histories should result in benefits for users of credit ratings. The
amendments, which implement the provisions of section 15E(q) of the
Exchange Act and, as discussed in sections II.E.1. and II.E.3. of this
release, took into account findings by the GAO, should result in
performance statistics that are more directly comparable across NRSROs
and ratings histories that are more useful for performance analyses
than those provided under the baseline requirements.\892\ To the extent
that the new disclosures therefore facilitate the evaluation of the
performance of an NRSRO's credit ratings and comparisons of rating
performance across NRSROs--including direct comparisons of different
NRSROs' treatment of the same obligor or instrument--the amendments may
benefit users of credit ratings by allowing them to better assess the
reliability and information content of credit ratings from different
NRSROs and, in the case of subscriber-paid credit ratings, make more
informed decisions regarding whether to subscribe to the credit ratings
of particular NRSROs.
---------------------------------------------------------------------------

    \892\ While the amendments are designed to facilitate
comparisons across NRSROs, differences in the meanings of the credit
ratings of different NRSROs and in the procedures and methodologies
they use to determine credit ratings will likely influence the
ability to make perfect comparisons. For example, there is
variability across NRSROs with respect to the information that is
reflected in a credit rating. See, e.g., S&P Letter; GAO Report 10-
782, p. 37-39. Some credit ratings, for example, reflect relative
assessments of the likelihood an obligor or issuer will default on
the ``first dollar'' owed, whereas other credit ratings also reflect
the expected loss in the case of default. In interpreting the
performance statistics and rating histories, users of credit ratings
may thus need to account for additional contextual information, such
as the general description of the procedures and methodologies used
by the NRSRO to determine credit ratings required to be disclosed in
Exhibit 2, in order to understand the limits to the comparability of
the disclosures.
---------------------------------------------------------------------------

    Specifically, the amendments to the instructions for Exhibit 1
requiring a standardized calculation of performance statistics--using
specified definitions and the single cohort approach--to be presented
in a standardized format and specifying that an applicant or NRSRO must
not disclose information in the Exhibit that is not required to be
disclosed are expected to result in simpler, more standardized
disclosures relative to the disclosures produced under the baseline
requirements. Moreover, the single cohort approach involves simpler
computations than other approaches, so it may be easier for users of
credit ratings to understand how the statistics were produced. Also,
requiring all NRSROs to use the single cohort approach ensures that the
cohorts being analyzed will be aligned across NRSROs, increasing the
comparability of the statistics versus other computation methods (such
as the average cohort approach). The amendments therefore may allow
users of credit ratings, including users with a wide range of
sophistication, to more readily compare the performance of credit
ratings of different NRSROs than they could previously. The new
requirement to divide the class of issuers of asset-backed securities
into subclasses and the requirement to separately disclose the number
of credit ratings that are withdrawn because the obligation has been
paid in full, because the obligor defaulted, and for other reasons, as
well as to report the total number of credit ratings in the start-date
cohort in each category, should provide users of credit ratings with
additional information that may help them better interpret the
transition and default rates for the purpose of evaluating and
comparing performance.\893\
---------------------------------------------------------------------------

    \893\ While the standard definition of default is intended to
facilitate comparisons across NRSROs, there may continue to be
differences across NRSROs in the identification of defaults in the
performance statistics which may reduce somewhat the comparability
of these statistics. When an event occurs that does not meet the
standardized definition of default in Exhibit 1, it may still be
categorized as a default by an NRSRO under its own definition of
default, which is incorporated into the Exhibit 1 definition. In
interpreting the performance statistics, users of credit ratings may
thus need to account for additional contextual information such as
the new requirement to ``clearly explain'' the usage of the term
default directly after the performance statistics.
---------------------------------------------------------------------------

    In addition, the new requirements that expand the scope of credit
ratings that must be included in the rating histories should, over
time, generate databases that will include a comprehensive sample of
rating actions (in contrast to the data disclosed under the baseline
requirements). The databases also will include information about
cohorts of credit ratings beyond those reflected in the performance
statistics disclosed in Exhibit 1. Thus, the enhanced rating histories
can be used to generate alternative statistics for evaluating and
comparing NRSRO performance, including certain transition and default
statistics using average cohort approaches (though, as discussed below,
these statistics will likely be based on fewer cohorts than were used
by NRSROs that disclosed performance statistics in Exhibit 1 using the
average cohort approach before today's amendments). Because the data
will be more comprehensive than that disclosed in the baseline, it
should also be more likely, relative to the baseline, that rating
histories of different NRSROs with respect to the same obligor or
instrument will be available. Therefore, users of credit ratings should
have more opportunities to directly compare and analyze different
NRSROs' treatment of the same obligor or instrument over time. The
requirements regarding the enhanced data fields to be included with a
rating action should make any analyses using the rating histories more
practicable than was the case with the more limited data fields
produced under the baseline requirements.\894\
---------------------------------------------------------------------------

    \894\ There may be differences across NRSROs in the
identification of defaults and paid off obligations in the rating
histories which reduce somewhat the comparability of this data
across NRSROs, since the amendments do not prescribe definitions of
these terms for the purpose of the rating histories. In interpreting
the rating histories, users of credit ratings may thus need to
account for additional contextual information such as the new
requirement to ``clearly explain'' the conditions under which an
NRSRO classifies obligors, securities, or money market instruments
as being in default after the performance statistics presented in
Exhibit 1.
---------------------------------------------------------------------------

    However, the benefits of the amendments in facilitating the
evaluation and comparisons of NRSROs may be constrained by limits on
the information required by the final rules, which, as discussed in
this section, are intended to reduce the burdens on NRSROs resulting
from the amendments and, with respect to the performance statistics,
make them easier for users of credit ratings to understand how the
statistics were produced. For example,

while mandating that only single cohort statistics be presented fosters
comparability, the resulting disclosures will present the performance
of only three particular cohorts of credit ratings (beginning one,
three, and ten years prior to the end of the fiscal year). These
statistics therefore may be subject to substantial volatility,
particularly for NRSROs with fewer credit ratings.\895\ The fact that
the credit ratings of particular NRSROs may be more heavily weighted
towards particular industries, geographies, or other sectors that might
experience more defaults or other changes in creditworthiness over a
particular measurement period also may exacerbate volatility in their
performance statistics and make it difficult to separate differences in
NRSRO performance from the effects of recent conditions.\896\ NRSROs
are only required to provide their current Form NRSRO on their Web
sites, so users of credit ratings may not have access to previous Forms
NRSRO in order to consider the cohorts analyzed in these other
years.\897\
---------------------------------------------------------------------------

    \895\ Averages over a smaller sample size are more susceptible
to being skewed by individual extreme data points. See also DBRS
Letter (stating that ``results will be significantly more volatile
within the shorter time period, which will make interpreting those
results more difficult'' and that ``the volatility impact will be
amplified for NRSROs with fewer ratings'').
    \896\ A particular industry, geography, or other sector of the
market may experience a period of poor performance common to all
issuers and securities in that group, resulting in high default
rates in that period. Economy-wide default rates are likely to be
less volatile than the default rates for these individual groups
since they reflect an average across many such groups, which may
face downturns at different times. Thus, when considering
performance over a short period, as in the case of the single cohort
approach, the performance of NRSROs that focus on fewer industries,
geographies, or other sectors may be skewed by any recent extremes
in performance experienced by these sectors, leading to more
volatile performance statistics. When such NRSROs are compared to
other NRSROs, it may be difficult to interpret whether differences
in their single cohort performance statistics may be due to the
recent performance of the sectors they focus on or whether they
reflect differences in the ability of the NRSROs to produce accurate
ratings.
    \897\ In the future, users of credit ratings will have access to
certain previous Forms NRSRO, including Exhibits 1 through 9 to
these Forms. As discussed below in section II.L. of this release,
the amendments to Rule 101 of Regulation S-T will require an NRSRO
to submit Form NRSRO and Exhibits 1 through 9 to the Form
electronically through the EDGAR system. Submission through the
EDGAR system will maintain the public availability of a Form NRSRO
even after updated versions are submitted.
---------------------------------------------------------------------------

    The rating histories may be helpful to users of credit ratings in
addressing the limitations of the performance statistics both in that
information about many additional cohorts may be available and also
through the ability to directly compare NRSRO performance with respect
to the same obligor or instrument. Such direct comparisons should not
be skewed by the industry or sector focus of a given NRSRO. However,
the final rules require only one or two years of history to be
disclosed initially, depending on the applicable grace periods, so the
benefits of these histories will be delayed until the histories grow to
a length suitable for analysis. Also, as discussed below, even as data
for additional years becomes available, the ability of NRSROs to remove
a rating history from the data file fifteen years after the credit
rating is withdrawn will limit the amount of historical information in
the data file and, therefore, limit analyses by users of credit ratings
that require a representative sample of credit ratings over an extended
period of time. On the other hand, users of credit ratings that are
interested in comparing NRSRO performance over time with respect to the
same obligor or instrument should not face the same limitation and,
therefore, should be able to take advantage of the full length of
histories provided under the amendments.
    A potential consequence of selecting one approach to be used for
purposes of the Exhibit 1 disclosures is that it may impact the
disclosures NRSROs make using other approaches. For example, even
though the amendments require NRSROs to use the single cohort approach,
NRSROs may continue on a voluntary basis to provide, not directly in
Exhibit 1 but by reference to an Internet Web site address in this
exhibit, disclosures of additional performance statistics such as
statistics using the average cohort approach. These supplementary
statistics may address some of the aforementioned limitations of
statistics using the single cohort approach in that they may provide
users of credit ratings with information about many more cohorts of
credit ratings. However, NRSROs that previously disclosed average
cohort statistics to fulfill their Exhibit 1 requirements might not
continue to report these statistics voluntarily or might report them in
an even less standardized fashion than previously (for example, for
performance periods different from the one-year, three-year, and ten-
year periods required in Exhibit 1). Importantly, NRSROs might be less
likely to voluntarily disclose such additional statistics when they do
not compare favorably to the performance of competitors.
    The amendments may result in other benefits to users of credit
ratings and NRSROs by enhancing accountability, competition, and
efficiency. As has been widely documented, the most common NRSRO
business model--the issuer-pay revenue model--creates an inherent
conflict of interest.\898\ Given this conflict, and because the demand
for an NRSRO's credit ratings depends on its reputation for producing
credit ratings of high quality, reputation is thought to play a
particularly important disciplinary role in this industry.\899\ To the
extent that the amendments facilitate the external monitoring and
comparative analysis of NRSROs, they may allow users of credit ratings
to develop more refined views of NRSRO performance and thereby
indirectly increase accountability and encourage integrity in the
production of credit ratings, since NRSROs should have the incentive to
maintain reputations for producing credit ratings of high quality in
order to remain competitive. More comparable performance data also may
help smaller NRSROs and new and recent entrants into the industry,
including subscriber-paid NRSROs, to attract attention to their track
records of issuing and monitoring credit ratings. If they produce track
records comparable or superior to those of other NRSROs, this could
enhance their ability to develop a reputation for producing high
quality credit ratings. Such a reputation may allow them to better
compete with more established competitors. The enhanced ability of
users of credit ratings to evaluate the performance of NRSROs also may
increase their ability to accurately interpret the information conveyed
by credit ratings, potentially resulting in more efficient investment
decisions. Market efficiency could also improve if this information is
reflected in asset prices.\900\
---------------------------------------------------------------------------

