[Federal Register Volume 79, Number 178 (Monday, September 15, 2014)]
[Rules and Regulations]
[Pages 55077-55314]
[FR Doc No: 2014-20890]

Vol. 79

Monday,

No. 178

September 15, 2014

Part II

Securities and Exchange Commission

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

17 CFR Parts 232, 240, 249, et al.

 Nationally Recognized Statistical Rating Organizations; Final Rule

Federal Register / Vol. 79 , No. 178 / Monday, September 15, 2014 /
Rules and Regulations

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

SECURITIES AND EXCHANGE COMMISSION

17 CFR Parts 232, 240, 249, and 249b

[Release No. 34-72936; File No. S7-18-11]
RIN 3235-AL15

Nationally Recognized Statistical Rating Organizations

AGENCY: Securities and Exchange Commission.

ACTION: Final rules.

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

SUMMARY: In accordance with the Dodd-Frank Wall Street Reform and
Consumer Protection Act (``Dodd-Frank Act'') and to enhance oversight,
the Securities and Exchange Commission (``Commission'') is: adopting
amendments to existing rules and new rules that apply to credit rating
agencies registered with the Commission as nationally recognized
statistical rating organizations (``NRSROs''); adopting a new rule and
form that apply to providers of third-party due diligence services for
asset-backed securities; and adopting amendments to existing rules and
a new rule that implement a requirement added by the Dodd-Frank Act
that issuers and underwriters of asset-backed securities make publicly
available the findings and conclusions of any third-party due diligence
report obtained by the issuer or underwriter. The Commission also is
adopting certain technical amendments to existing rules.

DATES: This rule is effective November 14, 2014; except the amendments
to Sec.  240.17g-3(a)(7) and (b)(2) and Form NRSRO, which are effective
on January 1, 2015; and the amendments to Sec.  240.17g-2(a)(9),
(b)(13) through (15), Sec.  240.17g-5(a)(3)(iii)(E), (c)(6) through
(8), Sec.  240.17g-7(a) and (b), and Form ABS-15G, which are effective
June 15, 2015. The addition of Sec. Sec.  240.15Ga-2, 240.17g-8,
240.17g-9, 240.17g-10, and Form ABS Due Diligence-15E are effective
June 15, 2015.

FOR FURTHER INFORMATION CONTACT: Randall W. Roy, Assistant Director, at
(202) 551-5522; Raymond A. Lombardo, Branch Chief, at<PHONE_NUMBER>;
Rose Russo Wells, Senior Counsel, at<PHONE_NUMBER>; Division of
Trading and Markets; Harriet Orol, Branch Chief, at<PHONE_NUMBER>;
Kevin Vasel, Attorney, at<PHONE_NUMBER>; Office of Credit Ratings; or,
with respect to the rules for issuers and underwriters of asset-backed
securities, Michelle M. Stasny, Special Counsel in the Office of
Structured Finance, at<PHONE_NUMBER>; Division of Corporation Finance;
Securities and Exchange Commission, 100 F Street NE., Washington, DC
20549-7010.

SUPPLEMENTARY INFORMATION: The Commission, with respect to NRSROs, is
adopting amendments to rules 17 CFR 232.101 (``Rule 101 of Regulation
S-T''), 17 CFR 240.17g-1 (``Rule 17g-1''), 17 CFR 240.17g-2 (``Rule
17g-2''), 17 CFR 240.17g-3 (``Rule 17g-3''), 17 CFR 240.17g-5 (``Rule
17g-5''), 17 CFR 240.17g-6 (``Rule 17g-6''), 17 CFR 240.17g-7 (``Rule
17g-7''), and 17 CFR 249b.300 (``Form NRSRO''); and is adopting new
rules 17 CFR 240.17g-8 (``Rule 17g-8'') and 17 CFR 240.17g-9 (``Rule
17g-9'').
    In addition, the Commission, with respect to providers of third-
party due diligence services for asset-backed securities, is adopting
new rules 17 CFR 240.17g-10 (``Rule 17g-10'') and 17 CFR 249b.500
(``Form ABS Due Diligence-15E'').
    Finally, the Commission, with respect to issuers and underwriters
of asset-backed securities, is adopting amendments to 17 CFR 249.1400
(``Form ABS-15G'') and is adopting new rule 17 CFR 240.15Ga-2 (``Rule
15Ga-2'').

Table Of Contents

I. Introduction
    A. Background
    B. Economic Analysis
    1. Guiding Principles9
    2. Baseline
    a. NRSROs
    b. Asset-Backed Security Issuers, Underwriters, and Third-Party
Due Diligence Providers
    c. Industry Practices
    3. Broad Economic Considerations
    a. Amendments and Rules Enhancing NRSRO Governance and Integrity
of Credit Ratings
    b. Amendments and Rules Enhancing Disclosure and Transparency of
Credit Ratings
II. Final Rules and Rule Amendments
    A. Internal Control Structure
    1. Prescribing Factors
    2. Amendment to Rule 17g-2
    3. Amendments to Rule 17g-3
    4. Economic Analysis
    B. Sales And Marketing Conflict of Interest
    1. New Prohibited Conflict
    2. Exemption for ``Small'' NRSROs
    3. Suspending or Revoking a Registration
    4. Economic Analysis
    C. ``Look-Back'' Review
    1. Paragraph (c) of New Rule 17g-8
    2. Amendment to Rule 17g-2
    3. Economic Analysis
    D. Fines and Other Penalties
    1. Final Rule
    2. Economic Analysis
    E. Disclosure of Information About the Performance of Credit
Ratings
    1. Amendments to Instructions for Exhibit 1 to Form NRSRO
    a. Proposal
    b. Final Rule
    2. Amendments to Rule 17g-1
    3. Amendments to Rule 17g-2 and Rule 17g-7
    a. Proposal
    b. Final Rule
    4. Economic Analysis
    F. Credit Rating Methodologies
    1. Paragraph (a) of New Rule 17g-8
    2. Amendment to Rule 17g-2
    3. Economic Analysis
    G. Form And Certifications to Accompany Credit Ratings
    1. Paragraph (a) of Rule 17g-7--Prefatory Text
    2. Paragraph (a)(1)(i) of Rule 17g-7--Format of the Form
    3. Paragraph (a)(1)(ii) of Rule 17g-7--Content of the Form
    4. Paragraph (a)(1)(iii) of Rule 17g-7--Attestation
    5. Paragraph (a)(2) of Rule 17g-7--Third-Party Due Diligence
Certification
    6. Economic Analysis
    H. Third-Party Due Diligence for Asset-Backed Securities
    1. New Rule 15Ga-2 and Amendments to Form ABS-15G
    2. New Rule 17g-10
    3. New Form ABS Due Diligence-15E
    4. Economic Analysis
    I. Standards of Training, Experience, and Competence
    1. New Rule 17g-9
    2. Amendment to Rule 17g-2
    3. Economic Analysis
    J. Universal Rating Symbols
    1. Paragraph (b) of New Rule 17g-8
    2. Amendment to Rule 17g-2
    3. Economic Analysis
    K. Annual Report of Designated Compliance Officer
    1. Amendment to Rule 17g-3
    2. Economic Analysis
    L. Electronic Submission of Form NRSRO and the Rule 17g-3 Annual
Reports
    1. Amendments to Rule 17g-1, Form NRSRO, Rule 17g-3, and
Regulation S-T
    2. Economic Analysis
    M. Other Amendments
    1. Changing ``Furnish'' to ``File''
    2. Amended Definition of NRSRO
    3. Definition of Asset-Backed Security
    4. Other Amendments to Form NRSRO
    a. Clarification with Respect to Items 6 and 7
    b. Clarification with Respect to Exhibit 8
    c. Clarification with Respect to Exhibits 10 through 13
    5. Economic Analysis
III. Effective Dates
    A. Amendments Effective Sixty Days After Publication in the
Federal Register
    B. Amendments Effective On January 1, 2015
    C. Amendments and New Rules Effective Nine Months After
Publication In the Federal Register
IV. Paperwork Reduction Act
    A. Summary of the Collection of Information Requirements
    1. Amendments to Rule 17g-1
    2. Amendments to Instructions for Exhibit 1 to Form NRSRO
    3. Amendments to Rule 17g-2
    4. Amendments to Rule 17g-3
    5. Amendments to Rule 17g-5
    6. Amendments to Rule 17g-7
    7. New Rule 17g-8

    8. New Rule 17g-9
    9. New Rule 17g-10 and New Form ABS Due Diligence-15E
    10. New Rule 15Ga-2 and Amendments to Form ABS-15G
    11. Amendments to Regulation S-T
    12. Form ID
    B. Use of Information
    1. Amendments to Rule 17g-1
    2. Amendments to Instructions for Exhibit 1 to Form NRSRO
    3. Amendments to Rule 17g-2
    4. Amendments to Rule 17g-3
    5. Amendments to Rule 17g-5
    6. Amendments to Rule 17g-7
    7. New Rule 17g-8
    8. New Rule 17g-9
    9. New Rule 17g-10 and New Form ABS Due Diligence-15E
    10. New Rule 15Ga-2 and Amendments to Form ABS-15G
    11. Amendments to Regulation S-T
    12. Form ID
    C. Respondents
    D. Total Initial and Annual Recordkeeping and Reporting Burdens
    1. Amendments to Rule 17g-1
    2. Amendments to Form NRSRO Instructions
    3. Amendments to Rule 17g-2
    4. Amendments to Rule 17g-3
    5. Amendments to Rule 17g-5
    6. Amendments to Rule 17g-7
    7. New Rule 17g-8
    8. New Rule 17g-9
    9. New Rule 17g-10 and New Form ABS Due Diligence-15E
    10. New Rule 15Ga-2 and Amendments to Form ABS-15G
    11. Amendments to Regulation S-T
    12. Form ID
    13. Total Paperwork Burdens
    E. Collection of Information Is Mandatory
    F. Confidentiality
    G. Retention Period of Recordkeeping Requirements
V. Implementation and Annual Compliance Considerations
    A. Internal Control Structure
    B. Conflicts of Interest Relating to Sales and Marketing
    C. ``Look-Back'' Review
    D. Fines and Other Penalties
    E. Enhancements to Disclosures of Performance Statistics
    F. Enhancements to Rating Histories Disclosures
    G. Credit Rating Methodologies
    H. Form and Certification To Accompany Credit Ratings
    I. New Rule 15ga-2 and Amendments to Form Abs-15g
    J. New Rule 17g-10 and New Form ABS Due Diligence-15e
    K. Standards of Training, Experience, and Competence
    L. Universal Rating Symbols
    M. Electronic Submission of Form NRSRO and the Rule 17G-3 Annual
Reports
VI. Final Regulatory Flexibility Analysis
    A. Need for and Objectives of the Amendments and New Rules
    B. Significant Issues Raised by Public Comments
    C. Small Entities Subject to the Rules
    1. NRSROs and Providers of Third-Party Due Diligence Services
    2. Issuers
    D. Reporting, Recordkeeping, and Other Compliance Requirements
    E. Agency Action To Minimize Effect on Small Entities
VII. Statutory Authority

I. Introduction

A. Background

    The Dodd-Frank Act,\1\ through Title IX, Subtitle C, ``Improvements
to the Regulation of Credit Rating Agencies,'' among other things,
establishes new self-executing requirements applicable to NRSROs and
requires that the Commission adopt rules applicable to NRSROs in a
number of areas.\2\ It also requires certain studies relating to
NRSROs.\3\ The NRSRO provisions in the Dodd-Frank Act augment the
Credit Rating Agency Reform Act of 2006 (the ``Rating Agency Act of
2006''), which established a registration and oversight program for
NRSROs through self-executing provisions added to the Exchange Act and
implementing rules adopted by the Commission under the Exchange Act, as
amended by the Rating Agency Act of 2006.\4\ Title IX, Subtitle C of
the Dodd-Frank Act also provides that the Commission shall prescribe
the format of a certification that providers of third-party due
diligence services must provide to each NRSRO producing a credit rating
for an asset-backed security to which the due diligence services
relate.\5\ Finally, Title IX, Subtitle C of the Dodd-Frank Act
establishes a new requirement for issuers and underwriters of asset-
backed securities

to make publicly available the findings and conclusions of any third-
party due diligence report obtained by the issuer or underwriter.\6\
---------------------------------------------------------------------------

