term ``transition,'' and also suggested that it may be useful to
highlight the box on the chart that corresponds with the credit rating
being at the same notch at the end of the period as it was at the
beginning.\661\ The Commission agrees that these types of modifications
could assist users to better understand the information disclosed in
the Transition/Default Matrices. Consequently, the narrative
instructions in paragraph (3) and the illustration of the sample
Transition/Default Matrix have been modified to require highlighting of
the cell in the matrix that corresponds with the credit rating being at
the same notch at the end of the period as it was at the beginning and
to require that the legends at the top of the matrix reflect that the
first two columns represent the status of the credit ratings as of the
period start date, the subsequent rating category columns represent the
status of the credit ratings as of the period end date, and the
Default, Paid Off, and Withdrawn (other) columns represent other
outcomes that occurred during the period.\662\
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    \661\ See CFA/AFR Letter. One commenter also suggested that the
Commission re-propose the rules and, in doing so, require NRSROs to
present their performance statistics in a way that allows the public
to compare and cross-reference different assets with the same credit
rating. See CFA II Letter. The Commission believes the amendments
being adopted today--by simplifying the presentation of the
transition and default statistics and enhancing the rating history
disclosures--will make it much easier for this kind of comparison to
be made.
    \662\ See paragraph (3) of the instructions for Exhibit 1.
---------------------------------------------------------------------------

    As adopted, the sample Transition/Default Matrix in Figure 2 is the
sample matrix provided in the instructions that the applicant or NRSRO
must use as a model for its Transition/Default Matrices.
[GRAPHIC] [TIFF OMITTED] TR15SE14.001

    Paragraph (4) of the instructions for Exhibit 1. The Commission is
adopting paragraph (4) of the instructions for Exhibit 1 with the
modifications discussed below.\663\ This paragraph prescribes how the
applicant or NRSRO must calculate the performance statistics and enter
information into the Transition/Default Matrices.\664\
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    \663\ See paragraph (4) of the instructions for Exhibit 1.
    \664\ See id.

---------------------------------------------------------------------------

Determining Start Date Cohorts
    The final amendments (as was proposed) require the applicant or
NRSRO to use the single cohort approach to calculate the transition and
default rates.\665\ One NRSRO stated that the single cohort approach is
a ``reasonable approach'' and ``is the best approach as it is, in our
opinion, the clearest way to calculate a meaningful default rate.''
\666\ Another NRSRO requested that the Commission provide ``fuller
background'' on decisions such as the determination to use the single
cohort approach rather than an average cohort approach, with a
description of potential benefits and limitations of those
decisions.\667\ Some commenters suggested that the Commission use an
average cohort approach in lieu of or in addition to the single cohort
approach.\668\
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    \665\ See id.
    \666\ See S&P Letter. This commenter also stated that a better
way to measure the performance of rating systems ``that do not
define their ratings in terms of target default and transition
rates'' is ``a measure of rank-ordering power, such as the Gini
coefficient.''
    \667\ See Kroll Letter.
    \668\ See DBRS Letter (advocating use of the average cohort
approach); CFA/AFR Letter (advocating using both approaches).
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    The Commission recognizes that different methods of measuring the
performance of credit ratings may have unique advantages in terms of
the information provided. As the GAO noted in comparing the single
cohort approach and the average cohort approach, ``[b]oth approaches
are valid, depending on the needs of the user, but they do not yield
comparable information.'' \669\ For example, the average cohort
approach may provide better information about how credit ratings
perform on average across a wider variety of economic conditions when
compared to the single cohort approach.\670\ However, the single cohort
approach, because it does not average out performance over multiple
cohorts, may more readily highlight how a given NRSRO's credit ratings
have performed in more recent economic cycles.
---------------------------------------------------------------------------

    \669\ See, e.g., GAO Report 10-782, p. 28.
    \670\ See section II.E.4. of this release (discussing in more
detail the relative advantages of the single and average cohort
approaches).
---------------------------------------------------------------------------

    Moreover, the single cohort approach is a simpler approach than the
other methods noted by the GAO and, therefore, it may be easier for
less sophisticated investors and other users of credit ratings to
understand how the performance statistics were produced. As stated
above, section (q)(2)(B) of the Exchange Act provides that the
Commission's rules shall require that the performance measurement
disclosures be clear and informative for investors having a wide range
of sophistication.\671\ The Commission notes that one commenter stated
that the single cohort approach ``is the clearest way to calculate a
meaningful default rate.'' \672\ In addition, it will be easier for
NRSROs to produce performance statistics using this approach as it
requires simpler calculations and, consequently, will be less
burdensome than the other approaches.
---------------------------------------------------------------------------