    \898\ See, e.g., Lawrence White, Markets: The Credit Rating
Agencies, J. of Economic Perspectives (Spring 2010), Volume 24,
Number 2, p. 211-226.
    \899\ See, e.g., Jerome Mathis, James McAndrews, and Jean-
Charles Rochet, Rating the Raters: Are Reputation Concerns Powerful
Enough to Discipline Rating Agencies?, J. of Monetary Economics
(July 2009), p. 657-674; Lawrence White, Markets: The Credit Rating
Agencies, J. of Economic Perspectives (Spring 2010), Volume 24,
Number 2, p. 211-226; Daniel M. Covitz and Paul Harrison, Testing
Conflicts of Interest at Bond Rating Agencies with Market
Anticipation: Evidence that Reputation Incentives Dominate, Federal
Reserve Board (Dec. 2003), available at http://www.federalreserve.gov/pubs/feds/2003/200368/200368pap.pdf.
    \900\ See section I.B.3. of this release (providing a broader
discussion of the potential impacts of the amendments and new rules
on efficiency, competition, and capital formation).
---------------------------------------------------------------------------

    The amendments to Rule 17g-1 and Rule 17g-7 requiring that these
disclosures be published on an ``easily accessible'' portion of the
NRSRO's Internet Web site could result in incremental benefits relative
to the baseline. As mentioned above, the Commission agrees with
commenters

that the disclosures would be on an ``easily accessible'' portion of an
NRSRO's Internet Web site if they could be accessed through a clearly
and prominently labeled hyperlink labeled ``Regulatory Disclosures'' on
the homepage of the Web site. Some NRSROs may already provide Form
NRSRO, Exhibits 1 through 9 to the form, and rating histories in such a
location. However, to the extent that these amendments result in NRSROs
moving the disclosures to a more prominent location on their Internet
Web sites to fulfill the requirement that they be ``easily
accessible,'' they may incrementally assist users of credit ratings in
locating these disclosures. Requiring that Exhibit 1 be made available
in writing when requested may benefit any users of credit ratings who
do not have access to the Internet.
    Relative to the baseline, the amendments with respect to the
disclosure of performance statistics and rating histories will impose
costs on applicants and NRSROs. In particular, while all NRSROs
currently disclose transition and default rates, the content and
presentation of these performance statistics differ, to varying
degrees, from the information required and the format prescribed by the
rules. The revised requirements therefore will require the initial
collection and analysis of certain additional historical data (for
example, whether issuers or instruments defaulted under the standard
definition) as well as changes in systems and procedures to collect and
present this information according to the amendments going forward. The
Commission's estimates of these costs--which are based on analyses for
purposes of the PRA--are provided below.
    Two NRSROs have commented that, in some cases, collecting certain
historical information would require substantial cost or could be
impossible.\901\ The historical information required for the transition
and default statistics which NRSROs may not have stored (or stored in a
readily retrievable format) consists of, over a ten year history, the
more detailed categorization of any withdrawn credit ratings and the
assignment of credit ratings in the asset-backed securities class into
sub-classes. As discussed above, the Commission has modified the
amendments to reduce the amount of historical information that may need
to be retrieved with respect to withdrawn credit ratings. In
particular, the amendments provide that, except in the case of the
asset-backed securities class of credit ratings, the transition and
default statistics must include only credit ratings assigned to an
obligor as an entity or, if there is no such credit rating, the credit
rating of the obligor's senior unsecured debt, instead of all credit
ratings of securities or money-market instruments in the respective
class or subclass. The Commission has also revised the standard
definition of paid off to eliminate the prong that applied to credit
ratings of obligors as entities. Because the Commission has narrowed
the scope of the credit ratings that must be included in the
performance statistics for four of the five classes of credit ratings,
and has revised the standard definition of paid off so that it does not
apply to entity credit ratings, the cost of categorizing historical
withdrawals based on the standard definitions of default and paid off
and withdrawals for other reasons should be substantially reduced. The
modifications from the proposal should therefore mitigate concerns to
some degree about having to obtain information that was not
traditionally retained by the NRSRO because it will significantly
narrow the scope of such information that will need to be collected in
order to calculate the performance statistics. While the Commission
believes that these modifications may substantially reduce the amount
of historical data to be collected, an NRSRO can seek exemptive relief
from the Commission under section 36 of the Exchange Act.
---------------------------------------------------------------------------

    \901\ See, e.g., Moody's Letter (stating that collecting certain
data for past rating actions would have to be done manually); S&P
Letter (stating that ``it may not be possible to track'' the
distinction between ratings withdrawn for different reasons
``retroactively'').
---------------------------------------------------------------------------

    The costs of the compliance efforts described above should vary
across NRSROs due to: (1) Differences in the quantity of credit ratings
they issue and the number of classes of credit ratings for which they
issue credit ratings; (2) differences in terms of how their disclosures
under the baseline requirements compare to the disclosures required
under the amendments; (3) differences with respect to the historical
information they currently store in a readily-retrievable format; (4)
differences in the number of past years and number of historical credit
ratings for which additional historical information will need to be
collected; and (5) differences in the design and flexibility of their
information systems. However, based on analysis for purposes of the
PRA, the Commission estimates that the amendments to Exhibit 1 to Form
NRSRO will result in total industry-wide one-time costs to NRSROs of
approximately $737,000 and total industry-wide annual costs to NRSROs
of approximately $295,000.\902\
---------------------------------------------------------------------------

    \902\ See section V.E. of this release (discussing
implementation and annual compliance considerations). The one-time
and annual costs are determined by monetizing internal hour burdens
and adding external costs identified in the PRA analysis in section
IV.D.2. of this release.
---------------------------------------------------------------------------

    Under the amendments to paragraph (i) of Rule 17g-1, NRSROs are
required to make Form NRSRO and Exhibits 1 through 9 freely available
on an easily accessible portion of their corporate Internet Web site
and to provide a paper copy of Exhibit 1 to individuals who request a
paper copy. NRSROs may need to re-configure their corporate Internet
Web sites to comply with the amendments and will need to establish
procedures and protocols for processing requests for a paper copy.
Based on analysis for purposes of the PRA, the Commission estimates
that the amendments to paragraph (i) of Rule 17g-1 will result in total
industry-wide one-time costs to NRSROs of approximately $150,000 and
total industry-wide annual costs to NRSROs of approximately
$121,000.\903\
---------------------------------------------------------------------------

    \903\ See section V.E. of this release (discussing
implementation and annual compliance considerations). The one-time
and annual costs are determined by monetizing internal hour burdens
and adding external costs identified in the PRA analysis in section
IV.D.1. of this release.
---------------------------------------------------------------------------

    The amendments to the instructions for Exhibit 1 also may result in
other costs to NRSROs. For some NRSROs, it is possible that using only
the single cohort approach to produce the performance statistics in
Exhibit 1 may lead users of credit ratings to misinterpret their
performance, negatively impacting competition in the industry.
Specifically, as discussed above, the single cohort approach will
produce statistics about three particular cohorts of credit ratings and
may thus be subject to volatility. Further, the statistics may be
particularly volatile for certain NRSROs, such as those that have a
small number of credit ratings in a given start date cohort or those
that focus on particular industries, geographies, or other sectors
within a class of credit ratings. The requirements of the final
amendments (that is, showing the number of credit ratings in the start
date cohort) are designed to provide persons reviewing the statistics
with sufficient information to readily assess the impact that a small
number of credit ratings can have on the statistics. Also, the
disclosure of ratings histories should permit more refined comparisons
of performance in cases where differences in performance statistics may
reflect differences in the universe of obligors or instruments rated

by NRSROs. However, some persons reviewing the transition and default
rates could inappropriately view the volatility resulting from such
factors unfavorably, potentially disadvantaging these NRSROs relative
to the baseline to the extent that their reputation for producing
quality credit ratings is negatively affected. The competitive position
of small NRSROs may be further disadvantaged by the burden associated
with establishing systems to produce the statistics, since this cost
may not depend on the number of credit ratings in the start-date
cohorts and thus may result in a higher relative burden for small
NRSROs.\904\
---------------------------------------------------------------------------

    \904\ See section I.B.3. of this release (providing a broader
discussion of the potential impacts of the amendments and new rules
on efficiency, competition, and capital formation).
---------------------------------------------------------------------------