    \1\ Public Law 111-203, 124 Stat. 1376, H.R. 4173 (July 21,
2010).
    \2\ See Public Law 111-203, 931 through 939H. In addition, Title
IX, Subtitle D, ``Improvements to the Asset-Backed Securitization
Process,'' contains section 943, which provides that the Commission
shall adopt rules, within 180 days, requiring an NRSRO to include in
any report accompanying a credit rating of an asset-backed security
a description of the representations, warranties, and enforcement
mechanisms available to investors and how they differ from the
representations, warranties, and enforcement mechanisms in issuances
of similar securities. See Public Law 111-203, 943. On January 20,
2011, the Commission adopted Rule 17g-7 to implement section 943.
See Disclosure for Asset-Backed Securities Required by Section 943
of the Dodd-Frank Wall Street Reform and Consumer Protection Act,
Securities Act of 1933 (``Securities Act'') Release No. 9175 (Jan.
20, 2011), 76 FR 4489 (Jan. 26, 2011). Prior to enactment of the
Dodd-Frank Act and the adoption of Rule 17g-7, the Commission
proposed a different rule to be codified at 17 CFR 240.17g-7. See
Proposed Rules for Nationally Recognized Statistical Rating
Organizations, Securities Exchange Act of 1934 (``Exchange Act'')
Release No. 57967 (June 16, 2008), 73 FR 36212 (June 25, 2008). This
proposed rule would have required an NRSRO to publish a report
containing certain information with the publication of a credit
rating for a structured finance product or, as an alternative, use
ratings symbols for structured finance products that differentiate
them from the credit ratings for other types of debt securities. See
id. In November 2009, the Commission announced it was deferring
consideration of action on that proposal and separately proposed a
different rule to be codified at 17 CFR 240.17g-7 that would have
required an NRSRO to annually disclose certain information. See
Proposed Rules for Nationally Recognized Statistical Rating
Organizations, Exchange Act Release No. 61051 (Nov. 23, 2009), 74 FR
63866 (Dec. 4, 2009). As discussed above, a different rule from
either of these proposals ultimately was adopted and codified at 17
CFR 240.17g-7 in January 2011. See Disclosure for Asset-Backed
Securities Required by Section 943 of the Dodd-Frank Wall Street
Reform and Consumer Protection Act, 76 FR 4489.
    \3\ See Public Law 111-203, 939(h), 939C, 939D, 939E, 939F.
Pursuant to section 939(h) of the Dodd-Frank Act, the Commission
submitted a staff report to Congress on standardizing credit rating
terminology. See Report to Congress Credit Rating Standardization
Study As Required by Section 939(h) of the Dodd-Frank Wall Street
Reform and Consumer Protection Act (Sept. 2012), available at http:/
/www.sec.gov/news/studies/2012/
939hcreditratingstandardization.pdf
(``2012 Staff Report on Credit Rating Standardization''). Pursuant
to section 939F of the Dodd-Frank Act, the Commission submitted a
staff report to Congress on the feasibility of establishing a system
for assigning NRSROs to determine credit ratings for structured
finance products. See Report to Congress on Assigned Credit Ratings
As Required by Section 939F of the Dodd-Frank Wall Street Reform and
Consumer Protection Act (Dec. 2012), available at http://www.sec.gov/news/studies/2012/assigned-credit-ratings-study.pdf
(``2012 Staff Report on Assigned Credit Ratings''). Pursuant to
section 939C of the Dodd-Frank Act, the Commission submitted a staff
report to Congress on the independence of credit rating agencies.
See Report to Congress on Credit Rating Agency Independence Study As
Required by Section 939C of the Dodd-Frank Wall Street Reform and
Consumer Protection Act (Nov. 2013), available at http://www.sec.gov/news/studies/2013/credit-rating-agency-independence-study-2013.pdf (``2013 Staff Report on Credit Rating Agency
Independence'').
    \4\ See Public Law 109-291 (2006). The Rating Agency Act of
2006, among other things, amended section 3 of the Exchange Act to
add definitions, added section 15E to the Exchange Act to establish
self-executing requirements for NRSROs and provide the Commission
with the authority to implement a registration and oversight program
for NRSROs, amended section 17 of the Exchange Act to provide the
Commission with recordkeeping, reporting, and examination authority
over NRSROs, and amended section 21B(a) of the Exchange Act to
provide the Commission with the authority to assess penalties
``against any person'' in administrative proceedings instituted
under section 15E of the Exchange Act. See Public Law 109-291, 3 and
4; 15 U.S.C. 78c; 15 U.S.C. 78o-7; 15 U.S.C. 78q; 15 U.S.C. 78u-2.
The Commission adopted rules to implement a registration and
oversight program for NRSROs in June 2007. See Oversight of Credit
Rating Agencies Registered as Nationally Recognized Statistical
Rating Organizations, Exchange Act Release No. 55857 (June 5, 2007),
72 FR 33564 (June 18, 2007). The implementing rules were Form NRSRO,
Rule 17g-1, Rule 17g-2, Rule 17g-3, Rule 17g-4, Rule 17g-5, and Rule
17g-6. The Commission has twice adopted amendments to some of these
rules. See Amendments to Rules for Nationally Recognized Statistical
Rating Organizations, Exchange Act Release No. 59342 (Feb. 2, 2009),
74 FR 6456 (Feb. 9, 2009); Amendments to Rules for Nationally
Recognized Statistical Rating Organizations, Exchange Act Release
No. 61050 (Nov. 23, 2009), 74 FR 63832 (Dec. 4, 2009).
    \5\ See Public Law 111-203, 932(a)(8) (adding new paragraph
(s)(4)(C) to section 15E of the Exchange Act); 15 U.S.C. 78o-
7(s)(4)(C)).
    \6\ See Public Law 111-203, 932(a)(8) (adding new paragraph
(s)(4)(A) to section 15E of the Exchange Act); 15 U.S.C. 78o-
7(s)(4)(A).
---------------------------------------------------------------------------

    On May 18, 2011, the Commission proposed for comment amendments to
existing rules and new rules in accordance with Title IX, Subtitle C of
the Dodd-Frank Act and to enhance oversight of NRSROs.\7\ The
Commission received a number of comment letters in response to the
proposals.\8\ The comments on specific proposals are summarized below
in the corresponding sections of this release discussing the proposals
and the amendments and new rules being adopted today.
---------------------------------------------------------------------------

    \7\ See Nationally Recognized Statistical Rating Organizations,
Exchange Act Release No. 64514 (May 18, 2011), 76 FR 33420 (June 8,
2011). The Commission also proposed technical amendments to its
existing NRSRO rules. Id.
    \8\ See letter from Jeffrey W. Rubin, Chair, Business Law
Section, American Bar Association, dated Aug. 19, 2011 (``ABA
Letter''); letter from Bruce E. Stern, Chairman, Association of
Financial Guaranty Insurers, dated Aug. 8, 2011 (``AFGI Letter'');
letter from Gerald W. McEntee, President, American Federation of
State, County and Municipal Employees, dated Aug. 5, 2011 (``AFSCME
Letter''); letter from Marcus Stanley, Policy Director, Americans
for Financial Reform, dated Apr. 1, 2014 (``AFR II Letter''); letter
from Daryl Schubert, Chair, Auditing Standards Board, American
Institute of Certified Public Accountants, dated Aug. 10, 2011
(``AICPA Letter''); letter from Larry G. Mayewski, Executive Vice
President, A.M. Best, dated Aug. 8, 2011 (``A.M. Best Letter'');
letter from the Honorable Robert E. Andrews, U.S. Congress, House of
Representatives, dated Mar. 3, 2012 (``Andrews Letter''); letter
from Tom Deutsch, Executive Director, American Securitization Forum,
dated Aug. 8, 2011 (``ASF Letter''); letter from Chris Barnard dated
June 30, 2011 (``Barnard Letter''); letter from Joel Barton dated
Aug. 8, 2011 (``Barton Letter''); letter from Marie Benson dated
June 16, 2011 (``Benson Letter''); letter from Dennis M. Kelleher,
President & CEO, and Stephen W. Hall, Securities Specialist, Better
Markets, Inc., dated Aug. 8, 2011 (``Better Markets Letter'');
letter from Zenia Brown dated May 21, 2011 (``Brown Letter'');
letter from John J. Cadigan, General Partner, CECO LLC, dated June
15, 2011 (``Cadigan Letter''); letter from Nancy Campbell dated
Sept. 29, 2011 (``Campbell Letter''); letter from Barbara Roper,
Director of Investor Protection, Consumer Federation of America, and
Marcus Stanley, Policy Director, Americans for Financial Reform,
dated Aug. 8, 2011 (``CFA/AFR Letter''); letter from Micah Hauptman,
Financial Services Counsel, and Barbara Roper, Director of Investor
Protection, Consumer Federation of America, dated Mar. 3, 2014
(``CFA II Letter''); letter from Robert M. Chandler dated June 8,
2011 (``Chandler Letter''); letter from Laurel Leitner, Senior
Analyst, Council of Institutional Investors, dated Aug. 8, 2011
(``CII Letter''); letter from Susan R. Clark dated June 17, 2011
(``Clark Letter''); letter from Steven Cohen, Senior Vice President
and General Counsel, Clayton Holdings LLC, dated Aug. 8, 2011
(``Clayton Letter''); letter from Gregory W. Smith, Chief Operating
Officer, General Counsel, Colorado Public Employees Retirement
Association, dated Aug. 8, 2011 (``COPERA Letter''); letter from
Dave Cowen dated May 23, 2011 (``Cowen Letter''); letter from
Stephen M. Renna, Chief Executive Officer, CRE Finance Council,
dated Aug. 8, 2011 (``CRE Letter''); letter from Gary D. Cristofani
dated July 28, 2011 (``Cristofani Letter''); letter from William
Michael Cunningham, Creative Investment Research, Inc., dated May
23, 2005 (``Cunningham I Letter''); letter from William Michael
Cunningham, Creative Investment Research, Inc., dated July 4, 2011
(``Cunningham II Letter''); letter from Bonnie Davis dated June 16,
2011 (``Davis Letter''); letter from Theresa Day dated June 16, 2011
(``Day Letter''); letter from Daniel Curry, President, and Mary
Keogh, Managing Director, Regulatory Affairs, DBRS, Inc., dated Aug.
8, 2011 (``DBRS Letter''); letter from Daniel Curry, Chief Executive
Officer, and Mary Keogh, Managing Director, Global Regulatory
Affairs, DBRS, Inc., dated Dec. 5, 2013 (``DBRS II Letter''); letter
from Deloitte & Touche LLP dated Aug. 8, 2011 (``Deloitte Letter'');
letter from Sean Egan, Egan-Jones Ratings Company, dated Aug. 5,
2011 (``EJR Letter''); letter from Roberta Y. Ely dated June 17,
2011 (``Ely Letter''); letter from Ernst & Young LLP dated Aug. 8,
2011 (``Ernst & Young Letter''); letter from Anne S. McCulloch,
Senior Vice President and Deputy General Counsel, Federal National
Mortgage Association, dated Aug. 8, 2011 (``Fannie Mae Letter'');
letter from Charles D. Brown, General Counsel, Fitch, Inc., dated
Aug. 5, 2011 (``Fitch Letter''); letter from Marianne Freebury dated
June 16, 2011 (``Freebury Letter''); letter from Richard M. Whiting,
Executive Director and General Counsel, The Financial Services
Roundtable, dated Aug. 8, 2011 (``FSR Letter''); letter from Myrna
D. Gardner dated June 14, 2011 (``Gardner Letter''); letter from
Corrine M. Garza dated June 14, 2011 (``Garza Letter''); letter from
David Gaus dated Nov. 1, 2012 (``Gaus Letter); letter from William
J. Harrington, dated Aug. 8, 2011 (``Harrington Letter''); letter
from William J. Harrington dated May 29, 2014 (``Harrington II
Letter''); letter from Karrie McMillan, General Counsel, Investment
Company Institute, dated Aug. 8, 2011 (``ICI Letter''); letter from
KPMG LLP dated Aug. 8, 2011 (``KPMG Letter''); letter from Markus
Krebsz dated Nov. 4, 2010 (``Krebsz Letter''); letter from Jules B.
Kroll, Chairman and CEO, Kroll Bond Rating Agency, Inc., dated Aug.
8, 2011 (``Kroll Letter''); letter from Jules B. Kroll, Chairman and
CEO, Kroll Bond Rating Agency, Inc., dated August 19, 2014 (``Kroll
II Letter''); letter from Francis Lambert dated Aug. 8. 2011
(``Lambert Letter''); letter from Kashif Latif dated May 19, 2011
(``Latif Letter''); letter from the Honorable Carl Levin, U.S.
Senate, Permanent Subcommittee on Investigations, dated Aug. 8, 2011
(``Levin Letter''); letter from Dee Longenbaugh dated June 15, 2011
(``Longenbaugh Letter''); letter from Ray Lynch dated June 17, 2011
(``Lynch Letter''); letter from Craig R. Mills, CraigRMills LLC,
dated Aug. 19, 2011 (``Mills Letter''); letter from Michel Madelain,
President and Chief Operating Officer, Moody's Investors Service,
dated Aug. 8, 2011 (``Moody's Letter''); letter from Robert Dobilas,
President, Morningstar Credit Ratings, LLC, dated Aug. 8, 2011
(``Morningstar Letter''); letter from Kevin Overholt dated June 14,
2011 (``Overholt Letter''); letter from Maneesh Pangasa dated July
29, 2011 (``Pangasa Letter''); letter from PricewaterhouseCoopers,
LLP, dated Aug. 8, 2011 (``PWC Letter''); letter from William E.
Reno dated June 16, 2011 (``Reno Letter''); letter from LaVonne L.
Rhyneer dated June 17, 2011 (``Rhyneer Letter''); letter from Andrew
M. Siff, Esquire, Siff & Associates, PLLC, dated June 13, 2011
(``Siff Letter''); letter from Deven Sharma, President, Standard and
Poor's Ratings Services, dated Aug. 8, 2011 (``S&P Letter''); letter
from Anne Rutledge, President, TradeMetrics Corporation, dated Aug.
8, 2011 (``TradeMetrics Letter''). Copies of these letters are
available on the Commission's Web site at: http://www.sec.gov/comments/s7-18-11/s71811.shtml. In addition, in connection with the
Commission's solicitation of comments on the Commission's request
pursuant to the Paperwork Reduction Act of 1995 (44 U.S.C. 3501 et
seq.) for approval of the extension of the previously approved
collection of information provided for in Rule 17a-7, several
commenters submitted letters that are relevant to this rulemaking.
See letter from Daniel Curry, President, and Mary Keogh, Managing
Director, Regulatory Affairs, DBRS, Inc., dated Apr. 14, 2014
(``DBRS PRA Letter''); letter from Angela Y. Liang, Assistant
General Counsel, Kroll Bond Rating Agency, Inc., dated Apr. 17, 2014
(``Kroll PRA Letter''); and letter from Michael Kanef, Chief
Regulatory and Compliance Officer, Moody's Investors Service, dated
Apr. 28, 2014 (``Moody's PRA Letter'').
---------------------------------------------------------------------------