    \671\ See 15 U.S.C. 78o-7(q)(2)(B).
    \672\ See S&P Letter.
---------------------------------------------------------------------------

    One commenter stated that the single cohort approach could lead to
results that are ``significantly more volatile within the shorter time
period, which will make interpreting those results more difficult.''
\673\ This commenter stated further that ``the volatility impact will
be amplified for NRSROs with fewer ratings, which could lead to bias
against smaller NRSROs.'' \674\ The Commission has balanced this
concern with the need to prescribe an easy to understand method for
calculating the performance statistics. As discussed below, the
requirements in the instructions for Exhibit 1 provide for very
transparent disclosures about the number of credit ratings in the start
date cohort and in the cohort for each notch in the credit rating scale
of a given class or subclass.\675\ This transparency will provide
persons reviewing the performance statistics with information to assess
how the small number of credit ratings in a given cohort may have
impacted the results.\676\ Moreover, as discussed above, the Commission
has modified paragraph (2) of the instructions for Exhibit 1 to permit
an NRSRO to include a statement about any advantages or limitations to
the single cohort approach the firm believes would be appropriate to
disclose and, if applicable, a statement disclosing that the NRSRO has
calculated performance statistics using the average cohort approach and
identifying the Internet Web site URL where those statistics are
located.
---------------------------------------------------------------------------

    \673\ See DBRS Letter.
    \674\ See id.
    \675\ See paragraph (4)(A) of the instructions for Exhibit 1
(requiring the applicant or NRSRO to enter into the second column of
the Transition/Default Matrix the number of credit ratings in the
start-date cohort for each notch in the rating scale). This
disclosure is illustrated in the first and second columns of the
Sample Transition/Default Matrix in Figure 2 (above).
    \676\ For example, if the outcome for a notch with ten credit
ratings is that five were classified as a default during the period,
the default rate reflected on the Transition/Default Matrix for that
notch would be 50%. Similarly, if the outcome of a notch with 5,000
credit ratings is that 2,500 were classified as a default during the
period, the default rate for that notch would be 50% as well.
Investors and other users of credit ratings might conclude that
2,500 credit ratings being classified as defaulting during the
period reflects significantly worse performance than five credit
ratings being classified as defaulting during the period.
---------------------------------------------------------------------------

    One commenter suggested that NRSROs should be required to calculate
performance statistics using both the single cohort approach and the
average cohort approach.\677\ One of the objectives of the amendments
is to make the disclosures in Exhibit 1 to Form NRSRO shorter and
easier to understand. Mandating two sets of 1-year, 3-year, and 10-year
performance statistics (one based on the single cohort approach and one
based on the average cohort approach) for each class or subclass of
credit ratings would substantially increase the length and complexity
of the disclosure in Exhibit 1. In addition, it would increase the
compliance burden. However, as discussed above, NRSROs that also
calculate performance statistics using the average cohort approach can
disclose that fact in Exhibit 1.
---------------------------------------------------------------------------

    \677\ See CFA/AFR Letter.
---------------------------------------------------------------------------

    Finally, one commenter stated that NRSROs should be required to use
the single cohort approach for credit ratings of corporate and
sovereign debt and a ``static pool approach'' for credit ratings of
structured finance products.\678\ The Commission believes that doing so
would make the disclosure unnecessarily complex and undermine the
objective of making the performance statistics clear and informative
for investors having a wide range of sophistication.\679\
---------------------------------------------------------------------------

    \678\ See TradeMetrics Letter.
    \679\ See 15 U.S.C. 78o-7(q)(2)(B).
---------------------------------------------------------------------------

    For all the reasons discussed above, the final amendments require
NRSROs to produce the performance statistics using the single cohort
approach.\680\ However, in response to comments, the Commission is
modifying the requirement with respect to identifying the credit
ratings that must be included in a start-date cohort. Several
commenters addressed the proposed requirement that a start-date cohort
consist of the obligors, securities, and money market instruments in
the applicable class or subclass of credit ratings that were assigned a
credit rating as of the beginning of the period. One NRSRO stated that
``mixing units of study,'' consisting of obligors, securities, and
money-market instruments ``can create mismatched data and potentially
double counting.'' \681\ Similarly, another NRSRO recommended that,
except for the structured finance class of credit

ratings, the rule should require calculating a senior credit rating for
a given issuer and using that rating in the construction of the cohort,
as a single issuer can have many issuances, and including each one in
the cohort may skew the performance statistics.\682\ A third NRSRO
stated that for the structured finance category of credit ratings,
``the obligations/issues should be included in the start-date cohorts''
because ``those transactions do not have obligors in a traditional
sense . . .'' \683\ A fourth NRSRO agreed, stating that ``the start-
date cohorts should be comprised of obligors for corporate ratings and
securities lines for the various subclasses of structured finance
ratings.'' \684\
---------------------------------------------------------------------------