    Under the baseline requirements, NRSROs publicly disclosed certain
rating histories data to fulfill the requirements of the 10% Rule and
the 100% Rule, but the sample of credit ratings subject to the
disclosure, the rating actions disclosed, the extent of the histories,
and the included data fields differ, to varying degrees, from those
required by the amendments. The amendments may thus require NRSROs to
add more rating histories to their disclosures because in contrast to
the baseline requirements the amendments: (1) Apply to all credit
ratings outstanding as of the specified date or initiated thereafter
rather than a random sample of credit ratings; (2) do not exclude
credit ratings that were outstanding as of the specified date but
initiated before June 26, 2007; and (3) require the rating histories of
withdrawn ratings to be retained in the file for fifteen years. Also,
the amendments will require NRSROs to revise which rating actions are
included and to provide more information about each rating action in
the rating histories. NRSROs initially will have to collect additional
historical data and edit the history files to meet these requirements.
Some of the required information which might not have been collected
previously--such as the categorization of credit ratings in the asset-
backed securities class into sub-classes--will be retrieved in the
process of complying with the amended instructions for Exhibit 1 to
Form NRSRO discussed above. NRSROs also will have to reprogram existing
systems and make changes in procedures to collect and upload the
information according to the amendments going forward. NRSROs may have
to make changes to their corporate Internet Web sites to disclose the
information on an ``easily accessible'' portion of their Web sites,
though the incremental changes required beyond the Web site changes to
disclose Form NRSRO discussed above may be minimal. On an ongoing
basis, the cost of the procedures required to update the rating
histories files at least monthly may exceed the annual burden
previously imposed by the 10% Rule (which is being repealed) and the
100% Rule before today's amendments, given the comprehensive nature of
the data required. The Commission's estimates of these costs--which are
based on analyses for purposes of the PRA--are provided below.
    One commenter stated that the Commission ``substantially
underestimated the costs'' of the proposed amendments to the 100% Rule
in the proposing release.\905\ Two other commenters raised concerns
that retrieving the required historical data would require substantial
cost or could be impossible.\906\ The Commission acknowledges that the
amendments will impose significant costs on NRSROs, and has modified
the proposal in a number of ways to mitigate costs. First, the final
amendments eliminate the requirement to include information for all
credit ratings outstanding on June 26, 2007, and replace it with a
standard three-year backward-looking requirement that applies
irrespective of when the NRSRO is registered in a class of credit
ratings. This should significantly reduce the costs of retrieving and
analyzing historical information for the purposes of making the rating
histories disclosures. Further, the final amendments eliminate two
types of rating actions that would trigger a requirement to add
information to a credit rating's history: Placements of the credit
rating on watch or review and affirmations of the credit rating. This
may further reduce the cost of retrieving the historical information
that must be disclosed in the rating histories, since a record of an
affirmation of the credit rating may not previously have been stored
(or stored in a readily retrievable format) by NRSROs. Consequently,
because of these modifications, NRSROs should not need to perform
analyses to identify historical affirmations and reconstruct the
information that would need to have been disclosed under the proposal
in connection with each affirmation of the credit rating (for example,
the date of the action). The remaining information that is required to
be disclosed, but may not have been systematically stored by NRSROs
previously (such as the required categorization of the reason for a
withdrawal), generally will need to be collected only once for each
rating history rather than for multiple rating actions within a
history, as each rating history should, for example, have only one
withdrawal (whereas a history could have multiple affirmations of the
credit rating). The narrowing of the scope of the types of rating
actions that are required to be included in the rating histories also
should reduce the burden of updating the XBRL data file with new
information in the future. While the Commission believes the
modifications discussed above may substantially reduce the costs of
retrieving historical data, an NRSRO can seek exemptive relief from the
Commission under section 36 of the Exchange Act. The amendments also
specify a standard for updating the file--no less frequently than
monthly. This should mitigate concerns that the file would need to be
updated more frequently. Finally, the final amendments modify the
proposal to reduce the time period a credit rating history must be
retained after the credit rating is withdrawn from twenty years to
fifteen years. This should reduce the data retention and maintenance
costs associated with the amendments compared to the proposal.
---------------------------------------------------------------------------

    \905\ See DBRS Letter.
    \906\ See, e.g., Moody's Letter (stating that collecting certain
data for past rating actions would have to be done manually and
``would require tens of thousands of hours of analysis''); S&P
Letter (stating that ``it may not be possible to track'' the
distinction between ratings withdrawn for different reasons
``retroactively'').
---------------------------------------------------------------------------

    The costs of the compliance efforts described above with respect to
the amended requirements for disclosing rating histories should vary
across NRSROs due to: (1) Differences in the quantity of credit ratings
they issue and have issued in the historical years subject to
disclosure; (2) differences in the data fields that they currently
include in their rating histories; (3) differences with respect to the
historical information they currently store in a readily-retrievable
format; and (4) differences in the design and flexibility of their
information systems. However, based on analysis for purposes of the
PRA, the Commission estimates that the amendments to Rule 17g-2 and
paragraph (b) of Rule 17g-7 will result in total industry-wide one-time
costs to NRSROs of approximately $393,000, and total industry-wide
annual costs to NRSROs of approximately $131,000.\907\
---------------------------------------------------------------------------

    \907\ See section V.F. of this release (discussing
implementation and annual compliance considerations). The one-time
and annual costs are determined by monetizing internal hour burdens
and adding external costs identified in the PRA analysis in section
IV.D.6. of this release.
---------------------------------------------------------------------------

    One commenter stated that the proposed amendments ``may force
NRSROs to incur increased licensing

costs to add new CUSIP data.'' \908\ The CUSIP Global Services' license
fees may vary based on the level of usage (that is, the number of
CUSIPs databased and the licensees' business lines and regions of
operation where the data will be used) and the form of usage (such as
the internal databasing of CUSIP data or the distribution of CUSIP
data).\909\ The Commission believes that most NRSROs already have
licensing agreements in place for their current usage of CUSIP data,
but it is possible that these baseline licensing agreements may need to
be expanded given the additional CUSIP data that may have to be stored
and disclosed to comply with the amendments. The comment letter that
highlighted these potential costs did not provide an estimate of these
costs and did not provide data or analysis that would allow the
Commission to estimate how NRSROs' CUSIP licenses would need to be
changed to account for the new requirements.\910\ Without information
about the scope of the NRSROs' current licenses and the cost of
obtaining updated licenses, it is not feasible for the Commission to
develop an estimate of any such costs.\911\
---------------------------------------------------------------------------

    \908\ See DBRS Letter (``Expanding the ratings history universe,
may also force NRSROs to incur increased licensing costs to add new
CUSIP data. Any such costs should be factored into the Commission's
cost-benefit analysis of this proposal.'').
    \909\ Information about CUSIP licenses is available at http://www.cusip.com/cusip/cgs-license-fees.htm.
    \910\ See DBRS Letter.
    \911\ CUSIP Global Services does provide some information about
potential license fees on its public Web site, but explicitly states
that the disclosed fee schedule does not apply to ``information
providers, whose fees for their own usage and redistribution of CGS
data are calculated using a different pricing model.'' The Web site
also states that the ``[f]inal determination of fees is at the
judgment of CGS and consideration will be given to aspects of a
customer's profile.'' See http://www.cusip.com/cusip/cgs-license-fees.htm.
---------------------------------------------------------------------------

    Another potential cost to NRSROs is the potential loss of revenue
from the sale of access to historical ratings data, as more of this
data becomes publicly available. The Commission understands that
revenue from this source may be significant for certain NRSROs, though
commenters did not provide data or analysis that would allow the
Commission to estimate the amount of revenue that could be lost.\912\
The Commission is unable to estimate the revenue attributable to the
sale of access to historical ratings data from other sources because
the information about NRSRO revenues available to the Commission is not
broken down at this level of granularity and, in practice, access to
such historical data may be bundled with access to analytical tools and
other services. This potential loss of revenue may be mitigated by the
grace periods before disclosure, the fact that historical information
before the three-year look-back period is not required to be disclosed,
the exclusion of placements on credit watch and affirmations from the
rating actions that must be disclosed in the public rating
histories,\913\ and the ability to remove a rating history from the
public data file fifteen years after the credit rating is withdrawn.
However, it is difficult to predict how subscribers will react to the
change in the extent of publicly available data.
---------------------------------------------------------------------------

    \912\ See, e.g., Fitch Letter.
    \913\ For example, as discussed below, academic research
suggests that placements on credit watch are significant information
events, so some users of credit ratings may value information about
historical NRSRO usage and timing of placements on credit watch.
---------------------------------------------------------------------------

    Because any such losses in revenue likely would disproportionately
affect NRSROs that are more dependent on revenue from selling access to
historical ratings data, and particularly NRSROs that operate on the
subscriber-pay model, the disclosure requirement may disadvantage these
NRSROs to the detriment of competition in the industry. Additional
impacts on competition may result from the disproportionate burden on
small NRSROs, given that some of the compliance costs are not likely to
vary with size, and on NRSROs that have systems and data collection
procedures that vary the most from the requirements of the amendments.
    In addition to these effects, the amendments may affect capital
formation. Some academic research indicates that credit rating agencies
should not focus exclusively on ratings accuracy, but also should
consider the feedback effects of their credit ratings on the
probability of survival of an issuer.\914\ Specifically, these theories
suggest that if credit ratings can directly affect the default
probability of an issuer, such as when a ratings downgrade itself makes
it harder or more costly for a company to raise funds, then it may be
optimal for credit rating agencies to delay credit rating downgrades in
order to lessen the impact of such feedback on the company's prospects.
If the adopted rules drive increased transparency with respect to
performance, and this leads to pressures on NRSROs to assign more
accurate credit ratings by making earlier downgrades, the amplified
feedback effects could increase the default frequencies of issuers and
other obligors.\915\
---------------------------------------------------------------------------