B. Economic Analysis

    The Commission has performed an economic analysis in connection
with today's adoption of the amendments and new rules discussed in
section II. of this release. The economic analysis is reflected in this
section I.B. of the release as well as throughout the rest of the
release.\9\
---------------------------------------------------------------------------

    \9\ The discussion of the amendments and new rules in section II
of this release is organized into sections that in large part are
based on the distinct rulemaking mandates in Title IX, Subtitle C of
the Dodd-Frank Act. See sections II.A. through II.M. of this
release. Each section includes an economic analysis that focuses
specifically on the amendments or rules being discussed in the
section.
---------------------------------------------------------------------------

1. Guiding Principles
    Title IX, Subtitle C of the Dodd-Frank Act mandates that the
Commission prescribe rules to improve regulation of NRSROs.\10\ Section
931 of the Dodd-Frank Act, ``Findings,'' introduces Title IX, Subtitle
C of the Dodd-Frank Act and provides context to what motivated Congress
to enact these provisions with respect to NRSROs.\11\ In particular,
Congress found:
---------------------------------------------------------------------------

    \10\ See Public Law 111-203, 931 through 939H, entitled
``Improvements to the Regulation of Credit Rating Agencies.''
    \11\ See Public Law 111-203, 931.
---------------------------------------------------------------------------

     Because of the systemic importance of credit ratings and
the reliance placed on credit ratings by individual and institutional
investors and financial regulators, the activities and performances of
credit rating agencies, including NRSROs, are matters of national
public interest, as credit rating agencies are central to capital
formation, investor confidence, and the efficient performance of the
U.S. economy.\12\
---------------------------------------------------------------------------

    \12\ See Public Law 111-203, 931(1).
---------------------------------------------------------------------------

     Credit rating agencies, including NRSROs, play a critical
``gatekeeper'' role in the debt market that is functionally similar to
that of securities analysts, who evaluate the quality of securities in
the equity market, and auditors, who review the financial statements of
firms. Such role justifies a similar level of public oversight and
accountability.\13\
---------------------------------------------------------------------------

    \13\ See Public Law 111-203, 931(2).
---------------------------------------------------------------------------

     Because credit rating agencies perform evaluative and
analytical services on behalf of clients, much as

other financial ``gatekeepers'' do, the activities of credit rating
agencies are fundamentally commercial in character and should be
subject to the same standards of liability and oversight as apply to
auditors, securities analysts, and investment bankers.\14\
---------------------------------------------------------------------------

    \14\ See Public Law 111-203, 931(3).
---------------------------------------------------------------------------

     In certain activities, particularly in advising arrangers
of structured financial products on potential ratings of such products,
credit rating agencies face conflicts of interest that need to be
carefully monitored and that therefore should be addressed explicitly
in legislation in order to give clearer authority to the
Commission.\15\
---------------------------------------------------------------------------

    \15\ See Public Law 111-203, 931(4).
---------------------------------------------------------------------------

     In the recent financial crisis, the ratings on structured
financial products have proven to be inaccurate. This inaccuracy
contributed significantly to the mismanagement of risks by financial
institutions and investors, which in turn adversely impacted the health
of the economy in the United States and around the world. Such
inaccuracy necessitates increased accountability on the part of credit
rating agencies.\16\
---------------------------------------------------------------------------

    \16\ See Public Law 111-203, 931(5).
---------------------------------------------------------------------------

    The amendments and new rules being adopted today to implement
sections 932, 936, and 938 of the Dodd-Frank Act are designed to
address these findings of Congress. For example, they are intended to
increase the integrity and transparency of credit ratings and promote
public oversight and accountability of NRSROs as ``gatekeepers'' for
the primary benefit of the users of credit ratings.\17\ The amendments
and new rules also prescribe new disclosure requirements relating to
structured finance products and, in particular, asset-backed
securities.\18\ These requirements are designed to address concerns
about the role of NRSROs in the financial crisis of 2007-2009 \19\ in
terms of how they rated certain types of structured finance products
and, in particular, the inherent conflicts of interest in rating these
products.\20\
---------------------------------------------------------------------------

    \17\ See John C. Coffee, Jr., Adolf A. Berle Professor of Law,
Columbia University Law School, Turmoil in the U.S. credit markets:
the role of the credit rating agencies (Apr. 22, 2008) (testimony
before the U.S. Senate Committee on Banking, Housing and Urban
Affairs), p. 1, available at http://www.banking.senate.gov/public/
files/
OpgStmtCoffeeSenateTestimonyTurmoilintheUSCreditMarkets.pdf
(``Coffee Testimony I'').
    \18\ The term structured finance product as used throughout this
release refers broadly to any security or money market instrument
issued by an asset pool or as part of any asset-backed or mortgage-
backed securities transaction. This broad category of financial
instrument includes an asset-backed security as defined in section
3(a)(79) of the Exchange Act (15 U.S.C. 78c(a)(79)) and other types
of structured debt instruments, including synthetic and hybrid
collateralized debt obligations (``CDOs''). The term Exchange Act-
ABS as used throughout this release refers more narrowly to an
asset-backed security as defined in section 3(a)(79) of the Exchange
Act. 15 U.S.C. 78c(a)(79).
    \19\ Throughout this Release, unless indicated otherwise, when
the Commission uses the term ``financial crisis'' it is referring to
the financial crisis that took place between 2007 and 2009.
    \20\ See Public Law 111-203, 931 (setting forth, among other
things, Congress' findings with respect to the role played by credit
ratings agencies, the services provided by credit ratings agencies,
certain conflicts of interests facing credit rating agencies, and
inaccuracies in ratings on structured finance products).
---------------------------------------------------------------------------

    In the market for structured finance products, the pool of assets
underlying or referenced by the product is often comprised of hundreds
of thousands of loans, each requiring time and expense to evaluate. In
these markets, the separation between the borrower and the ultimate
provider of credit can introduce significant information asymmetries
between the parties involved in the securitization process that creates
a structured finance product \21\ and investors in the product, who may
have less information on the credit quality and other relevant
characteristics of the asset pool.\22\ Further, disclosures to
investors regarding the asset pool may not be sufficiently detailed to
allow investors to adequately evaluate the quality of the collateral
backing the securities and, thereby, assess the credit risk of the
securities. Consequently, the market for structured finance products
has evolved as a ``rated'' market in which the credit risk of the
products is assessed by credit rating agencies \23\ and the valuations
of the products depend significantly on credit ratings.\24\ To curb
their informational disadvantage, certain investors in structured
finance products may use credit ratings to inform their investment
decisions.\25\
---------------------------------------------------------------------------

    \21\ Asset-backed securitization--the process used to create
asset-backed securities--is a financing technique in which financial
assets are pooled and converted into instruments that may be offered
and sold in the capital markets. In a basic securitization
structure, an entity--often a financial institution--originates or
otherwise acquires a pool of financial assets, such as mortgage
loans, either directly or through an affiliate. It then sells the
financial assets, again either directly or through an affiliate, for
the purpose of depositing them into a specially created investment
vehicle that issues securities ``backed'' by those financial assets.
Payment on the asset-backed securities depends primarily on the cash
flows generated by the assets in the underlying pool (and possibly
other rights designed to assure timely payment, generally known as
``credit enhancements''). See Asset-Backed Securities, Securities
Act Release No. 8518 (Dec. 22, 2004), 70 FR 1506 (Jan. 7, 2005).
    \22\ See Adam B. Ashcraft and Til Schuermann, Understanding the
Securitization of Subprime Mortgage Credit, Staff Report, Federal
Reserve Bank of New York, Working Paper No. 318 (2008). The authors
identify seven information frictions that can cause moral hazard and
adverse selection problems in a subprime mortgage securitization
transaction.
    \23\ See Joshua Coval, Jakub Jurek, and Erik Stafford, The
Economics of Structured Finance, 23(1) J. Econ. Perspectives 3-26
(2009).
    \24\ See Adam Ashcraft, Paul Goldsmith-Pinkham, Peter Hull, and
James Vickery, Credit Ratings and Security Prices in the Subprime
MBS Market, 101(3), Amer. Econ. Rev. 115-119 (2011).
    \25\ See Frank Partnoy, Overdependence on Credit Ratings Was a
Primary Cause of the Crisis, in The Panic of 2008: Causes,
Consequences, and Implications for Reform (Edward Elgar Press 2010,
Lawrence Mitchell and Arthur Wilmarth, eds.). References to credit
ratings in federal regulations also may have contributed to investor
reliance on credit ratings. Section 939A of the Dodd-Frank Act
requires each federal agency, including the Commission, to review
any regulation issued by such agency that requires the use of an
assessment of the creditworthiness of a security or money market
instruments and any references to or requirements in such
regulations regarding credit ratings. See Public Law 111-203, 939A.
The section further provides that each such agency shall ``modify
any such regulations identified by the review . . . to remove any
reference to or requirement of reliance on credit ratings, and to
substitute in such regulations such standard of creditworthiness as
each respective agency shall determine as appropriate for such
regulations.'' Id.
---------------------------------------------------------------------------

    Given that investors may not know the quality of the assets
underlying structured finance products, certain originators of these
assets may attempt to adversely transfer risks of poor origination
decisions to investors by creating complex and opaque structured
finance products.\26\ This risk is especially pronounced when the
originator, sponsor, depositor, or underwriter receives compensation
before investors learn about the quality of the assets.\27\ Because
origination fees

are based on transaction volume and risks are transferred to investors,
an originator may have the economic incentive to produce as many assets
(for example, mortgage loans) as possible without adequately screening
their credit quality.\28\
---------------------------------------------------------------------------

    \26\ See Chris Downing, Dwight Jaffee, and Nancy Wallace, Is the
Market for Mortgage-Backed Securities a Market for Lemons?, 22(7)
Rev. Fin. Stud. 2457-2494 (2009). The authors argue that the quality
of the assets sold to investors through securitization is lower than
the quality of similar assets that are not sold to investors. They
find empirical support for this proposition using a comprehensive
dataset of sales of mortgage-backed securities (Freddie Mac
Participation Certificates) to special-purpose vehicles over the
period 1991 through 2002.
    \27\ Several parties may be involved in the securitization
process that creates an asset-backed security, including an
originator, sponsor, depositor, issuing entity, underwriter, and
arranger. See generally Asset-Backed Securities, 70 FR at 1508. The
originator is the entity that creates a financial asset (for
example, mortgage loan, auto loan, or credit card receivable) that
collateralizes an asset-backed security through an extension of
credit or otherwise and that sells the asset to be included in an
asset-backed security. The sponsor is the entity that organizes and
initiates the asset-backed securities transaction by transferring
the financial assets underlying an asset-backed security directly or
indirectly to the issuing entity. The depositor is an entity that
receives or purchases the financial assets from the sponsor and
transfers them to the issuing entity (in some cases the sponsor
transfers the financial assets directly to the issuing entity,
thereby by-passing the use of a separate depositor). The issuing
entity is the trust or other vehicle created at the direction of the
sponsor or depositor that owns or holds the financial assets and in
whose name the asset-backed securities are issued. The underwriter
is the entity that underwrites the offering of asset-backed
securities and sells them to investors. The arranger is an entity
that organizes and arranges a securitization transaction, but does
not sell or transfer the assets to the issuing entity. It also
structures the transaction and may act as an underwriter for the
deal. In jurisdictions where an arranger is used, the arranger's
role is similar to that of a sponsor in other jurisdictions. In some
cases, a single entity may perform more than one function (for
example, a financial institution may act as an originator and
sponsor). The issuer of a structured finance product as used in this
release can mean, depending on the context, the issuing entity or
the person that organizes and initiates the offering of the
structured finance product (for example, the sponsor or depositor).
Generally, when this release discusses an issuer taking a specific
action in the context of an offering of a structured finance product
(for example, making a disclosure), the person that organizes and
initiates the offering would be the person taking the action (as
opposed to the issuing entity). Further, in the context of the
discussion of Rules 17g-10 and 15Ga-2, the term issuer (which is
defined in Rule 17g-10) includes a sponsor or depositor.
    \28\ See Amiyatosh Purnanandam, Originate-to-Distribute Model
and the Subprime Mortgage Crisis, 24(6) Rev. Fin. Stud. 1881-1915
(2011). The author argues that, during the financial crisis, banks
with high involvement in the originate-to-distribute market
originated excessively poor-quality mortgages, consistent with the
view that the originating banks did not expend resources to
adequately screen the credit quality of their borrowers.
---------------------------------------------------------------------------