    \680\ See paragraph (4) of the instructions for Exhibit 1.
    \681\ See Kroll Letter.
    \682\ See Moody's Letter.
    \683\ See S&P Letter.
    \684\ See DBRS Letter.
---------------------------------------------------------------------------

    The Commission agrees with these comments and has modified the
instructions. The final amendments provide that, to determine the
number of credit ratings outstanding as of the period start date for
all classes of credit ratings other than the class of issuers of asset-
backed securities, the applicant or NRSRO must: (1) Identify each
obligor that the applicant or NRSRO assigned a credit rating to as an
entity where the credit rating was outstanding as of the period start
date; (2) identify each additional obligor that issued securities or
money market instruments that the applicant or NRSRO assigned credit
ratings to where the credit ratings were outstanding as of the period
start date; and (3) include in the start-date cohort only credit
ratings assigned to an obligor as an entity, or, if the obligor is not
assigned a credit rating as an entity, the credit rating of the
obligor's senior unsecured debt.\685\ All other credit ratings
outstanding as of the period start date assigned to securities or money
market instruments issued by the obligor must be excluded from the
start-date cohort.\686\ For the class of issuers of asset-backed
securities, the start-date cohort (as was proposed) must consist of
credit ratings that the applicant or NRSRO assigned to all securities
or money market instruments in the class where the credit ratings were
outstanding as of the period start date, excluding expected or
preliminary credit ratings.\687\
---------------------------------------------------------------------------

    \685\ See paragraph (4)(A) of the instructions for Exhibit 1.
    \686\ See id. For example, assume an obligor is assigned a
credit rating of AA as an entity, and also has outstanding senior
unsecured debt that is also rated AA and subordinated debt that is
rated BBB, meaning there are a total of three credit ratings
associated with the obligor. Under the final amendments, the
obligor's credit rating as an entity must be included in the start-
date cohort, and the credit ratings of the obligor's senior
unsecured debt and subordinated debt must be excluded.
Alternatively, if the obligor in the above example is not assigned a
credit rating as an entity, the credit rating of the obligor's
senior unsecured debt must be included in the start-date cohort and
the credit rating of the obligor's subordinated debt must be
excluded.
    \687\ See paragraph (4)(A) of the instructions for Exhibit 1;
Nationally Recognized Statistical Rating Organizations, 76 FR at
33438. For example, assume a structured finance issuer has ten
tranches of securities and the NRSRO has assigned credit ratings to
six of the tranches. All six credit ratings must be included in the
start-date cohort. As stated, ``expected'' or ``preliminary'' credit
ratings must be excluded from the start-date cohort. These types of
credit ratings most commonly are issued by an NRSRO with respect to
a structured finance product at the time the issuer commences the
offering and typically are included in pre-sale reports. Expected or
preliminary credit ratings may include a range of credit ratings, or
any other indications of a credit rating prior to the assignment of
an initial credit rating for a new issuance. Consequently, they
should be excluded from the start date cohort since the issuance of
the initial credit rating is the first formal expression of the
NRSRO's view of the relative creditworthiness of the obligor,
security, or money market instrument.
---------------------------------------------------------------------------

    Finally, as proposed, the start date cohort for all classes of
credit ratings must exclude credit ratings that the applicant or NRSRO
classified as in default (using its own definition of default) as of
the period start-date (and, as discussed above, expected or preliminary
credit ratings).\688\ As explained in the proposing release, the
Transition/Default Matrices should not include credit ratings of
obligors, securities, and money market instruments the applicant or
NRSRO has classified as in default because the firm is no longer
assessing the relative likelihood that the obligor, security, or money
market will continue to meet its obligations to make timely payments of
principal and interest as they come due (that is, not default on its
obligations).\689\ Consequently, as long as the obligor, security, or
money market instrument continues to be classified as in default there
is no credit rating performance to measure. However, if the credit
rating is upgraded from the default category because, for example, the
obligor emerges from a bankruptcy proceeding, the obligor's credit
rating will need to be included in a Transition/Default Matrix that has
a start date after the upgrade.\690\
---------------------------------------------------------------------------

    \688\ See paragraph (4)(A) of the instructions for Exhibit 1;
Nationally Recognized Statistical Rating Organizations, 76 FR at
33438-33439. The determination of whether the credit rating of the
obligor, security, or money market instrument should be excluded
from the start-date cohort would be based on the definition of