    \914\ See, e.g., Gustavo Manso, Feedback Effects of Credit
Ratings, J. of Financial Economics (2013), Volume 109, p. 535-548.
    \915\ See section I.B.3. of this release (providing a broader
discussion of the potential impacts of the amendments and new rules
on efficiency, competition, and capital formation).
---------------------------------------------------------------------------

    The Commission has considered the costs and benefits of reasonable
alternatives relative to today's amendments, including certain
alternatives that have been raised by commenters and discussed above.
One NRSRO requested that the Commission provide ``fuller background''
on decisions such as the determination to require the single cohort
approach rather than an average cohort approach for performance
statistics, with a description of potential benefits and limitations of
those decisions.\916\ As an alternative to the single cohort approach,
the Commission could have required NRSROs to use the average cohort
approach, or to present two sets of statistics using the average and
single cohort approaches respectively, as suggested by commenters.\917\
Statistics generated using the average cohort approach would provide
information to users of credit ratings that is not available from
statistics generated using the single cohort approach, specifically
with regard to how credit ratings perform on average across a wider
variety of economic conditions. Such information may be of use to users
of credit ratings in evaluating and comparing the performance of
NRSROs. However, variation in the length of histories available at the
different NRSROs makes it difficult to produce a standardized
methodology for computing average cohort statistics that would be
comparable across NRSROs. Also, because the single cohort approach
requires simpler calculations, it may be less burdensome for NRSROs to
produce such statistics and easier for less sophisticated investors to
understand how such performance measurement statistics were produced.
As discussed above, NRSROs will continue to be permitted to present
alternative statistics on a voluntary basis on their public Web sites,
and by reference to a URL in Exhibit 1.
---------------------------------------------------------------------------

    \916\ See Kroll Letter.
    \917\ See CFA/AFR Letter; DBRS Letter.
---------------------------------------------------------------------------

    A second alternative with respect to the performance statistics
would be to require the disclosure of withdrawn credit ratings, without
requiring that this category be separated into credit ratings that were
withdrawn because the related obligation was paid off, because the
obligor defaulted, or for other reasons. This alternative would be less
burdensome than the approach in the amendments, because, as discussed
by

two commenters,\918\ NRSROs that have not tracked this information
historically likely would incur costs to collect the required
information retroactively and change their systems to collect and
report this information going forward. However, given that an applicant
or NRSRO could withdraw a credit rating to make its transition or
default rates appear more favorable, information about the reasons for
withdrawal is likely to be useful to users of credit ratings in
interpreting the performance statistics.
---------------------------------------------------------------------------

    \918\ See Moody's Letter (stating that it does not
``systematically capture data that sub-divides withdrawn credit
ratings into the three sub-categories'' and that collecting this
data for past rating actions ``would have to be done manually'');
S&P Letter (``NRSROs may not currently distinguish between ratings
on instruments that are paid off and withdrawn. Tracking this
distinction going forward, to the extent it is not presently being
done, will require significant systems changes. In addition, it may
not be possible to track this distinction retroactively.'').
---------------------------------------------------------------------------

    An alternative approach to the amendments regarding rating
histories would be to require the inclusion of placements on credit
watch in the rating histories, while still excluding ratings
affirmations, which would be consistent with the rating actions subject
to disclosure in histories under the baseline requirements. Among the
three commenters that recommended that the scope of rating actions
included in public rating histories be narrowed, two did not raise
concerns about the inclusion of placements on credit watch.\919\
Academic research has found that credit watch announcements are
associated with abnormal stock and bond returns, indicating that
placing a rating on credit watch is a significant information
event.\920\ Including these announcements in rating histories would
thus allow persons to, for example, judge which NRSROs have
historically been more likely to provide, and more timely at providing,
this information to the users of credit ratings, and thus may increase
the accountability, time sensitivity, and judiciousness of NRSROs in
placing credit ratings on credit watch. However, while making
information about placements on credit watch publicly available in the
rating histories may benefit users of credit ratings that value this
information, the fact that some users of credit ratings may value this
information also means that excluding such information from rating
histories may make subscribers to NRSRO services that include access to
historical ratings data (including placements on credit watch) somewhat
less likely to stop subscribing as an increasing amount of historical
ratings data becomes publicly available. The Commission therefore
believes that excluding placements on credit watch from the rating
histories may reduce potential losses in NRSRO revenues from services
that include access to their credit ratings and/or rating histories
while still permitting users of credit ratings to use the public rating
histories to conduct certain analyses (such as calculating alternative
transition and default statistics) to evaluate and compare NRSRO
performance.
---------------------------------------------------------------------------

    \919\ See ABA Letter; S&P Letter. Another commenter recommended
that the Commission exclude both affirmations and placements on
credit watch, as well as assignments of default status, from the
definition of rating action. See Moody's Letter.
    \920\ See, e.g., Hand, Holthausen, and Leftwich, The Effect of
Bond Rating Agency Announcements on Bond and Stock Prices; Chung,
Frost, and Kim, Characteristics and Information Value of Credit
Watches.
---------------------------------------------------------------------------

    Additional alternatives with respect to rating history disclosure
would be to not permit a rating history for a credit rating to be
removed from the data file fifteen years after the credit rating is
withdrawn, or to shorten the retention period to ten years as suggested
by a commenter.\921\ Under the first alternative, the retention period
could be substantially increased or a history could be required to be
retained permanently. In particular, because the amendments allow
credit ratings to be removed from the histories fifteen years after
they are withdrawn, any data that becomes available for periods over
fifteen years in the past will not reflect a representative sample of
the credit ratings of the NRSRO, since withdrawn credit ratings,
including credit ratings withdrawn because of default, will be
underrepresented in the sample of outstanding credit ratings in the
rating histories for a period that is more than fifteen years in the
past.\922\ Thus, the data files disclosed pursuant to the amendments
will over time result in no more than fifteen years (and likely no more
than thirteen or fourteen years, given the permitted grace periods) of
data that is fully comprehensive and can therefore be used to calculate
performance statistics or perform other analyses that require a
representative sample of credit ratings. The data will, over time,
become sufficient to produce, for example, five-year and twelve-year
performance statistics using the single cohort approach or, for
example, three-year performance statistics using the average cohort
approach applied to the eleven annual cohorts beginning thirteen years
ago. However, performance statistics using the data from ratings
histories will be limited to cohorts of credit ratings over these
thirteen or fourteen years of history and thus may not reflect as wide
as a variety of economic conditions as may be desired.
---------------------------------------------------------------------------

    \921\ See DBRS Letter.
    \922\ See GAO Report 10-782, pp. 46, 98. See also id. at 98
(stating that ``[t]o the extent that withdrawn ratings are not
included in the data, users will not be able to generate withdrawal-
adjusted statistics and the data will underrepresent defaulted
issuers and issues'' and recommending that ``withdrawn ratings are
not removed from these disclosures'').
---------------------------------------------------------------------------

    Increasing the retention period would therefore benefit users of
credit ratings interested in using the rating histories to perform
analyses that require a representative sample of the credit ratings of
the NRSRO outstanding as of a date or a series of dates that are more
than thirteen or fourteen years in the past. However, as in the case of
excluding data with respect to placements on credit watch, applying a
shorter retention period may reduce potential losses to NRSROs of
revenue from selling access to historical ratings data. Also, one NRSRO
stated that ``the amount of data storage required'' to comply with a
twenty-year retention requirement for the public rating histories
``would be considerable.'' \923\ The Commission therefore believes that
a fifteen-year retention requirement may reduce the burden on NRSROs,
while still permitting users of credit ratings to use the public rating
histories to conduct certain analyses (such as transition and default
statistics that require up to thirteen or fourteen years of data, or
comparisons over longer horizons of NRSRO performance with respect to
the same obligor or instrument) to evaluate and compare NRSRO
performance.
---------------------------------------------------------------------------

    \923\ See S&P Letter.
---------------------------------------------------------------------------

    For these reasons, the Commission also does not believe it would be
appropriate to shorten the retention period to ten years as suggested
by one commenter.\924\ A ten year retention period (rather than a
fifteen year retention period) would further limit the utility of the
rating histories in terms of being able to use the data to generate
performance statistics that are different than the performance
statistics that must be disclosed in Exhibit 1 to Form NRSRO.
---------------------------------------------------------------------------

    \924\ See DBRS Letter.
---------------------------------------------------------------------------

    A further alternative for rating history disclosure would be to
increase or decrease the grace periods relative to the twelve- and
twenty-four-month grace periods that are permitted for issuer-paid and
other credit ratings respectively under the amendments. Longer
permitted grace periods likely would reduce potential losses
experienced by NRSROs in revenues

from services that include access to their credit ratings and/or rating
histories. However, shorter grace periods would increase the benefits
from the disclosure by making more, and more timely, information
available to users of credit ratings for the purpose of evaluating and
comparing the performance of NRSROs. The Commission believes it has
appropriately balanced the costs and benefits of increasing or
decreasing the grace periods in setting the grace periods permitted
under the amendments.