    The rating process for structured finance products differs from the
rating process for corporate bonds, whose ratings are largely based on
publicly available data such as audited financial statements. The data
used in rating structured finance products is primarily provided by the
sponsor, depositor, or underwriter.\29\ Unlike credit ratings for
corporate bonds, credit ratings of structured finance products are
``highly sensitive to the assumptions of (1) default probability and
recovery value, (2) correlation of defaults, and (3) the relation
between payoffs and the economic states that investors care about
most.'' \30\ The rating process for these products may happen in the
reverse of how a more traditional product is rated because the sponsor,
depositor, arranger, or underwriter often decides before the structure
is finalized what credit rating it would like for each tranche of
securities to be issued, within the limits of what is possible, and
structures the product accordingly (for example, with regard to
selecting the underlying assets and establishing the credit
enhancements applicable to the different tranches of securities).
Concerns have been raised that the inherently iterative nature of the
process between the credit rating agency and the sponsor, depositor,
arranger, or underwriter may give rise to potential conflicts of
interest \31\ and that credit rating agencies marketing advisory and
consulting services to their clients during this process may accentuate
the conflict.\32\
---------------------------------------------------------------------------

    \29\ See Summary Report of Issues Identified in the Commission
Staff's Examinations of Select Credit Rating Agencies (July 2008),
available at http://www.sec.gov/news/studies/2008/craexamination070808.pdf (``2008 Staff Inspection Report''), pp. 7-
10. The report describes the rating process for a residential
mortgage-backed security (``RMBS'') and CDO at the three examined
credit rating agencies (Standard & Poor's Ratings Services, Moody's
Investor's Services, Inc., and Fitch, Inc.). For example, with
respect to a involving subprime loans, the arranger of the RMBS
typically initiates the rating process by sending the credit rating
agency data on each of the subprime loans to be held by the trust
(for example, principal amount, geographic location of the property,
credit history and FICO score of the borrower, ratio of the loan
amount to the value of the property, and type of loan), the proposed
capital structure of the trust and the proposed levels of credit
enhancement for each tranche issued by the trust. Id. at 7. Upon
receipt of the information, the credit rating agency assigns a lead
analyst who is responsible for analyzing the loan pool, the proposed
capital structure, and the proposed credit enhancement levels and,
ultimately, for formulating a rating recommendation to a rating
committee composed of analysts and/or senior-level analytic
personnel. Id. at 7. The rating committee votes on the credit
ratings for each tranche and usually communicates its decision to
the issuer. Id. at 9. In most cases, the issuer can appeal a rating
decision, although the appeal is not always granted (and, if
granted, may not necessarily result in any change in the rating
decision). Typically, the credit rating agency is paid for
determining the credit rating only if the credit rating is issued.
    \30\ See Coval, Jurek, and Stafford, The Economics of Structured
Finance, p. 23. The authors argue that, ``unlike corporate bonds,
whose fortunes are primarily driven by firm-specific considerations,
the performance of securities created by tranching large asset pools
is strongly affected by the performance of the economy as a whole.''
Id. at 23.
    \31\ See International Organization of Securities Commissions
(``IOSCO''), The Role of Credit Rating Agencies in Structured
Finance Markets (May 2008), p. 5 (``Some critics have argued that
the inherently iterative nature of this process may give rise to
potential conflicts of interest.'').
    \32\ See Coffee Testimony I, p. 3, (``Today, the rating agency
receives one fee to consult with a client, explain its model, and
indicate the likely outcome of the rating process; then, it receives
a second fee to actually deliver the rating (if the client wishes to
go forward once it has learned the likely outcome)''). Rule 17g-6
prohibits, among other things, an NRSRO from conditioning or
threatening to condition the issuance of a credit rating on the
purchase by an obligor or issuer, or an affiliate of the obligor or
issuer, of any other services or products, including pre-credit
rating assessment products, of the NRSRO or any person associated
with the NRSRO. See 17 CFR 240.17g-6(a)(1).
---------------------------------------------------------------------------

    Just prior to the financial crisis, the size of the structured
finance market was considerable. New issuances of RMBS, for example,
peaked in 2006 for a total of $801.7 billion.\33\ Low interest rates
drove investor demand for products that had high yields but also were
highly rated by the credit rating agencies.\34\ Mortgage originators
largely exhausted the supply of traditional quality mortgages and, to
keep up with investor demand for RMBS, subprime lending became
increasingly popular. As the number of delinquencies on subprime
mortgages suddenly soared in late 2007, RMBS lost a considerable amount
of value,\35\ and investors began to question the accuracy of credit
ratings assigned to RMBS and CDOs linked to RMBS.\36\ Certain academic
studies argue that, as the structured finance market boomed between
2004 and 2007, NRSROs might have had an incentive to generate revenue
by relaxing rating standards,\37\ inflating credit ratings,\38\
facilitating the sale of asset-backed securities by a small number of
large issuers,\39\ and reducing due diligence in

the presence of investors that solely rely on credit ratings.\40\ The
concerns about the accuracy of credit ratings fueled an emergent
reluctance to invest in these products.\41\ The new issuances of RMBS
totaled $715.3 billion in 2007 and plunged to $34.5 billion in 2008.
---------------------------------------------------------------------------

    \33\ The total amount of new issuances is calculated by staff in
the Commission's Division of Economics and Risk Analysis (``DERA'')
using Asset-Backed Alert and Commercial Mortgage Alert databases.
The amounts include only non-agency RMBS sold in the United States
through Commission-registered offerings, Rule 144A offerings, or
traditional private offerings.
    \34\ See Testimony of John B. Taylor, the Mary and Robert
Raymond Professor of Economics at Stanford University and George P.
Shultz Senior Fellow in Economics at Stanford's Hoover Institution,
before the Subcommittee on Monetary Policy and Trade Committee on
Financial Services, U.S. House of Representatives (Mar. 5, 2013),
available at http://financialservices.house.gov/uploadedfiles/hhrg-113-ba19-wstate-jtaylor-20130305.pdf.
    \35\ See Board of Governors of the Federal Reserve System
(``Federal Reserve''), Report to the Congress on Risk Retention
(Oct. 2010), pp. 50-51 (discussing the drop in the triple-A and
triple-B ABX.HE 2006-2 index (-70% by the end of 2008 for triple-A
rated and -95% for triple-B rated subprime RMBS issued in 2006)).
    \36\ See IOSCO, The Role of Credit Rating Agencies in Structured
Finance Markets, p. 2.
    \37\ See John M. Griffin and Dragon Yongjun Tang, Did
Subjectivity Play a Role in CDO Credit Ratings?, 67(4) J. Fin. 1293-
1328 (2012). The authors analyze a sample of 916 CDOs and find that
a large credit rating agency frequently made positive adjustments
outside its main model that resulted in increasingly larger AAA
tranche sizes. These adjustments are difficult to explain by likely
determinants, such as manager experience or credit enhancements, but
exhibit a clear pattern: CDOs with smaller model-implied AAA sizes
receive larger adjustments and CDOs with larger adjustments
experience more severe subsequent downgrading.
    \38\ See Vasiliki Skreta and Laura Veldkamp, Ratings Shopping
and Asset Complexity: A Theory of Ratings Inflation, 56 J. Monetary
Econ. 678-695 (2009); Efraim Benmelech and Jennifer Dlugosz, The
Credit Rating Crisis, NBER Working Paper No. 15045 (2009); Bo Becker
and Todd Milbourn, How Did Increased Competition Affect Credit
Ratings?, 101 J. Fin. Econ. 493-514 (2011); Andrew Cohen and Mark D.
Manuszak, Ratings Competition in the CMBS Market, 45(1) J. Money,
Credit and Banking 93-119 (2013).
    \39\ See Jie He, Jun Qian, and Philip E. Strahan, Credit Ratings
and the Evolution of the Mortgage-Backed Securities Market, 101(3)
Amer. Econ. Rev., 131-135 (2011). The authors find that in 2006 the
mortgage-backed securities (``MBS'') market was highly concentrated
among large issuers, with the top five accounting for 39% of all
newly issued securities; between 2004 and 2006, a larger fraction of
MBS sold by large issuers received triple-A ratings than MBS sold by
small issuers; and tranches sold by large issuers then experienced
larger price drops than those sold by smaller issuers when the
``housing bubble'' began to unravel.
    \40\ See Patrick Bolton, Xavier Freixas, and Joel Shapiro, The
Credit Ratings Game, 67(1) J. of Finance 85-111 (2012), available at
http://onlinelibrary.wiley.com/doi/10.1111/j.1540-6261.2011.01708.x/full. The authors develop a model of competition among credit rating
agencies that includes two types of investors with different
incentives to perform due diligence: sophisticated and ``trusting''
investors. Trusting investors take credit ratings at face value
because their compensation depends only marginally on the ex-post
returns of the assets they manage. In the authors' view, regulation
that forces money managers to only purchase investments with good
credit ratings could also provide incentives to be trusting. The
authors find that competition can reduce efficiency, as it
facilitates rating shopping. Moreover, credit ratings are more
likely to be inflated during booms and when investors are more
trusting.
    \41\ See Coval, Jurek, and Stafford, The Economics of Structured
Finance.
---------------------------------------------------------------------------

    In August 2007, the Commission staff initiated examinations of the
three largest credit rating agencies to review their role in the
turmoil in the subprime mortgage-related securities markets.\42\ Among
other things, these examinations revealed that the credit rating
agencies struggled to adjust the number of staff and resources employed
in the rating process to the increasing volume and complexity of RMBS
and CDOs.\43\ Certain significant aspects of the rating process and
methodologies used to rate RMBS and CDOs were not documented or
disclosed.\44\ The credit rating agencies examined did not have
specific written procedures for rating RMBS and CDOs.\45\ Also, the
credit rating agencies did not appear to have specific written policies
and procedures to identify or address errors in their models or
methodologies.\46\ In certain instances, Commission staff believed that
adjustments to models were made without appropriately documenting a
rationale for deviations from the model.\47\ Processes for performing
surveillance and monitoring of outstanding credit ratings on an ongoing
basis appeared to be less robust than the processes for determining
initial credit ratings.\48\ Moreover, in the Commission staff's view,
sufficient steps were not taken to prevent considerations of fees,
market share, or other business interests from influencing credit
ratings or rating criteria.\49\ Finally, the examined credit rating
agencies appeared to solely rely on the information provided by RMBS
sponsors.\50\ In particular, they did not appear to verify the
integrity and accuracy of such information as, in their view, due
diligence duties belonged to other parties and they did not appear to
seek representations from sponsors that due diligence was
performed.\51\
---------------------------------------------------------------------------

    \42\ See 2008 Staff Inspection Report.
    \43\ See 2008 Staff Inspection Report, p. 10-13.
    \44\ See 2008 Staff Inspection Report, p. 13.
    \45\ See 2008 Staff Inspection Report, p. 16 (``One rating
agency maintained comprehensive written procedures for rating
structured finance securities, but these procedures were not
specifically tailored to rating RMBS and CDOs. The written
procedures for the two other rating agencies were not comprehensive
and did not address all significant aspects of the RMBS and/or CDO
ratings process. For example, written materials set forth guidelines
for the structured finance ratings committee process (including its
composition, the roles of the lead analyst and chair, the contents
of the committee memo and the voting process) but did not describe
the ratings process and the analyst's responsibilities prior to the
time a proposed rating is presented to a ratings committee.'').
    \46\ See 2008 Staff Inspection Report, p. 17.
    \47\ Id. at 19.
    \48\ Id. at 21.
    \49\ Id. at 24.
    \50\ Id. at 18.
    \51\ Id. at 18.
---------------------------------------------------------------------------

    Following the financial crisis, the Dodd-Frank Act mandated
regulatory actions intended to enhance regulation, accountability, and
transparency of NRSROs.\52\ Generally, the majority of the rulemaking
mandated by the Dodd-Frank Act addresses all classes of credit ratings,
rather than credit ratings for only structured finance products.\53\ In
implementing the mandate, the amendments and new rules being adopted
today are designed to further enhance the governance of NRSROs in their
role as ``gatekeepers'' \54\ and increase the transparency of the
credit rating process as a whole. Further, as discussed in section II.
of this release, the amendments and new rules being adopted today
include new requirements designed to enhance transparency with respect
to structured finance products, including requirements for NRSROs to
disclose information about the performance and history of credit
ratings for subclasses of structured finance products and requirements
for NRSROs, issuers, underwriters, and providers of third-party due
diligence services to disclose information about due diligence services
performed with respect to asset-backed securities.\55\
---------------------------------------------------------------------------