F. Credit Rating Methodologies

    Section 932(a)(8) of the Dodd-Frank Act amended section 15E of the
Exchange Act to add subsection (r).\925\ Section 15E(r) of the Exchange
Act provides that the Commission shall prescribe rules, for the
protection of investors and in the public interest, with respect to the
procedures and methodologies, including qualitative and quantitative
data and models, used by NRSROs that require each NRSRO to ensure that
objectives identified in section 15E(r) are met.\926\ The Commission
proposed to implement section 15E(r) in large part, through paragraph
(a) of Rule 17g-8, which would require an NRSRO to establish, maintain,
enforce, and document policies and procedures that are reasonably
designed to ensure it meets the objectives identified in section
15E(r).\927\ The intent was to provide flexibility for an NRSRO to
establish policies and procedures that can be integrated with its
procedures and methodologies for determining credit ratings, which vary
across NRSROs.\928\ The proposed approach also was sensitive to the
limitation in section 15E(c)(2) of the Exchange Act, given that the
objectives set forth in section 15E(r) of the Exchange Act relate to
the procedures and methodologies an NRSRO uses to determine credit
ratings.\929\ The Commission also proposed an amendment to Rule 17g-2
to apply the record retention and production requirements of that rule
to the documentation of the policies and procedures that would be
required under proposed paragraph (a) of Rule 17g-8.\930\
---------------------------------------------------------------------------

    \925\ See Public Law 111-203, 932(a)(8); 15 U.S.C. 78o-7(r).
    \926\ The objectives are: (1) To ensure that credit ratings are
determined using procedures and methodologies, including qualitative
and quantitative data and models, that are (A) approved by the board
of the NRSRO or a body performing a similar function; and (B) in
accordance with the policies and procedures of the NRSRO for the
development and modification of credit rating procedures and
methodologies; (2) to ensure that when material changes to credit
rating procedures and methodologies (including changes to
qualitative and quantitative data and models) are made, that (A) the
changes are applied consistently to all credit ratings to which the
changed procedures and methodologies apply; (B) to the extent that
changes are made to credit rating surveillance procedures and
methodologies, the changes are applied to then-current credit
ratings by the NRSRO within a reasonable time period determined by
the Commission, by rule; and (C) the NRSRO publicly discloses the
reason for the change; and (3) to notify users of credit ratings (A)
of the version of a procedure or methodology, including the
qualitative methodology or quantitative inputs, used with respect to
a particular credit rating; (B) when a material change is made to a
procedure or methodology, including to a qualitative model or
quantitative inputs; (C) when a significant error is identified in a
procedure or methodology, including a qualitative or quantitative
model, that may result in credit rating actions; and (D) of the
likelihood of a material change described in subparagraph (B)
resulting in a change in current credit ratings. See 15 U.S. C. 78o-
7(r)(1) through (3).
    \927\ See paragraph (a) of Rule 17g-8, as proposed; Nationally
Recognized Statistical Rating Organizations, 76 FR at 33452-33465.
As discussed below, the Commission proposed to implement section
15E(r)(3)(A) of the Exchange Act (which addresses notice of the
version of a procedure or methodology used with respect to a
particular credit rating) also through paragraph (a) of Rule 17g-7,
as proposed. See Nationally Recognized Statistical Rating
Organizations, 76 FR at 33459.
    \928\ See Nationally Recognized Statistical Rating
Organizations, 76 FR at 33452.
    \929\ See id. at 33452. See also 15 U.S.C. 78o-7(r); 15 U.S.C.
78o-7(c)(2) (providing, in pertinent part, that the Commission may
not regulate the substance of credit ratings or the procedures and
methodologies by which any NRSRO determines credit ratings).
    \930\ See Nationally Recognized Statistical Rating
Organizations, 76 FR at 33456.
---------------------------------------------------------------------------

1. Paragraph (a) of New Rule 17g-8
    As proposed, paragraph (a) of Rule 17g-8 would require an NRSRO to
establish, maintain, enforce, and document policies and procedures that
are reasonably designed to ensure that it achieves the objectives
identified in section 15E(r) of the Exchange Act.\931\ In particular,
the prefatory text of paragraph (a) would require an NRSRO to
establish, maintain, enforce, and document policies and procedures that
are reasonably designed to ensure that it meets the objectives
identified in paragraphs (a)(1), (2), (3), (4), and (5).\932\ The rule
text in proposed paragraphs (a)(1), (2), (3), (4), and (5) of Rule 17g-
8 largely mirrored the statutory text of section 15E(r) of the Exchange
Act.\933\
---------------------------------------------------------------------------

    \931\ See proposed paragraph (a) of Rule 17g-8; Nationally
Recognized Statistical Rating Organizations, 76 FR at 33542.
    \932\ See proposed prefatory text of paragraph (a) of Rule 17g-
8; Nationally Recognized Statistical Rating Organizations, 76 FR at
33542.
    \933\ Compare paragraphs (a)(1), (2), (3), (4), and (5) of Rule
17g-8, as proposed, with 15 U.S. C. 78o-7(r)(1) through (3).
---------------------------------------------------------------------------

    The Commission is adopting the prefatory text of paragraph (a) of
Rule 17g-8 as proposed.\934\ The final rule requires an NRSRO to
establish, maintain, enforce, and document policies and procedures
reasonably designed to ensure that it meets the objectives identified
in paragraphs (a)(1), (2), (3), (4), and (5) of the rule.
---------------------------------------------------------------------------

    \934\ See prefatory text of paragraph (a) of Rule 17g-8.
---------------------------------------------------------------------------

    One commenter stated that the proposal appropriately recognizes
that procedures and methodologies vary across NRSROs and thus there is
a need for flexibility to establish policies and procedures that can be
integrated with the NRSRO's existing credit rating methodologies.\935\
Some commenters expressed general opposition to the proposal on the
basis of cost.\936\ One of these commenters stated that certain aspects
of the proposals, including those regarding credit rating
methodologies, would compound barriers to entry, and that many of the
rules would be expensive and burdensome to implement.\937\ More
specifically, this commenter stated that the Commission should take
into account the dominance of very large players and expand exemptions
for small NRSROs designed to level the competitive field.\938\
---------------------------------------------------------------------------

    \935\ See ICI Letter.
    \936\ See A.M. Best Letter; Kroll Letter. Alternatively, another
commenter expressed the view that rule should, in general, be
strengthened by explicitly requiring NRSROs to assign higher risk to
products issued by financial institutions with a track record of
issuing poor quality assets. See Levin Letter. This recommendation
is beyond the scope of the proposal and could implicate section
15E(c)(2) of the Exchange Act. See 15 U.S. C. 78o-7(c)(2) (which,
among other things, prohibits the Commission from regulating the
substance of credit ratings and the procedures and methodologies by
which any NRSRO determines credit ratings).
    \937\ See Kroll Letter.
    \938\ See id.
---------------------------------------------------------------------------

    In response, the Commission notes that the final rule is designed
to meet the rulemaking mandate of section 15E(r) of the Exchange Act in
a manner that provides flexibility to NRSROs to design the required
policies and procedures. Consequently, an NRSRO can tailor and scale
its policies and procedures to its business model, size, and the scope
of its activities as well as to its procedures and methodologies for
determining credit ratings, which should mitigate concerns to some
degree about the costs of the final rule and its potential to create
barriers to entry for small credit rating agencies. The Commission also
believes that the policies and procedures required under section
15E(r), as implemented by the Commission in paragraph (a) of Rule 17g-
8, will promote the integrity and transparency of the procedures and
methodologies NRSROs use to determine credit ratings by, for example,

promoting board oversight of these procedures and methodologies and
requiring disclosure when material changes are made to them.
Nonetheless, as discussed below in the economic analysis, the
Commission acknowledges that these requirements will result in costs
and that those costs could create competitive barriers.
    As proposed, paragraph (a)(1) of Rule 17g-8 would implement section
15E(r)(1)(A) of the Exchange Act.\939\ This section identifies the
objective of ensuring that credit ratings are determined using
procedures and methodologies, including qualitative and quantitative
data and models, that are approved by the board of the NRSRO, or a body
performing a function similar to that of a board.\940\ Paragraph
(a)(1), as proposed, would require an NRSRO to establish, maintain,
enforce, and document policies and procedures reasonably designed to
ensure that credit ratings are determined using procedures and
methodologies, including qualitative and quantitative data and models,
that are approved by the board of the NRSRO, or a body performing a
function similar to that of a board.\941\ The Commission intended this
requirement to operate in conjunction with section 15E(t)(3)(A) of the
Exchange Act, which establishes a statutory requirement that the board
of an NRSRO ``shall oversee'' the establishment, maintenance, and
enforcement of the policies and procedures for determining credit
ratings.\942\
---------------------------------------------------------------------------

    \939\ See paragraph (a)(1) of Rule 17g-8, as proposed;
Nationally Recognized Statistical Rating Organizations, 76 FR at
33453.
    \940\ See 15 U.S.C. 78o-7(r)(1)(A).
    \941\ See paragraph (a)(1) of Rule 17g-8, as proposed;
Nationally Recognized Statistical Rating Organizations, 76 FR at
33542.
    \942\ See 15 U.S.C. 78o-7(t)(3)(A); Nationally Recognized
Statistical Rating Organizations, 76 FR at 33453.
---------------------------------------------------------------------------

    The Commission is adopting paragraph (a)(1) of Rule 17g-8, as
proposed.\943\ The final rule requires an NRSRO to have policies and
procedures that are reasonably designed to ensure that the procedures
and methodologies it 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.\944\ In relation to this requirement in
paragraph (a)(1), section 15E(t)(3)(A) of the Exchange Act (as
discussed above) contains a self-executing requirement that the board
of an NRSRO ``shall oversee'' the ``establishment, maintenance, and
enforcement of the policies and procedures for determining credit
ratings.'' \945\ Consequently, as discussed in the proposing release,
the policies and procedures required pursuant to paragraph (a)(1) of
Rule 17g-8, as adopted, must be reasonably designed to ensure that the
NRSRO's board carries out this statutorily mandated
responsibility.\946\ In addition, section 15E(t)(5) of the Exchange Act
provides that the Commission may permit an NRSRO to delegate
responsibilities required in section 15E(t) to a committee if the
Commission finds that compliance with the provisions of that section
present an unreasonable burden on a small NRSRO.\947\ In this case, the
policies and procedures required pursuant to paragraph (a)(1) of Rule
17g-8, as adopted, must be reasonably designed to ensure the NRSRO's
committee carries out the responsibility to oversee the establishment,
maintenance, and enforcement of the NRSRO's procedures and
methodologies for determining credit ratings.\948\
---------------------------------------------------------------------------