    \52\ See Public Law 111-203, 932, entitled ``Enhanced
Regulation, Accountability, and Transparency of Nationally
Recognized Statistical Rating Organizations.''
    \53\ One commenter suggested that the proposed rules are overly
broad in their application and ``fail to sufficiently account for
the differences between corporate ratings (such as financial
strength ratings of insurance companies) and ratings of the
structured and asset-backed financial products that contributed to
the recent economic crisis.'' See A.M. Best Letter. The Commission
notes that the amendments and new rules being adopted today reflect
the statutory mandate that generally, with one exception, was not
limited to certain classes of credit ratings. In particular,
sections 932, 936 and 938 of the Dodd-Frank Act generally do not
focus exclusively on activities relating to rating structured
finance products, with the exception of section 932(s)(4) (which
focuses on third-party due diligence services with respect to asset-
backed securities).
    \54\ See John C. Coffee, Jr., Gatekeepers: The Professions and
Corporate Governance, Oxford University Press (2006).
    \55\ See sections II.E.1. and II.E.2. of this release
(discussing requirements for NRSROs to disclose performance
statistics and rating history information for subclasses of
structured finance products); sections II.G. and II.H. of this
release (discussing requirements to disclose information about
third-party due diligence services provided for asset-backed
securities).
---------------------------------------------------------------------------

2. Baseline
    The amendments and new rules being adopted today primarily affect
NRSROs, issuers, and underwriters of asset-backed securities, and
providers of third-party due diligence services for asset-backed
securities. To the extent that the new requirements change the business
practices of the primarily affected parties, such changes may also
affect clients of NRSROs (that is, obligors who pay NRSROs to obtain
entity credit ratings, issuers who pay NRSROs to obtain credit ratings
for their issued securities, subscribers who pay NRSROs to access
credit ratings and research, and persons who pay NRSROs for other
services), credit raters or credit rating agencies other than NRSROs,
parties involved in asset-backed securities markets (other than
issuers, underwriters, third-party due diligence providers, and
NRSROs), and users of credit ratings in general.
    The baseline against which economic costs and benefits, as well the
impact of the amendments and new rules being adopted today on
efficiency, competition, and capital formation, are measured is the
situation in existence today, prior to the adoption of the amendments
and rules. The baseline includes an estimate of the number of entities
that will likely be directly affected by the amendments and rules and a
description of the relevant features of the regulatory and economic
environment in which the affected entities operate. The discussion
below identifies the main features of the regulatory and economic
baseline, which will be further developed in section II of this release
discussing the amendments and rules, including in the

focused economic analyses that follow the discussions of the amendments
and rules.
a. NRSROs
    As discussed above, the Rating Agency Act of 2006, among other
things, amended section 3 of the Exchange Act to add definitions, added
section 15E to the Exchange Act to establish self-executing
requirements for NRSROs and provide the Commission with the authority
to implement a registration and oversight program for NRSROs, amended
section 17 of the Exchange Act to provide the Commission with
recordkeeping, reporting, and examination authority over NRSROs, and
amended section 21B(a) of the Exchange Act to provide the Commission
with the authority to assess penalties ``against any person'' in
administrative proceedings instituted under section 15E of the Exchange
Act.\56\
---------------------------------------------------------------------------

    \56\ See Public Law 109-291, 3, 4; 15 U.S.C. 78c; 15 U.S.C. 78o-
7; 15 U.S.C. 78q; 15 U.S.C. 78u-2.
---------------------------------------------------------------------------

    To implement the Rating Agency Act of 2006, the Commission adopted
Rules 17g-1 through 17g-6 and Form NRSRO.\57\ Section 943 of the Dodd-
Frank Act mandates that the Commission adopt rules requiring an NRSRO
to include in any report accompanying a credit rating of an asset-
backed security a description of the representations, warranties, and
enforcement mechanisms available to investors and how they differ from
the representations, warranties, and enforcement mechanisms in
issuances of similar securities.\58\ In January 2011, the Commission
adopted Rule 17g-7 to implement section 943.\59\ The Exchange Act,
Rules 17g-1 through 17g-7, and Form NRSRO represent the baseline for
the amendments and new rules being adopted today in terms of
requirements applicable to NRSROs.
---------------------------------------------------------------------------

    \57\ See Oversight of Credit Rating Agencies Registered as
Nationally Recognized Statistical Rating Organizations, 72 FR 33564.
    \58\ See Public Law 111-203, 943.
    \59\ See Disclosure for Asset-Backed Securities Required by
Section 943 of the Dodd-Frank Wall Street Reform and Consumer
Protection Act, 76 FR 4489.
---------------------------------------------------------------------------

    Pursuant to section 6 of the Rating Agency Act of 2006, the
Commission is required to submit an annual report to the Committee on
Banking, Housing, and Urban Affairs of the Senate and the Committee on
Financial Services of the House of Representatives that includes the
views of the Commission on the state of competition, transparency, and
conflicts of interest among NRSROs.\60\ In addition, section 15E(b) of
the Exchange Act provides that not later than ninety days after the end
of each calendar year, each 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 or documents during the previous calendar year; and (3)
amending its credit ratings performance statistics.\61\ Rule 17g-1
requires these filings (``annual certifications'') to be made on Form
NRSRO.\62\ Further, each NRSRO is required to furnish the Commission
with annual reports containing audited financial statements and
information about revenues and other matters.\63\ The Commission's
annual reports submitted to Congress and the NRSROs' annual
certifications and annual reports are an integral part of establishing
the baseline for the amendments and new rules being adopted today, as
discussed below.
---------------------------------------------------------------------------

    \60\ See Public Law 109-291, 6. The Commission staff annual
reports are available at http://www.sec.gov/ocr.
    \61\ See 15 U.S.C. 78o-7(b).
    \62\ See paragraph (f) of Rule 17g-1. See also Oversight of
Credit Rating Agencies Registered as Nationally Recognized
Statistical Rating Organizations, 72 FR at 33567, 33569-33582.
    \63\ See 17 CFR 240.17g-3.
---------------------------------------------------------------------------

    As of today, there are ten credit rating agencies registered with
the Commission as NRSROs.\64\ Based on the annual reports the NRSROs
furnish with the Commission, in their 2013 fiscal years, the ten NRSROs
had $5.4 billion of total revenue--an approximate 6% increase over
their 2012 fiscal years. In addition, based on their annual
certifications, the NRSROs employed a total of 4,218 credit analysts at
the end of the 2013 calendar year. Table 1 shows the number of credit
analysts employed by each NRSRO at the end of the 2013 calendar year
and, of the total number of credit analysts employed by the NRSROs, the
percent of credit analysts at S&P, Moody's, and Fitch (90%) and the
remaining seven NRSROs (10%).
---------------------------------------------------------------------------

    \64\ The ten NRSROs are: A.M. Best Company, Inc. (``A.M.
Best''); DBRS, Inc. (``DBRS''); Egan-Jones Ratings Company
(``EJR''); Fitch, Inc. (``Fitch''); HR Ratings de Mexico, S.A. de
C.V. (``HR Ratings''); Japan Credit Rating Agency, Ltd. (``JCR'');
Kroll Bond Rating Agency, Inc. (``Kroll''); Moody's Investor's
Services, Inc. (``Moody's''); Morningstar Credit Ratings, LLC
(``Morningstar''); and Standard & Poor's Ratings Services (``S&P'').
See Commission staff, Annual Report on Nationally Recognized
Statistical Rating Organizations (Dec. 2013), p. 6, available at
http://www.sec.gov/divisions/marketreg/ratingagency/nrsroannrep1213.pdf. (``2013 Annual Staff Report on NRSROs'').

        Table 1--Credit Analysts Employed by NRSROs (as of [--])
------------------------------------------------------------------------
                  NRSROs                       Total credit analysts
------------------------------------------------------------------------
S&P, Moody's, & Fitch....................  90%
Other NRSROs.............................  10%
A.M. Best................................  123
DBRS.....................................  98
EJR......................................  7
Fitch....................................  1,102
HR Ratings...............................  34
JCR......................................  57
Kroll....................................  58
Moody's..................................  1,244
Morningstar..............................  30
S&P......................................  1,465
                                          ------------------------------
    Total................................  4,218
------------------------------------------------------------------------
Note: The total number of credit analysts, including credit analyst
  supervisors, is provided by each NRSRO in Exhibit 8 to Form NRSRO,
  which is available on each NRSRO's Web site.

    Among other things, the operations of the ten NRSROs differ in
terms of business model, classes of credit ratings for which they are
registered, history of issuing credit ratings, size, and market share.
Of the ten NRSROs, seven operate primarily under the issuer-pay
model,\65\ in which an obligor pays the NRSRO to rate it as an entity
or an issuer pays the NRSRO to rate the securities it issues.\66\ One
NRSRO operates exclusively under the subscriber-pay model,\67\ in which

subscribers pay a fee to access the credit ratings issued by the
NRSRO.\68\ Two NRSROs previously operated primarily under the
subscriber-pay model but for several years have been issuing an
increasing number of credit ratings paid for by the obligor being rated
or the issuer of the securities that are rated.\69\
---------------------------------------------------------------------------

    \65\ The seven NRSROs are A.M. Best, DBRS, Fitch, HR Ratings,
JCR, Moody's, and S&P. See 2013 Annual Staff Report on NRSROs, p. 6.
    \66\ The issuer-pay model often raises concerns of potential
conflicts of interest because the collection of fees from rated
entities and issuers of rated securities, as a principal source of
revenue, may provide an NRSRO with an economic incentive to issue
inflated ratings as a way to promote business with its clients.
Several academic studies try to answer theoretically and empirically
the question of whether reputational concerns of a credit rating
agency effectively neutralize potential conflicts of interest in the
issuer-pay model. The conclusions of these studies are neither
unanimous nor definite. For example, recently, Kashyap and
Kovrijnykh (2013) found that, under the issuer-pay model, a credit
rating is less accurate than under the subscriber-pay model.
However, the authors found that subscribers tend to ask for a credit
rating inefficiently (that is, when the expected quality of the
rated entity or security is sufficiently high) and that the
subscriber-pay model suffers from a potential free-riding problem.
Cole and Cooley (2014) argue that much of the regulatory concerns
with the conflict created by issuers paying for ratings are a
distraction. The authors argue that in equilibrium, reputation
ensures that credit ratings have value and reflect sound assessments
of creditworthiness. Regulatory reliance on credit ratings and the
importance of risk-weighted capital in prudential regulation more
likely contributed to distorted credit ratings than the matter of
who pays for them. See Anil Kashyap and Natalia Kovrijnykh, Who
Should Pay for Credit Ratings and How?, NBER working paper No. 18923
(Mar. 2013); Harold Cole and Thomas F. Cooley, Rating Agencies, NBER
working paper No. 19972 (Mar. 2014).
    \67\ The one NRSRO is EJR. See 2013 Annual Staff Report on
NRSROs, p. 6.
    \68\ See 2013 Annual Staff Report on NRSROs, p. 23. The
subscriber-pay model also is subject to potential conflicts of
interest. See id. at p. 23. For example, the NRSRO may be aware that
an influential subscriber holds a securities position (long or
short) that could be advantaged if a credit rating upgrade or
downgrade causes the market value of the security to increase or
decrease; or that the subscriber invests in newly issued bonds and
would obtain higher yields if the bonds were to have lower credit
ratings. Another example of a conflict in the subscriber-pay model
is that the NRSRO may be aware that a subscriber wishes to acquire a
particular security but is prevented from doing so because the
credit rating of the security is lower than internal investment
guidelines or an applicable contract permit.
    \69\ The two NRSROs are Kroll and Morningstar. See 2013 Annual
Staff Report on NRSROs, p. 7.
---------------------------------------------------------------------------

    The ten NRSROs also differ by the scope of their business and, in
particular, by whether their operations include products and services
other than credit ratings,\70\ which can be provided through business
lines, segments, groups, or divisions within the NRSROs or through
affiliated companies or other businesses not within the NRSRO.\71\ For
credit ratings, there are five classes of credit ratings for which a
credit rating agency can be registered as an NRSRO: (1) Financial
institutions, brokers, or dealers; (2) insurance companies; (3)
corporate issuers; (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''); and (5) issuers of government securities, municipal
securities, or securities issued by a foreign government.\72\ Eight of
the NRSROs are registered in multiple classes, while two NRSROs are
registered in one class.\73\ Table 2 shows the approximate number of
outstanding credit ratings as reported by each NRSRO in its annual
certification for the 2013 calendar year end, in each of the five
categories for which the NRSRO is registered.
---------------------------------------------------------------------------

    \70\ Ancillary services often raise concerns of potential
conflicts of interest because, for example, an NRSRO might issue a
more favorable credit rating to an issuer in exchange for purchasing
ancillary services, or an issuer that purchases a large amount of
ancillary services might pressure the NRSRO to issue a more
favorable credit rating for the issuer. See 2013 Staff Report on
Credit Rating Agency Independence, pp. 21-24. Another concern with
respect to ancillary services is that they might have involved an
NRSRO making recommendations on the structure of a security to be
rated. Id. at 22-23. Paragraph (c)(5) of Rule 17g-5 prohibits an
NRSRO from issuing or maintaining a credit rating with respect to an
obligor or security where the NRSRO or a person associated with the
NRSRO made recommendations to the obligor or the issuer,
underwriter, or sponsor of the security about the corporate or legal
structure, assets, liabilities, or activities of the obligor or
issuer of the security. See 17 CFR 240.17g-5(c)(5). In addition,
Rule 17g-6 prohibits, among other things, an NRSRO from: (1)
Conditioning or threatening to condition the issuance of a credit
rating on the purchase by an obligor or issuer, or an affiliate of
the obligor or issuer, of any other services or products, including
pre-credit rating assessment products, of the NRSRO or any person
associated with the NRSRO; (2) issuing, or offering or threatening
to issue, a credit rating that is not determined in accordance with
the NRSRO's established procedures and methodologies for determining
credit ratings, based on whether the rated person, or an affiliate
of the rated person, purchases or will purchase the credit rating or
any other service or product of the NRSRO or any person associated
with the NRSRO; and (3) modifying, or offering or threatening to
modify, a credit rating in a manner that is contrary to the NRSRO's
established procedures and methodologies for modifying credit
ratings based on whether the rated person, or an affiliate of the
rated person, purchases or will purchase the credit rating or any
other service or product of the NRSRO or any person associated with
the NRSRO. See 17 CFR 240.17g-6.
    \71\ See 2013 Staff Report on Credit Rating Agency Independence,
p. 19.
    \72\ See 15 U.S.C. 78c(a)(62) (defining the term nationally
recognized statistical rating organization).
    \73\ See 2013 Annual Staff Report on NRSROs, p. 8.

                  Table 2--Approximate Number of NRSRO Credit Ratings Outstanding by Class of Credit Rating (as of [December 31, 2013])
--------------------------------------------------------------------------------------------------------------------------------------------------------
                                      Financial            Insurance                             Asset-backed         Government
             NRSROs                  institutions          companies       Corporate issuers      securities          securities         Total ratings
--------------------------------------------------------------------------------------------------------------------------------------------------------
S&P, Moody's, & Fitch..........  84%                  74%                 92%                 90%                 99%                 97%
Other NRSROs...................  16%                  26%                 8%                  10%                 1%                  3%
A.M. Best......................  N/R                  4,492               1,653               56                  N/R                 6,201
DBRS...........................  13,624               150                 3,790               10,706              16,038              44,308
EJR............................  104                  46                  877                 N/R                 N/R                 1,027
Fitch..........................  49,821               3,222               15,299              53,612              204,303             326,257
HR Ratings.....................  N/R                  N/R                 N/R                 N/R                 189                 189
JCR............................  150                  27                  463                 N/R                 56                  696
Kroll..........................  15,982               44                  2,749               1,401               25                  20,201
Moody's........................  53,383               3,418               40,008              76,464              728,627             901,900
Morningstar....................  N/R                  N/R                 N/R                 11,567              N/R                 11,567
S&P............................  59,000               7,200               49,700              90,000              918,800             1,124,700
                                ------------------------------------------------------------------------------------------------------------------------
    Total......................  192,064              18,599              114,539             243,806             1,868,038           2,437,046
--------------------------------------------------------------------------------------------------------------------------------------------------------
Note: The approximate number of NRSRO credit ratings outstanding as of December 31, 2013 is provided by each NRSRO in its annual certification, which is
  available on each NRSRO's Web site. ``N/R'' indicates that an NRSRO is not registered for that class of credit rating.

    As shown in Table 2, S&P has the greatest number of outstanding
credit ratings in each of the five classes. S&P, Moody's, and Fitch are
the top three producers of credit ratings in every class of credit
ratings except for insurance companies (in this class, A.M. Best has
the second highest number of outstanding credit ratings after S&P).
Overall, S&P accounts for about 46% of the total NRSRO credit ratings
outstanding, followed by Moody's (37%) and Fitch (13%), implying that
two NRSROs (S&P and Moody's) account for 83% of all credit ratings
outstanding and three NRSROs (S&P, Moody's, and Fitch) account for
approximately 97%. Also, as discussed above, Table 1 shows that these
three NRSROs employ 90% of the total number of NRSRO credit analysts.
Comparing the number of credit ratings outstanding for established
NRSROs and newly registered NRSROs may not provide a complete picture
of competition in the industry. The incumbent NRSROs (particularly S&P,
Moody's, and Fitch) have a longer history of issuing credit ratings,
and their credit ratings include those for

debt obligations and obligors that were rated long before the
establishment of the newer entrants.\74\
---------------------------------------------------------------------------

    \74\ See 2013 Annual Staff Report on NRSROs, p. 12.
---------------------------------------------------------------------------

    Recent trends in the industry structure are shown in Table 3, which
reports the inverse of the Herfindahl-Hirschman Index (HHI) as a
measure of industry concentration by rating class.\75\ The HHI inverse
is calculated from 2007 to 2013 for credit ratings outstanding as
reported by the NRSROs in each rating class. Table 3 shows that the
NRSRO industry concentration for all rating classes has moderately
increased as suggested by the decrease in the HHI inverse since 2010.
Despite a monotonic increase in competition in the rating class of
asset-backed securities, the NRSRO industry remains concentrated, with
the three largest NRSROs accounting for approximately 95% of the
NRSROs' 2013 fiscal year total revenue, based on the annual reports the
NRSROs furnish to the Commission.
---------------------------------------------------------------------------

    \75\ The inverse of HHI can be interpreted as the number of
equally-sized firms necessary to replicate the degree of
concentration in a particular industry.

                                        Table 3--Inverse of Herfindahl-Hirschman Index by Class of Credit Rating
--------------------------------------------------------------------------------------------------------------------------------------------------------
                                                             Financial       Insurance       Corporate     Asset-backed     Government
                          Year                             institutions      companies        issuers       securities      securities     Total ratings
--------------------------------------------------------------------------------------------------------------------------------------------------------
2007....................................................            3.37            4.02            3.27            2.71            2.35            2.65
2008....................................................            3.72            4.05            3.79            2.82            2.83            2.99
2009....................................................            3.85            3.84            3.18            3.18            2.65            2.86
2010....................................................            3.99            3.37            3.17            3.20            2.69            2.88
2011....................................................            4.16            3.76            3.02            3.38            2.47            2.74
2012....................................................            4.04            3.72            3.00            3.44            2.50            2.75
2013....................................................            3.99            3.68            3.03            3.48            2.46            2.72
--------------------------------------------------------------------------------------------------------------------------------------------------------
Note: The inverse of HHI is determined using the approximate numbers of NRSRO credit ratings outstanding reported in the Commission staff annual reports
  on NRSROs published in June 2008, September 2009, January 2011, March 2012, December 2012, and December 2013. For the 2013 calendar year end, the
  inverse of HHI is calculated using the number of outstanding credit ratings reported by NRSROs in their annual certifications.

    In particular, for the asset-backed security class--which includes,
among other things, RMBS, commercial mortgage backed securities
(``CMBS''), and consumer finance and other asset-backed securities--
Table 4 below shows the number of credit ratings outstanding from 2007
to 2013. The total number of outstanding credit ratings has
significantly decreased (by 38%) since 2007, mostly due to pay-downs of
existing asset-backed securities that have not been replaced by newly
issued asset-backed securities that are rated by NRSROs.\76\ While the
three largest NRSROs accounted for 97% of the outstanding credit
ratings for asset-backed securities in 2007, this number decreased to
90% in 2013.
---------------------------------------------------------------------------

    \76\ See 2013 Annual Staff Report on NRSROs, p. 12.

                                                  Table 4--Approximate Number of Credit Ratings Outstanding in the Asset-Backed Security Class
------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
              NRSROs                        2007                   2008                   2009                   2010                   2011                  2012                  2013
------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
S&P, Moody's, & Fitch............  97%                    96%                    94%                    94%                    91%                    91%                   90%
Other NRSROs.....................  3%                     4%                     6%                     6%                     9%                     9%                    10%
A.M. Best........................  54                     54                     54                     54                     56                     55                    56
DBRS.............................  840                    7,470                  8,430                  10,091                 9,889                  10,054                10,706
EJR..............................  --                     14                     14                     13                     13                     N/R                   N/R
Fitch............................  72,278                 77,480                 69,515                 64,535                 58,315                 56,311                53,612
HR Ratings.......................  --                     --                     --                     --                     --                     N/R                   N/R
JCR..............................  68                     71                     64                     N/R                    N/R                    N/R                   N/R
Kroll............................  246                    0                      0                      0                      40                     352                   1,401
Moody's..........................  110,000                109,261                106,337                101,546                93,913                 82,357                76,464
Morningstar......................  10,235                 9,200                  8,856                  8,322                  16,070                 13,935                11,567
R&I..............................  214                    210                    186                    N/R                    --                     --                    --
S&P..............................  197,700                198,200                124,600                117,900                108,400                97,500                90,000
                                  --------------------------------------------------------------------------------------------------------------------------------------------------------------
    Total........................  391,635                401,960                318,056                302,461                286,696                260,564               243,806
------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
Note: ``N/R'' indicates that an NRSRO is not registered for the asset-backed security class of credit ratings and ``--'' indicates that the credit rating agency was not registered as an NRSRO
  for the applicable year. Kroll acquired LACE Financial Corp. in August 2010. Morningstar, formerly known as Realpoint LLC, changed its name in 2011. Rating and Investment Information, Inc.
  (``R&I'') withdrew its registration as an NRSRO with the Commission in October 2011. HR Ratings became registered as an NRSRO in 2012. Statistics come from the Commission staff annual
  reports on NRSROs published in June 2008, September 2009, January 2011, March 2012, December 2012, and December 2013. For calendar year 2013, the statistics come from the annual
  certifications of the NRSROs.

    In 2013, some of the relatively newer or smaller NRSROs increased
their market shares in terms of rating asset-backed securities. Table 5
reports full-year credit rating agency information for 2013, compared
to 2007, the year immediately prior to the financial crisis. As the
total issuances of asset-backed securities decreased considerably from
2007 to 2013, DBRS has maintained its market share in rating new
issuances and has become the most active participant in rating RMBS,
while S&P, Moody's and Fitch have lost market shares. DBRS, Kroll, and
Morningstar have gained market shares in rating CMBS after the
financial crisis and have rated a significant number of newly issued
CMBS in 2013. Finally, in the market for rating consumer finance and
other asset-backed securities, which has

the largest number of issuances, DBRS and Kroll have increased their
market shares, although S&P, Moody's and Fitch continue to play a
significant role.

         Table 5--Market Shares of Credit Rating Agencies for RMBS, CMBS, and Consumer Finance and Other Asset-Backed Securities, 2013 and 2007
--------------------------------------------------------------------------------------------------------------------------------------------------------
                                                          2013 Issuance   Number of      Market     2007 Issuance   Number of      Market     2007-2013
               Rank                       NRSROs            ($ mil.)      offerings    share  (%)     ($ mil.)      offerings    share  (%)  Change  (%)
--------------------------------------------------------------------------------------------------------------------------------------------------------
                                                         Residential mortgage-backed securities
--------------------------------------------------------------------------------------------------------------------------------------------------------
1................................  DBRS................      $12,501.90           50         61.4      $12,817.60           20          2.9         -2.5
2................................  Fitch...............        9,969.60           23         48.9      253,721.10          318         58.2        -96.1
3................................  S&P.................        9,597.50           23         47.1      409,532.40          534         94.0        -97.7
4................................  Kroll...............        7,908.70           17         38.8             N/A          N/A          N/A          N/A
5................................  Moody's.............        3,796.00            9         18.6      324,923.50          421         74.6        -98.8
                                                        ------------------------------------------------------------------------------------------------
    Total........................  ....................       20,372.00           68        100.0      435,815.60          575        100.0        -95.3
--------------------------------------------------------------------------------------------------------------------------------------------------------
                                                          Commercial mortgage-backed securities
--------------------------------------------------------------------------------------------------------------------------------------------------------
1................................  Moody's.............      $62,802.60           67         72.9     $171,787.00           61         74.6        -63.4
2................................  Fitch...............       50,447.70           56         58.6      159,687.30           60         69.4        -68.4
3................................  Kroll...............       45,140.10           55         52.4             N/A          N/A          N/A          N/A
4................................  S&P.................       34,255.20           49         39.8      202,381.00           71         87.9        -83.1
5................................  DBRS................       18,574.90           26         21.6       13,295.30            6          5.8         39.7
6................................  Morningstar.........       17,089.00           27         19.8             N/A          N/A          N/A          N/A
                                                        ------------------------------------------------------------------------------------------------
    Total........................  ....................       86,135.80          122        100.0      230,195.80           86        100.0        -62.6
--------------------------------------------------------------------------------------------------------------------------------------------------------
                                                   Consumer finance and other asset-backed securities
--------------------------------------------------------------------------------------------------------------------------------------------------------
1................................  S&P.................     $134,860.60          244         69.3     $576,417.90          884         96.7        -76.6
2................................  Moody's.............      114,569.90          155         58.9      563,982.90          735         94.6        -79.7
3................................  Fitch...............      113,213.80          156         58.2      342,140.10          418         57.4        -66.9
4................................  DBRS................       16,530.60           51          8.5       43,102.70           73          7.2        -61.6
5................................  Kroll...............        3,983.10           16          2.0             N/A          N/A          N/A          N/A
                                                        ------------------------------------------------------------------------------------------------
    Total........................  ....................      194,600.70          341        100.0      596,016.20          981        100.0        -67.3
--------------------------------------------------------------------------------------------------------------------------------------------------------
Note: A single offering of asset-backed securities may consist of multiple tranches of securities. An NRSRO may rate one or multiple tranches of the
  securities issued in the offering. Market shares of individual NRSROs do not add up to 100% since more than one NRSRO may rate a particular offering.
  ``N/A'' indicates that statistics are not available for 2007. CMBS data relates to U.S. CMBS, including U.S. conduit/fusion and U.S. single borrower.
  Data comes from Asset-Backed Alert and Commercial Mortgage Alert Web sites, publicly available at http://www.abalert.com/ranks.php and http://www.cmalert.com/ranks.php.