    \943\ See paragraph (a)(1) of Rule 17g-8.
    \944\ See id.
    \945\ See 15 U.S.C. 78o-7(t)(3)(A).
    \946\ See Nationally Recognized Statistical Rating
Organizations, 76 FR at 33453.
    \947\ See 15 U.S.C. 78o-7(t)(5).
    \948\ See 15 U.S.C. 78o-7(t)(3)(A).
---------------------------------------------------------------------------

    One commenter stated that the proposal appropriately meets the
Exchange Act mandate.\949\ Another commenter cited the high costs
associated with having an independent board and stated that given those
high costs the scope of board functions should not be inadvertently
expanded.\950\ This commenter also stated that it would have been
helpful for the final rule to provide greater guidance to confirm that
the board is not required to approve or pass judgment on, for example,
``qualitative and quantitative data and models.'' \951\ A second
commenter stated that a periodic approval process is more consistent
with the board of directors' oversight role and provides the board of
directors a better opportunity to provide well-planned and meaningful
guidance that would be better at creating consistency in best practices
across the NRSRO.\952\ A third commenter stated that responsibility for
the development of ratings criteria, methodologies, and models ``should
be in the hands of experienced ratings professionals'' and that the
board should be responsible for approving the policies and procedures
that are used to develop the NRSROs' criteria, methodologies, and
models.\953\ The commenter did not interpret the proposal to require
the board to approve the criteria, methodologies, or models themselves,
stating that any such requirement would not be feasible given the vast
amounts of continually developing criteria used by NRSROs.\954\
---------------------------------------------------------------------------

    \949\ See S&P Letter.
    \950\ See Kroll Letter. Section 15E(t)(2) of the Exchange Act
prescribes a self-executing requirement that at least one half of
the members of an NRSRO's board must be independent. See 15 U.S.C
78o-7(t)(2).
    \951\ See Kroll Letter.
    \952\ See Morningstar Letter.
    \953\ See S&P Letter.
    \954\ See id.
---------------------------------------------------------------------------

    In response to the comments, the Commission notes that section
15E(t)(3)(A) of the Exchange Act provides that the board of an NRSRO
shall oversee the establishment, maintenance, and enforcement of
policies and procedures for determining credit ratings.\955\
Consequently, the self-executing requirement in the statute governs the
responsibility of the board. Paragraph (a)(1) of Rule 17g-8 governs the
responsibility of the NRSRO to have policies and procedures reasonably
designed to ensure that the board carries out this responsibility. In
terms of complying with the statutory requirement to oversee rating
policies and procedures, the Commission recognizes that the board
cannot be involved in managing the day-to-day affairs of the NRSRO.
There must be an appropriate balance between the board's
responsibilities as a governing body and the responsibilities of the
NRSRO's managers as supervisors of the daily activities of the NRSRO.
As a practical matter, an NRSRO will need to appropriately allocate
responsibilities to the NRSRO's board and to the NRSRO's managers with
respect to the implementation of rating procedures and methodologies,
with the board exercising its statutory responsibility to oversee the
establishment, maintenance, and enforcement of the NRSRO's policies and
procedures for determining credit ratings. Consequently, the Commission
does not expect board members to undertake the detailed work of
developing rating procedures and methodologies.
---------------------------------------------------------------------------

    \955\ See 15 U.S.C. 78o-7(t)(3)(A).
---------------------------------------------------------------------------

    Further, as discussed above, section 15E(t)(5) of the Exchange Act
provides exception authority under which the Commission may permit an
NRSRO to delegate responsibilities of the board required in section
15E(t) to a committee if the Commission finds that compliance with the
provisions of that section present an unreasonable burden on a small
NRSRO.\956\ The ability to request an exception under section 15E(t)(5)
provides a means for a small NRSRO to seek relief to delegate

responsibilities to a committee if the potential costs and burdens
associated with the requirements of section 15E(t) of the Exchange
Act--including the requirement that the board oversee the
establishment, maintenance, and enforcement of the policies and
procedures for determining credit ratings--are an unreasonable
burden.\957\
---------------------------------------------------------------------------

    \956\ See 15 U.S.C. 78o-7(t)(5).
    \957\ The Commission will respond to such requests in a manner
similar to requests for relief under section 36 of the Exchange Act.
See 15 U.S.C. 78mm. Further information about requesting relief
under section 36 of the Exchange Act is available at http://www.sec.gov/rules/exempt.shtml.
---------------------------------------------------------------------------

    Commenters also questioned whether the board of directors would
need to have members with expertise in rating methodologies.\958\ One
of these commenters stated that the rule should require the NRSRO to
appoint at least one board member with quantitative financial analysis
expertise.\959\ Section 15E(t)(3)(A) of the Exchange Act, while
mandating that the NRSRO's board must ``oversee'' the establishment,
maintenance, and enforcement of the NRSRO's policies and procedures for
determining credit ratings, does not address whether the board must
include a member with specific expertise in this area.\960\ Similarly,
section 15E(r)(1)(A) of the Exchange also does not address board
expertise and, consequently, neither does paragraph (a)(1) of Rule 17g-
8.\961\ In complying with the statute and rule, an NRSRO and its
shareholders will need to strike an appropriate balance between board
members who have generalized experience and those who have more
specific experience with aspects of the NRSRO's business activities,
including with rating methodologies.
---------------------------------------------------------------------------

    \958\ See, e.g., AFSCME Letter (expressing concerns that the
board may not possess the necessary expertise, particularly in
quantitative analysis, to carry out the oversight function specified
in paragraph (a)(1) of Rule 17g-8); COPERA Letter (expressing
similar concerns); Morningstar Letter.
    \959\ See AFSCME Letter.
    \960\ See 15 U.S.C. 78o-7(t)(3)(A). The statute does require the
NRSRO to have independent board members, some of whom must be users
of credit ratings of NRSROs. See 15 U.S.C. 78o-7(t)(2)(A).
    \961\ See 15 U.S.C. 78o-7(r)(1)(A).
---------------------------------------------------------------------------

    Paragraph (a)(2) of Rule 17g-8, as proposed, would implement
section 15E(r)(1)(B) of the Exchange Act.\962\ This section identifies
the objective of ensuring that credit ratings are determined using
procedures and methodologies, including qualitative and quantitative
data and models, that are in accordance with the policies and
procedures of the NRSRO for the development and modification of credit
rating procedures and methodologies.\963\ As proposed, paragraph (a)(2)
would require an NRSRO 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, that the NRSRO uses to determine credit ratings are
developed and modified in accordance with the policies and procedures
of the NRSRO.\964\
---------------------------------------------------------------------------

    \962\ See paragraph (a)(2) of Rule 17g-8, as proposed;
Nationally Recognized Statistical Rating Organizations, 76 FR at
33453.
    \963\ See 15 U.S.C. 78o-7(r)(1)(B).
    \964\ See paragraph (a)(2) of Rule 17g-8, as proposed;
Nationally Recognized Statistical Rating Organizations, 76 FR at
33542.
---------------------------------------------------------------------------

    The Commission is adopting paragraph (a)(2) of Rule 17g-8 as
proposed.\965\ Section 15E(c)(3)(A) of the Exchange Act requires an
NRSRO to ``establish, maintain, enforce, and document an effective
internal control structure governing the implementation of and
adherence to policies, procedures, and methodologies for determining
credit ratings.'' \966\ Consequently, section 15E(c)(3)(A) establishes
a statutory requirement that an NRSRO have an internal control
structure that governs the implementation of rating procedures and
methodologies.\967\ In addition, paragraph (a)(2) of Rule 17g-8
establishes a complementary requirement that an NRSRO have policies and
procedures reasonably designed to ensure that rating procedures and
methodologies are developed and modified in accordance with the NRSRO's
procedures for developing and modifying rating procedures and
methodologies.\968\
---------------------------------------------------------------------------

    \965\ See paragraph (a)(2) of Rule 17g-8.
    \966\ See 15 U.S.C. 78o-7(c)(3)(A) (emphasis added).
    \967\ See id.
    \968\ See paragraph (a)(2) of Rule 17g-8.
---------------------------------------------------------------------------

    Two commenters supported the proposal.\969\ In contrast, one
commenter suggested the Commission take a different approach than was
proposed in paragraph (a)(2) of Rule 17g-8.\970\ Specifically, this
commenter recommended that the rule establish a ``committee assessment
function'' devoted to analyzing the performance of rating
committees.\971\ In response, the Commission notes that the rulemaking
mandate in section 15E(r)(1)(B) of the Exchange Act addresses ensuring
that the NRSRO uses rating procedures and methodologies that are in
accordance with the NRSRO's procedures and methodologies for developing
and modifying such procedures and methodologies.\972\ In other words,
the statute is concerned with ensuring that the NRSRO follows its
processes for developing and modifying rating procedures and
methodologies. The commenter's suggestion for a committee assessment
function addresses the performance of rating committees in determining
credit ratings (that is, in applying the rating procedures and
methodologies). Consequently, the Commission considers the commenter's
proposal outside the scope of this rulemaking.
---------------------------------------------------------------------------

    \969\ See ICI Letter; S&P Letter.
    \970\ See Harrington Letter.
    \971\ See id.
    \972\ See 15 U.S.C. 78o-7(r)(1)(B).
---------------------------------------------------------------------------

    Paragraph (a)(3)(i) of Rule 17g-8, as proposed, would implement
section 15E(r)(2)(A) of the Exchange Act.\973\ This section identifies
the objective of ensuring that, when material changes are made to
rating procedures and methodologies (including changes to qualitative
and quantitative data and models), the changes are applied consistently
to all credit ratings to which the changed procedures and methodologies
apply.\974\ As proposed, paragraph (a)(3)(i) would require an NRSRO to
establish, maintain, enforce, and document policies and procedures
reasonably designed to ensure that material changes to the procedures
and methodologies, including changes to qualitative and quantitative
data and models, the NRSRO uses to determine credit ratings are applied
consistently to all credit ratings to which the changed procedures and
methodologies apply.\975\
---------------------------------------------------------------------------

    \973\ See paragraph (a)(3)(i) of Rule 17g-8, as proposed;
Nationally Recognized Statistical Rating Organizations, 76 FR at
33453.
    \974\ See 15 U.S.C. 78o-7(r)(2)(A).
    \975\ See paragraph (a)(3)(i) of Rule 17g-8, as proposed;
Nationally Recognized Statistical Rating Organizations, 76 FR at
33542-33543.
---------------------------------------------------------------------------

    Paragraph (a)(3)(ii) of Rule 17g-8, as proposed, would implement
section 15E(r)(2)(B) of the Exchange Act.\976\ This section identifies
the objective of ensuring that when material changes are made to rating
procedures and methodologies (including changes to qualitative and
quantitative data and models), to the extent that changes are made to
credit rating surveillance procedures and methodologies, the changes
are applied to then-current credit ratings by the NRSRO within a
reasonable time period determined by the Commission, by rule.\977\ As
proposed, paragraph (a)(3)(ii) would require an NRSRO to establish,
maintain, enforce, and document policies and procedures reasonably
designed to ensure that material changes to the procedures and
methodologies, including changes to qualitative and

quantitative data and models, the NRSRO uses to determine credit
ratings are, to the extent that the changes are to surveillance or
monitoring procedures and methodologies, applied to then-current credit
ratings within a reasonable period of time taking into consideration
the number of ratings impacted, the complexity of the procedures and
methodologies used to determine the credit ratings, and the type of
obligor, security, or money market instrument being rated.\978\ The
proposed rule text differed from the text of section 15E(r)(2)(B) of
the Exchange Act because it provided that the changes must be applied
to then-current credit ratings within a reasonable period of time
taking into consideration the number of credit ratings impacted, the
complexity of the procedures and methodologies used to determine the
credit ratings, and the type of obligor, security, or money market
instrument being rated.\979\
---------------------------------------------------------------------------

    \976\ See paragraph (a)(3)(ii) of Rule 17g-8, as proposed;
Nationally Recognized Statistical Rating Organizations, 76 FR at
33453-33454.
    \977\ See 15 U.S.C. 78o-7(r)(2)(B).
    \978\ See paragraph (a)(3)(ii) of Rule 17g-8, as proposed;
Nationally Recognized Statistical Rating Organizations, 76 FR at
33543.
    \979\ See paragraph (a)(3)(ii) of Rule 17g-8, as proposed; 15
U.S.C. 78o-7(r)(2)(B). The proposed rule text was designed to
implement the rulemaking provision in section 15E(r)(2)(B) that the
changes are to be applied to then-current credit ratings by the
NRSRO within a reasonable time period determined by the Commission,
by rule. See Nationally Recognized Statistical Rating Organizations,
76 FR at 33453-33454.
---------------------------------------------------------------------------

    The Commission is adopting paragraphs (a)(3)(i) and (ii) of Rule
17g-8 with modifications to paragraph (a)(3)(i) to clarify the
requirements of the rule in response to comment.\980\ Specifically, one
commenter stated that the provision appropriately meets the
requirements of the Exchange Act but asked the Commission to clarify
that paragraph (a)(3)(i) is applicable only to changes to procedures
and methodologies that may impact new credit ratings, and that the
implementation of changes affecting existing ratings are addressed
separately in paragraph (a)(3)(ii).\981\ The commenter's interpretation
of paragraph (a)(3)(i) is incorrect. The Commission intended this
paragraph to address the procedures and methodologies an NRSRO uses to
determine new credit ratings and to make adjustments to current credit
ratings. Otherwise, the policies and procedures required under
paragraph (a)(3)(i) would not address the consistent treatment of
current credit ratings. However, to remove any ambiguity, the text of
paragraph (a)(3)(i) has been modified to clarify that the paragraph
applies to ``current and future credit ratings.'' \982\
---------------------------------------------------------------------------

    \980\ See paragraph (a)(3)(i) and (ii) of Rule 17g-8.
    \981\ See S&P Letter.
    \982\ See paragraph (a)(3)(i) of Rule 17g-8.
---------------------------------------------------------------------------

    Another commenter questioned whether the provision was appropriate
given the commenter's view that an NRSRO cannot ensure that changes are
applied consistently to all credit ratings to which the changed
procedures and methodologies apply because qualitative assessments
differ from credit rating committee to credit rating committee.\983\
The Commission acknowledges that rating procedures and methodologies
commonly incorporate qualitative analysis that introduces a degree of
subjectivity to the rating process. The final rule is not intended to
interfere with the qualitative process that is part of determining a
credit rating. Rather, it is designed to ensure that an NRSRO does not
apply different rating procedures and methodologies when determining
credit ratings with respect to types of obligors or obligations that
are intended to be subject to the same rating procedures and
methodologies. If, for example, an NRSRO changes a rating procedure or
methodology for determining initial credit ratings for RMBS, the
policies and procedures of the NRSRO must be reasonably designed to
ensure that the NRSRO does not continue to use the old procedure or
methodology to determine initial credit ratings for some RMBS and the
new procedure or methodology to determine initial credit ratings for
other RMBS.\984\
---------------------------------------------------------------------------

    \983\ See Harrington Letter.
    \984\ Similarly, if the NRSRO changes a procedure or methodology
for monitoring credit ratings of RMBS, the policies and procedures
of the NRSRO under paragraph (a)(3)(i) must be reasonably designed
to ensure that it does not continue to use the old procedure or
methodology to monitor some RMBS and the new procedure or
methodology to monitor other RMBS.
---------------------------------------------------------------------------

    The Commission is making modifications to paragraph (a)(3)(ii) of
Rule 17g-8 from the rule text as proposed.\985\ As stated above, one
commenter asked the Commission to clarify that paragraph (a)(3)(i) is
applicable only to changes to procedures and methodologies that may
impact new credit ratings, and that the implementation of changes
affecting current ratings are addressed separately in paragraph
(a)(3)(ii).\986\ As discussed above, the commenter's interpretation of
paragraph (a)(3)(i) was not correct and the paragraph has been modified
to clarify that it applies to current and future credit ratings.
However, the commenter is correct that paragraph (a)(3)(ii) was
intended to apply to current credit ratings. Specifically, the
Commission intended paragraph (a)(3)(ii) to address the timeframe in
which an NRSRO must apply an updated procedure or methodology for
performing surveillance or monitoring of credit ratings to current
credit ratings to which the changed procedure or methodology applies.
For example, if the NRSRO changes the methodology for monitoring credit
ratings of RMBS, paragraph (a)(3)(i) of the final rule requires the
firm to have policies and procedures that are reasonably designed to
ensure that it uses the updated methodology to monitor all RMBS credit
ratings going forward.\987\ The change in methodology, however, may
require the NRSRO to adjust the current credit ratings assigned to
RMBS. Paragraph (a)(3)(ii), as proposed, was intended to address the
timeframe in which an NRSRO must apply the updated methodology to
current credit ratings to determine whether they should be adjusted.
The Commission has modified the text of paragraph (a)(3)(ii) to make
this more clear. Specifically, the final rule requires an NRSRO to
establish, maintain, enforce, and document policies and procedures
reasonably designed to ensure that material changes to the procedures
and methodologies, including changes to qualitative and quantitative
data and models, the NRSRO uses to determine credit ratings are, to the
extent that the changes are to surveillance or monitoring procedures
and methodologies, applied to current credit ratings to which the
changed procedures or methodologies apply within a reasonable period of
time, taking into consideration the number of credit ratings impacted,
the complexity of the procedures and methodologies used to determine
the credit ratings, and the type of obligor, security, or money market
instrument being rated.\988\
---------------------------------------------------------------------------

    \985\ See paragraph (a)(3)(ii) of Rule 17g-8.
    \986\ See S&P Letter.
    \987\ See paragraph (a)(3)(i) of Rule 17g-8.
    \988\ See paragraph (a)(3)(ii) of Rule 17g-8 (emphasis added to
highlight the modification).
---------------------------------------------------------------------------

    One commenter asked for clarification as to what time period
constitutes a ``reasonable period'' for applying changed surveillance
or monitoring procedures and methodologies to current credit
ratings.\989\ Two commenters supported the decision not to prescribe a
timeframe given the variables surrounding such a change (for example,
number of impacted credit ratings).\990\ Another commenter acknowledged
the need for flexibility with respect to the timeframe but expressed
the concern that absent any guidance there would continue to be
insufficient resources made available for surveillance and monitoring
of credit

ratings.\991\ Two commenters argued that the Commission must establish
a firm deadline for the application of revised rating methodologies or
surveillance procedures to current credit ratings to ensure NRSROs act
promptly.\992\ Another commenter, more generally, urged the Commission
to require prompt re-testing after the NRSRO makes any such material
changes.\993\
---------------------------------------------------------------------------

    \989\ See DBRS Letter.
    \990\ See S&P Letter; DBRS Letter.
    \991\ See AFSCME Letter.
    \992\ See Better Markets Letter; CFA/AFR Letter.
    \993\ See Levin Letter.
---------------------------------------------------------------------------

    In response to the comments that the rule should prescribe a
specific timeframe in which the review must take place or prescribe
what constitutes a reasonable period of time, the Commission is not
persuaded that doing so would be feasible or appropriate. For example,
some NRSROs have hundreds of thousands of credit ratings outstanding in
certain classes of credit ratings, whereas others have fewer than one
thousand.\994\ Consequently, if the specified timeframe was too short,
an NRSRO with a large number of credit ratings might need to rush to
meet the deadline. This could negatively impact the quality of the
review of the credit ratings subject to the changed surveillance or
monitoring procedures and methodologies and could result in adjustments
to those credit ratings that were not the result of thorough analysis.
If the specified timeframe was too long, an NRSRO with relatively few
credit ratings would have a ``safe harbor'' that allowed the firm to
act more slowly to apply the changed surveillance procedures and
methodologies to current credit ratings than was necessary.\995\
Consequently, the final rule retains the proposed requirement that the
updated surveillance or monitoring procedure or methodology must be
applied to the current credit ratings to which the changed procedure or
methodology applies within a reasonable period of time, taking into
consideration the number of credit ratings impacted, the complexity of
the procedures and methodologies used to determine the credit ratings,
and the type of obligor, security, or money market instrument being
rated. The question of whether the NRSRO has acted within a reasonable
period of time will depend on factors such as the number of credit
ratings an NRSRO has outstanding that would be impacted by the change.
---------------------------------------------------------------------------