b. Asset-Backed Security Issuers, Underwriters, and Third-Party Due
Diligence Providers
    The asset-backed security market that existed in the United States
as of the end of 2013 differed significantly from the market prior to
the crisis. In 2004, issuing entities of non-agency asset-backed
securities held $2.6 trillion in assets, which grew to $4.5 trillion in
2007 and declined to $1.6 trillion in 2013.\77\ Table 6 presents
issuance amounts, number of offerings, and number of unique issuers for
non-agency asset-backed securities, categorized by type of
offering.\78\ While new issuances of registered asset-backed securities
represented the majority of offerings and totaled $1.0 trillion in
2004, they drastically dropped to $140.7 billion in 2008. In 2013, the
asset-backed security market totaled $393.6 billion, of which $174.1
billion is the new issuance amount of registered asset-backed
securities.
---------------------------------------------------------------------------

    \77\ This information is derived from data compiled by the
Federal Reserve and published in quarterly Z.1 releases, which are
available at http://www.federalreserve.gov/releases/Z1/default.htm.
Statistics include private mortgage pools, consumer credit, business
loans, student loans, consumer leases, and trade credit
securitization.
    \78\ In this section of the release, the issuer of the asset-
back security means the person that primarily organizes and
initiates the offering of the asset-backed security, often referred
to as the sponsor.

                                       Table 6--Issuance Amount, Number of Offerings, and Number of Unique Issuers for Non-Agency Asset-Backed Securities
------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
                                                                        Issuance amount ($ bln)                       Number of offerings                      Number of unique issuers
                            Year                             -----------------------------------------------------------------------------------------------------------------------------------
                                                               Regist'd     144A     Private     Total     Regist'd     144A     Private     Total     Regist'd     144A     Private     Total
------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
2002........................................................     617.13     122.07       2.00     741.20      1,074        491         31      1,596        143        226         17        327
2003........................................................     790.47     149.20       0.17     939.85      1,271        589          3      1,863        139        223          3        309
2004........................................................   1,024.16     186.53       0.85   1,211.53      1,370        670          2      2,042        131        218          2        298
2005........................................................   1,450.33     322.64       3.70   1,776.68      1,594        907          3      2,504        134        300          2        376
2006........................................................   1,446.07     623.38       0.50   2,069.95      1,508      1,551          1      3,060        116        406          1        460
2007........................................................   1,048.81     518.59       0.55   1,567.95      1,088      1,102          1      2,191        111        342          1        396
2008........................................................     140.70     130.80       0.00     271.49        163        240          0        403         51         96          0        128

2009........................................................      85.45     120.14       0.00     205.58         80        266          0        346         30         81          0         97
2010........................................................      51.01     163.30      14.01     228.32         65        401          4        470         29        145          1        160
2011........................................................      74.94     139.06      13.58     227.59         86        291         15        392         39        163          6        179
2012........................................................     157.15     186.53       0.00     343.68        157        465          0        622         51        242          0        270
2013........................................................     174.06     219.47       0.08     393.61        182        532          1        715         61        294          1        336
------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
Note: Statistics are calculated by DERA using the Asset-Backed Alert and Commercial Mortgage Alert databases. A single offering of asset-backed securities may consist of multiple tranches of
  securities. An NRSRO may rate one or multiple tranches of the securities issued in the offering. The offerings are categorized by offering year and offering type (Commission registered, Rule
  144A, or traditional private offerings). Non-agency asset-backed securities include RMBS, CMBS, and other asset-backed securities. Non-agency RMBS include residential, Alt-A, subprime RMBS,
  high loan-to-value (``no-equity'') loans, and non-U.S. residential loans. Auto loan asset-backed securities include asset-backed securities backed by auto loans and auto leases, both prime
  and subprime, motorcycle loans, recreational vehicle loans, and truck loans. The first set of columns show the total issuance amounts in billions of dollars. The second set of columns show
  the total number of asset-backed security offerings. The third set of columns show the number of unique issuers of asset-backed securities in each category. The number in the column
  ``Total'' may not be the sum of numbers in the columns ``Regist'd'', ``144A'' and ``Private'' because some issuers may initiate offerings in several categories. Only non-agency asset-backed
  security offerings sold in the United States and issuers of such offerings are counted.

    Issuers of asset-backed securities often include banks, mortgage
companies, finance companies, investment banks, and other entities that
originate or acquire and package financial assets for resale as asset-
backed securities.\79\ As reported in Table 6, in 2004 there were 298
unique issuers, while in 2013 there were 336 unique issuers, mostly
involved in Rule 144A offerings.\80\ The ten most active issuers were
responsible for about 30% of the total issuance amounts at the end of
2013.\81\
---------------------------------------------------------------------------

    \79\ See Asset-Backed Securities, Securities Act No. 8518 (Dec.
22, 2004), 70 FR 1506 (Jan. 7, 2005).
    \80\ The number of issuers varies across segments of the asset-
backed security market. For example, as of December of 2013 there
were twenty-two and eighty-three issuers involved in RMBS and CMBS
offerings, respectively.
    \81\ The market share attributed to the issuer of an asset-
backed security is calculated by DERA staff using the Asset-Backed
Alert and Commercial Mortgage Alert databases.
---------------------------------------------------------------------------

    As noted in Figure 1 below, an analysis of the segments of the
asset-backed security market shows that all segments experienced
significant downturns during the crisis but only a few of them have
experienced a recovery in the aftermath. Figure 1 focuses on non-agency
asset-backed security offerings and reports the issuance volume by main
asset classes (RMBS, CMBS, auto loans/leases, credit card loans,
student loans, and other asset-backed securities).
[GRAPHIC] [TIFF OMITTED] TR15SE14.000

    As shown in Figure 1, new issuances of non-agency RMBS in 2004
totaled $542 billion, with registered offerings representing the
majority of non-agency RMBS issued before the crisis. Non-agency RMBS
issuance--which totaled $715 billion in 2007--dropped drastically to
$35 billion in 2008. As of the end of 2013, the non-agency RMBS

market remains weak and consists almost exclusively of unregistered
RMBS offerings. In particular, new issuances of non-agency RMBS totaled
$25 billion in 2013, which represents about 5% of the issuance level in
2004. CMBS experienced a similar drop in issuance levels, though it has
rebounded to a level that is closer to the 2004 issuance level than
RMBS. In particular, CMBS issuance rose from $96 billion in 2004 to
$231 billion in 2007. It then dropped to $12 billion in 2008. It was
$86 billion in 2013, which is about 90% of the issuance level in 2004.
The consumer finance asset-backed security market also declined
drastically in terms of number of offerings and issuance volume after
the financial crisis. For example, $70 billion of securities backed by
auto loans and leases were issued in 2004, but issuance decreased to
$38 billion in 2008. The issuances of consumer finance asset-backed
securities, especially those securities backed by auto loans and
leases, and other asset-backed securities have steadily increased since
2008 to reach pre-crisis levels of about $75 billion in 2013.
    Among the asset-backed security segments, the non-agency RMBS
segment has experienced a significant decline in the number of issuers
with twenty-two issuers arranging non-agency RMBS (and only one issuer
arranging non-agency registered RMBS) as of the end of 2013, compared
to fifty-eight issuers in 2004. In the RMBS market, issuers arranging
non-agency RMBS encounter competitive pressure from government-
sponsored enterprises that arrange RMBS that are guaranteed \82\ and
exempt from registration and reporting requirements.\83\ As non-agency
RMBS issuance has declined, issuance of agency RMBS has increased.
Issuances of RMBS arranged by the Federal National Mortgage
Association, the Federal Home Loan Mortgage Corporation, and the
Government National Mortgage Association were $1.4 trillion in 2004 and
grew to $1.9 trillion in 2013.\84\
---------------------------------------------------------------------------

    \82\ See N. Eric Weiss, GSEs and the Government's Role in
Housing Finance: Issues for the 113th Congress, Congressional
Research Service Report for Congress (2013).
    \83\ Mortgage-backed securities issued by government-sponsored
enterprises and the Government National Mortgage Association have
been and continue to be exempt from registration under the
Securities Act and most provisions of the federal securities laws.
For example, the mortgage-backed securities issued by the Government
National Mortgage Association are exempt securities under section
3(a)(2) of the Securities Act (15 U.S.C. 77c(a)(2)) and section
3(a)(12) of the Exchange Act (15 U.S.C. 78c(a)(12)). The chartering
legislation for the Federal National Mortgage Association and the
Federal Home Loan Mortgage Corporation contain exemptions with
respect to the mortgage-backed securities issued by these entities.
See 12 U.S.C. 1723c; 12 U.S.C. 1455g.
    \84\ See Securities Industry Financial Market Association
(``SIFMA''), U.S. Mortgage-Related Issuance and Outstanding Data
from 1996 to May 2014 (issuance), 2002 to 2014 Q1 (outstanding)
(June 3, 2014 update).
---------------------------------------------------------------------------

    Table 7 shows the number of unique underwriters of non-agency
asset-backed securities. As of the end of 2013, it is a highly
concentrated industry with ninety underwriters (if international
securitizations are included in the data) and fifty underwriters (if
international securitizations are excluded), with the top ten
underwriters by volume underwriting about 70% of the
securitizations.\85\
---------------------------------------------------------------------------

    \85\ The market share attributed to an asset-backed security
underwriter is calculated by DERA staff using Asset-Backed Alert and
Commercial Mortgage Alert databases.

                          Table 7--Number of Unique Asset-Backed Security Underwriters
----------------------------------------------------------------------------------------------------------------
                                                                              Total                     Total
                 Year                     Regist'd      144A     Private    excluding    Internat'l   including
                                                                            internat'l                internat'l
----------------------------------------------------------------------------------------------------------------
2002..................................           22         40         15           47           86          107
2003..................................           29         41          3           47           87          109
2004..................................           29         46          2           56           99          123
2005..................................           29         45          3           50          101          118
2006..................................           28         57          1           59          114          137
2007..................................           27         59          1           61          109          132
2008..................................           19         42          0           44           95          113
2009..................................           14         26          0           28           58           72
2010..................................           15         45          1           46           76           90
2011..................................           18         44          5           45           62           79
2012..................................           20         46          0           48           63           81
2013..................................           22         47          0           50           72           90
----------------------------------------------------------------------------------------------------------------
Note: Statistics are calculated by DERA staff using the Asset-Backed Alert and Commercial Mortgage Alert
  databases. A single offering of asset-backed securities may consist of multiple tranches of securities. An
  NRSRO may rate one or multiple tranches of the securities issued in the offering. The number of unique
  underwriters of asset-backed securities is divided into categories by type of offering (registered, 144A,
  private, or international). The total number in the last column may not be the sum of numbers in the columns
  labeled ``Public'', ``144A'', ``Private,'' and ``Internat'l'' because some underwriters may market offerings
  in several categories. Only non-agency asset-backed security offerings and underwriters of such deals are
  counted.

    Finally, providers of third-party due diligence services with
respect to asset-backed securities are significantly affected by the
amendments and new rules being adopted today. The Commission has little
information about these firms and the characteristics of the industry.
The Commission estimates that there are approximately fifteen providers
of third-party due diligence services.\86\ Because there are very few
publicly traded firms specializing in due diligence, little is known
about these service providers in terms of loan review volume, market
share, and revenue.\87\
---------------------------------------------------------------------------

    \86\ This number comes from combining the names of third-party
due diligence firms cited by Vicki Beal, Senior Vice President of
Clayton Holdings, in her testimony before the Financial Crisis
Inquiry Commission, and the names of third-party due diligence firms
that S&P reviews as a part of its U.S. RMBS rating process. See
Testimony of Vicki Beal, Senior Vice President of Clayton Holdings
before the Financial Crisis Inquiry Commission, (Sept. 23, 2010),
available at http://fcic-static.law.stanford.edu/cdnmedia/
fcic-testimony/2010-0923-Beal.pdf (``Clayton Testimony''). S&P's
updated list of third-party due diligence firms reviewed for U.S.
RMBS is available at https://www.globalcreditportal.com/
ratingsdirect/
renderArticle.do?articleId=1246530&SctArtId=208825&from=CM&nsl
code=LIME. The Commission does not know whether the estimate of
fifteen providers of third-party due diligence services captures all
of the primary participants in this business but believes that,
based on available information, this is a reasonable estimate for
purposes of this economic analysis.
    \87\ See Clayton Testimony, p. 1 (describing the market for due
diligence services as ``highly fragmented, highly competitive and
rapidly changing'').
---------------------------------------------------------------------------

    Asset-backed security issuers and underwriters may use third-party
due diligence services to identify issues with loans, to negotiate
better prices on pools of loans they are considering for

purchase, and to negotiate expanded representations and warranties in
purchase and sale agreements from sellers.\88\ The reviews of third-
party due diligence providers are performed on an adverse or random
sample of loans consistent with the guidelines of clients. Compensation
is likely not contingent on due diligence findings or the ultimate
performance of the loans reviewed. Instead, third-party due diligence
providers may be paid a standard service fee for each loan
reviewed.\89\
---------------------------------------------------------------------------

    \88\ See id. at 2.
    \89\ See id. at 3.
---------------------------------------------------------------------------

c. Industry Practices
    The Commission staff conducts annual examinations of each NRSRO and
publishes a report summarizing the essential findings of the
examinations, as required by section 15E(p)(3) of the Exchange Act.\90\
The staff's 2013 report noted improvements, relative to prior
examinations, among the NRSROs in five general areas that are related
to the amendments and new rules being adopted today: Enhanced
documentation, disclosure, and board of director oversight of criteria
and methodologies; investment in software or computer systems for
electronic recordkeeping and monitoring employee securities trading;
increased prominence of the role of the designated compliance officer
within NRSROs; implementation or enhancement of internal controls over
the rating process (for example, use of audits and other testing to
verify compliance with federal securities laws, and employee training
on compliance matters); and adherence to internal policies and
procedures.\91\ The report also discussed certain weaknesses or
concerns in a number of review areas: Adherence to policies,
procedures, and methodologies; \92\ management of conflicts of
interest; \93\ implementation of ethics policies; \94\ internal
supervisory controls; \95\ governance; \96\ the activities of the
designated compliance officer; \97\ the processing of complaints; \98\
and the policies governing post-employment activities of former staff
of the NRSRO.\99\ These essential findings were related to several
areas of NRSRO operations and were not limited to activities relating
to rating asset-backed securities.
---------------------------------------------------------------------------

    \90\ Section 923(a)(8) of the Dodd-Frank Act struck the existing
text in paragraph (p) of section 15E of the Exchange Act, which
related to the date of applicability of the Rating Agency Act of
2006, and added new text. See Public Law 111-203, 932(a)(8). Section
15E(p)(3) of the Exchange Act requires, among other things, the
Commission staff to conduct an examination of each NRSRO at least
annually. See 15 U.S.C. 78o-7(p)(3). Annual inspection reports for
2011, 2012, and 2013 are available at http://www.sec.gov/divisions/marketreg/ratingagency.htm.
    \91\ See Commission staff, 2013 Summary Report of Commission
Staff's Examinations of Each Nationally Recognized Statistical
Rating Organization (Dec. 2013) (``2013 Annual Staff Inspection
Report''), pp. 7-9.
    \92\ See 2013 Annual Staff Inspection Report, pp. 9-11.
    \93\ Id. at 11-13.
    \94\ Id. at 13-14.
    \95\ Id. at 14-19.
    \96\ Id. at 19-20.
    \97\ Id. at 20-21.
    \98\ Id. at 21-22.
    \99\ Id. at 22-23.
---------------------------------------------------------------------------

3. Broad Economic Considerations
    In this section, the Commission describes the primary economic
impacts that may derive from the amendments and new rules being adopted
today, relative to the baseline discussed above. A detailed analysis of
the particular economic effects--including the costs and benefits and
the impact on efficiency, competition, and capital formation--that may
result from the amendments and rules is presented in the focused
economic analyses in section II of this release.\100\
---------------------------------------------------------------------------

    \100\ See sections II.A.4., II.B.4., II.C.3., II.D.2., II.E.4.,
II.F.3., II.G.6., II.H.4., II.I.3., II.J.3., II.K.2., II.L.2., and
II.M.5. of this release.
---------------------------------------------------------------------------

    Section 3(f) of the Exchange Act requires the Commission, when
engaging in rulemaking that requires the Commission to consider or
determine whether an action is necessary or appropriate in the public
interest, to also consider whether the action will promote efficiency,
competition, and capital formation.\101\ Further, section 23(a)(2) of
the Exchange Act requires the Commission, when adopting rules under the
Exchange Act, to consider the impact that any new rule would have on
competition and to not adopt any rule that would impose a burden on
competition that is not necessary or appropriate in furtherance of the
purposes of the Exchange Act.\102\ The Commission's analysis of the
economic effects, including the likely costs and benefits and the
likely impact on efficiency, competition, and capital formation of the
amendments and new rules, include those attributable to the rulemaking
that the Commission is mandated to undertake in accordance with the
Dodd-Frank Act and those attributable to the exercise of the
Commission's discretionary authority.
---------------------------------------------------------------------------

    \101\ See 15 U.S.C. 78c(f).
    \102\ See 15 U.S.C. 78w(a)(2); see also Current Guidance on
Economic Analysis in SEC Rulemakings (available at: http://
insider.sec.gov/divisionsoffices/hqo/dera/rsfi-guidance-
econanalysis-rulemaking.pdf)
---------------------------------------------------------------------------

    In the proposing release, the Commission solicited comments on all
aspects of the costs and benefits associated with the proposed rules.
In addition to comments on the economic effects of specific provisions,
which will be discussed in section II of this release, the Commission
received comments on the overall economic effects of the proposed
amendments and new rules. Generally, commenters expressed concerns that
the potential cumulative burden and costs associated with the proposed
amendments and new rules could be so onerous that they would have
negative effects on competition by imposing an excessive burden on
smaller NRSROs and raising barriers to entry for credit rating agencies
that seek to register as NRSROs.\103\ In particular, one commenter
suggested that ``fostering competition among rating agencies was a
primary goal of both the Rating Agency Act of 2006 and the Dodd-Frank
Act'' but that ``the proposed rules will be so costly to implement that
additional credit rating agencies are unlikely to register as NRSROs
and the existing pool of registrants may contract.'' \104\
---------------------------------------------------------------------------

    \103\ See A.M. Best Letter; DBRS Letter; EJR Letter; Kroll
Letter; Morningstar Letter; S&P Letter; TradeMetrics Letter.
    \104\ See DBRS Letter. This commenter also stated that a
``contradiction lies in the fact that, while directing the
Commission to impose costly and onerous new obligations on rating
agencies who choose to register as NRSROs, the Dodd-Frank Act also
directs the Commission to remove all references to credit ratings
from the federal securities regulations.'' See DBRS Letter. See also
Public Law 111-203, 939A.
---------------------------------------------------------------------------

    As discussed in section II of this release, the Commission has
considered these comments and has modified the amendments and new rules
being adopted today from the proposals in a number of ways that are
designed to reduce the cumulative burden and costs associated with
complying with the new requirements. Nonetheless, the Commission
recognizes--as reflected in the economic analysis--that the amendments
and rules establish a substantial package of new requirements
applicable to NRSROs and that complying with these requirements will
entail significant costs to NRSROs.\105\ The amendments and rules also
impose burdens on issuers and underwriters of asset-backed securities
and providers of third-party due diligence services with respect to
asset-backed securities. As discussed throughout the economic analysis,
the Commission believes that

the new requirements should result in substantial benefits and should
not impose a burden on competition that is not necessary or appropriate
in furtherance of the purposes of the Exchange Act.
---------------------------------------------------------------------------

    \105\ Some NRSROs may be subject to rules in foreign
jurisdictions under which certain of their policies and procedures
or other practices are affected by requirements of these foreign
jurisdictions that may be similar to some of the requirements
imposed by the amendments and new rules. While the requirements of
foreign jurisdictions are not analyzed here in detail, they may
impact the incremental costs and benefits of the amendments and new
rules.
---------------------------------------------------------------------------

    In particular, the amendments and new rules being adopted today are
designed to implement Title IX, Subtitle C of the Dodd-Frank Act,
which, in turn, was designed to address the causes of certain market
failures (that is, the principal-agent problem,\106\ including
conflicts of interest, and asymmetric information) that may impair the
integrity and transparency of NRSRO credit ratings and the procedures
and methodologies NRSROs use to determine credit ratings. Some of the
amendments and new rules are primarily designed to enhance the
integrity of how NRSROs determine credit ratings by improving internal
governance of NRSROs, managing potential principal-agent problems and
conflicts of interest in the credit rating process, and promoting
adherence to the procedures and methodologies for determining credit
ratings and compliance with laws and regulations.\107\ For example,
provisions in the amendments and new rules require an NRSRO, among
other things, to: (1) Assess and report on the effectiveness of
internal controls; (2) address conflicts of interest relating to sales
and marketing activities and employment of former analysts; (3) have
policies and procedures relating to their procedures and methodologies
for determining credit ratings; (4) have standards of training,
experience and competence for their credit analysts; and (5) have
policies and procedures to promote the consistent use of credit rating
symbols.\108\
---------------------------------------------------------------------------

    \106\ A principal-agent problem occurs when one person (the
``agent'') is able to act in the person's own best interest rather
than in the interest of another person (the ``principal''). The
problem arises when the parties have different interests and the
agent has more information than the principal so that the principal
cannot ensure that the agent is always acting in the principal's
best interests, especially where activities that are useful to the
principal are costly to the agent and where monitoring of the
agent's activities is costly to the principal. For example, a
principal-agent problem may arise if an NRSRO produces credit
ratings that, as a result of conflicts of interest, are not
informative to the users of credit ratings.
    \107\ These requirements are discussed below in sections II.A.,
II.B., II.C., II.D., II.F., II.I., II.J., and II.K. of this release.
    \108\ These requirements are discussed below in sections II.A.,
II.B., II.C., II.F., II.I., and II.J. of this release.
---------------------------------------------------------------------------

    Other provisions in the amendments and new rules being adopted
today are designed mainly to enhance the transparency of NRSRO credit
ratings by increasing disclosure and reducing information asymmetries
that may adversely affect users of credit ratings. This should
facilitate external scrutiny of NRSRO activities. More specifically,
provisions in the amendments and new rules require an NRSRO, among
other things, to disclose: (1) Standardized performance statistics; (2)
increased information about credit rating histories; (3) information
about material changes and significant errors in the procedures and
methodologies used to determine credit ratings; and (4) information
about a specific rating action.\109\ The main objective of these
requirements is to improve the information provided to users of credit
ratings, including investors. The enhanced disclosure may reduce
information asymmetries between the NRSRO and the users of its credit
ratings, enabling the users to make more informed investment and credit
related decisions and allowing them to compare the performance of
credit ratings by different NRSROs. Additionally, there are
requirements in the amendments and new rules that are designed to
reduce information asymmetries among issuers and underwriters of asset-
backed securities, NRSROs rating asset-backed securities, and the users
of credit ratings for asset-backed securities.\110\ These requirements
may benefit NRSROs and users of credit ratings, including investors in
these securities.
---------------------------------------------------------------------------

    \109\ These requirements are discussed below in sections II.E.,
II.F., II.G., and II.L. of this release.
    \110\ These requirements are discussed below in sections II.E.,
II.G., and II.H of this release.
---------------------------------------------------------------------------

a. Amendments and Rules Enhancing NRSRO Governance and Integrity of
Credit Ratings
    The requirements in the amendments and new rules being adopted
today that are primarily designed to enhance an NRSRO's internal
governance should have economic benefits, relative to the existing
baseline, in terms of promoting the integrity of how NRSROs determine
and monitor credit ratings. In particular, there are new requirements
applicable to NRSROs that assign responsibilities to an NRSRO's
management and board of directors, which should promote accountability
and facilitate internal oversight over the processes governing the
determination of credit ratings and the implementation of the
procedures and methodologies an NRSRO uses to determine credit ratings.
For example, an NRSRO is required to file an annual report containing
an assessment by management of the effectiveness during the fiscal year
of the internal control structure governing the implementation of and
adherence to policies, procedures, and methodologies for determining
credit ratings.\111\ Similarly, an NRSRO is required to establish,
maintain, enforce, and document policies and procedures reasonably
designed to ensure that the procedures and methodologies, including
qualitative and quantitative data and models, the NRSRO uses to
determine credit ratings are approved by its board of directors or a
body performing a function similar to that of a board of
directors.\112\ The board's oversight may prevent situations in which
an NRSRO seeks to implement a procedure or methodology to determine
credit ratings that is designed to inappropriately issue favorable
credit ratings for existing and prospective clients in order to retain
or gain market share.\113\
---------------------------------------------------------------------------

    \111\ This requirement is discussed below in section II.A.3. of
this release.
    \112\ This requirement is discussed below in section II.F.1. of
this release.
    \113\ See Griffin and Tang, Did Subjectivity Play a Role in CDO
Credit Ratings?
---------------------------------------------------------------------------