    \994\ See, e.g., 2013 Annual Staff Report on NRSROs, p. 8.
    \995\ See Harrington Letter (raising this concern).
---------------------------------------------------------------------------

    Another commenter stated that the Commission should clarify the
manner in which changes in rating procedures and methodologies would
apply to current credit ratings.\996\ More specifically, the commenter
explained that proposed paragraph (a)(3)(i) of Rule 17g-8 did not
address whether an NRSRO applying changed procedures or methodologies
to outstanding credit ratings must re-rate the transaction based upon
the information available at the time of the initial rating or whether
the process should include performance information received after that
time.\997\ The commenter also stated that the NRSRO should not apply
changes in procedures or methodologies to current credit ratings
without a change in the performance of the credit rating.\998\ In
response, the Commission notes that the final rule does not require the
NRSRO to adjust the outstanding credit ratings impacted by the changed
rating procedure or methodology; nor does it specify on what basis an
NRSRO should adjust an outstanding credit rating.\999\ Rather, it
requires the NRSRO to have policies and procedures reasonably designed
to ensure that changes to surveillance or monitoring procedures and
methodologies are applied to current credit ratings to which the
changed procedures or methodologies apply within a reasonable
timeframe. The question of whether an outstanding credit rating must be
adjusted after the application of the changed procedures or
methodologies will depend solely on the NRSRO's procedures and
methodologies. Based on those procedures and methodologies, the NRSRO
may adjust an existing credit rating because of the change in the
procedure or methodology, because of a change in circumstances that
impacts the creditworthiness of the obligor or issuer that is subject
to the credit rating, or a combination of these factors. This decision,
however, will be based solely on the NRSRO's procedures and
methodologies.\1000\
---------------------------------------------------------------------------

    \996\ See FSR Letter.
    \997\ See id.
    \998\ See id.
    \999\ As discussed above, in implementing section 15E(r) of the
Exchange Act, the Commission has been sensitive to the limitation in
section 15E(c)(2) of the Exchange Act. See 15 U.S.C. 78o-7(c)(2)
(which, among other things, prohibits the Commission from regulating
the substance of credit ratings and the procedures and methodologies
by which any NRSRO determines credit ratings).
    \1000\ See 15 U.S.C. 78o-7(c)(2).
---------------------------------------------------------------------------

    Paragraph (a)(4)(i) of Rule 17g-8, as proposed, would implement
sections 15E(r)(2)(C), 15E(r)(3)(B), and 15E(r)(3)(D) of the Exchange
Act.\1001\ Section 15E(r)(2)(C) identifies the objective of ensuring
that when material changes are made to rating procedures and
methodologies (including changes to qualitative and quantitative data
and models), the NRSRO publicly discloses the reason for the
change.\1002\ Section 15E(r)(3)(B) identifies the objective of ensuring
that an NRSRO notifies users of credit ratings when a material change
is made to a procedure or methodology, including to a qualitative model
or quantitative input.\1003\ Section 15E(r)(3)(D) identifies the
objective of ensuring that the NRSRO notifies users of credit ratings
when a material change is made to a procedure or methodology, including
to a qualitative model or quantitative input, of the likelihood the
change will result in a change in current credit ratings.\1004\ The
Commission proposed to implement these sections in paragraph (a)(4)(i)
of Rule 17g-8, which would require an NRSRO to establish, maintain,
enforce, and document policies and procedures reasonably designed to
ensure that the NRSRO promptly publishes on an easily accessible
portion of its corporate Internet Web site material changes to the
procedures and methodologies, including to qualitative models or
quantitative inputs, the NRSRO uses to determine credit ratings, the
reason for the changes, and the likelihood the changes will result in
changes to any ``current ratings.'' \1005\
---------------------------------------------------------------------------

    \1001\ See paragraph (a)(4)(i) of Rule 17g-8, as proposed;
Nationally Recognized Statistical Rating Organizations, 76 FR at
33454.
    \1002\ See 15 U.S.C. 78o-7(r)(2)(C).
    \1003\ See 15 U.S.C. 78o-7(r)(3)(B).
    \1004\ See 15 U.S.C. 78o-7(r)(3)(D).
    \1005\ See paragraph (a)(4)(i) of Rule 17g-8, as proposed;
Nationally Recognized Statistical Rating Organizations, 76 FR at
33543.
---------------------------------------------------------------------------

    The Commission is adopting paragraph (a)(4)(i) of Rule 17g-8 with a
minor modification to make terminology throughout the rule
consistent.\1006\ As adopted, paragraph (a)(4)(i) requires the NRSRO to
have policies and procedures that are reasonably designed to ensure
that the NRSRO promptly publishes on an easily accessible portion of
its corporate Internet Web site material changes to the procedures and
methodologies, including to qualitative models or quantitative inputs,
the NRSRO uses to determine credit ratings, the reason for the changes,
and the likelihood the changes will result in changes to any current
credit ratings.\1007\
---------------------------------------------------------------------------

    \1006\ See paragraph (a)(4)(i) of Rule 17g-8. The modification
adds the word ``credit'' after the word ``current'' and before the
word ``ratings'' to consistently use the term ``credit ratings''
throughout the rule.
    \1007\ See paragraph (a)(4)(i) of Rule 17g-8.
---------------------------------------------------------------------------

    Paragraph (a)(4)(ii) of Rule 17g-8, as proposed, would implement
section

15E(r)(3)(C) of the Exchange Act.\1008\ This section provides that the
Commission's rules shall require an NRSRO to notify users of credit
ratings when a significant error is identified in a procedure or
methodology, including a qualitative or quantitative model, that may
result in credit rating actions.\1009\ As proposed, paragraph
(a)(4)(ii) would require the NRSRO to establish, maintain, enforce, and
document policies and procedures reasonably designed to ensure that the
NRSRO promptly publishes on an easily accessible portion of its
corporate Internet Web site significant errors identified in a
procedure or methodology, including a qualitative or quantitative
model, the NRSRO uses to determine credit ratings that may result in a
change in the current ratings.\1010\
---------------------------------------------------------------------------

    \1008\ See paragraph (a)(4)(ii) of Rule 17g-8, as proposed;
Nationally Recognized Statistical Rating Organizations, 76 FR at
33454.
    \1009\ See 15 U.S.C. 78o-7(r)(3)(C).
    \1010\ See paragraph (a)(4)(ii) of Rule 17g-8, as proposed;
Nationally Recognized Statistical Rating Organizations, 76 FR at
33543.
---------------------------------------------------------------------------

    The Commission is adopting paragraph (a)(4)(ii) of Rule 17g-8 with
a minor modification. As proposed, the rule provided, in pertinent
part, that the NRSRO must publish ``significant errors'' identified in
a rating procedure or methodology. The proposal was intended to notify
users of the NRSRO's credit ratings when a significant error is
identified.\1011\ One potential reading of the text, however, was that
it required publication of the actual error. This was not intended.
Further, publication of the error without context--rather than
notification that an error was identified--could diminish the value of
the disclosure. For example, if the error was in the code of a
quantitative model, the disclosure of the code containing the error
without identifying that it contained an error likely would not inform
users of the NRSRO's credit ratings that there was an error.
Consequently, the final rule is modified to provide for the prompt
publication of notice of the existence of a significant error. More
specifically, the final rule requires an NRSRO to have policies and
procedures that are reasonably designed to ensure that the NRSRO
promptly publishes on an easily accessible portion of its corporate
Internet Web site notice of the existence of a significant error
identified in a procedure or methodology, including a qualitative or
quantitative model, the NRSRO uses to determine credit ratings that may
result in a change to current credit ratings.\1012\
---------------------------------------------------------------------------

    \1011\ See Nationally Recognized Statistical Rating
Organizations, 76 FR at 33453.
    \1012\ See paragraph (a)(4)(ii) of Rule 17g-8 (emphasis added to
highlight the modification).
---------------------------------------------------------------------------

    A number of commenters addressed paragraph (a)(4) of Rule 17g-8, as
proposed.\1013\ Some commenters stated that Internet Web site
publication would help ensure that NRSROs communicate information
pertaining to material changes in procedures and methodologies, as well
as significant errors in the procedures and methodologies, to investors
and other users of credit ratings in a timely manner.\1014\ One
commenter opposed the provision in paragraph (a)(4) of Rule 17g-8
requiring NRSROs to publish material changes and significant errors on
an easily accessible portion of the NRSRO's corporate Internet Web
site.\1015\ The commenter argued that the statute requires more direct
notification than Internet Web site publication, which could include
allowing users to sign up for alerts.\1016\ The Commission believes
that specifying publication on an easily accessible portion of the
NRSRO's Internet Web site is the most direct and cost effective way to
provide an opportunity for all potentially interested parties to have
access to the required disclosures.\1017\ This does not preclude an
NRSRO from offering additional disclosure services such as alerts or
third parties from offering alert services based on the disclosures an
NRSRO publishes.
---------------------------------------------------------------------------

    \1013\ See Barnard Letter; CFA/AFR Letter; DBRS Letter; Gardner
Letter; Harrington Letter; ICI Letter; Levin Letter; S&P Letter.
    \1014\ See DBRS Letter; Harrington Letter; ICI Letter; S&P
Letter.
    \1015\ See CFA/AFR Letter.
    \1016\ See id.
    \1017\ See DBRS Letter (supporting Web site-based disclosure);
Harrington Letter (same); ICI Letter (same).
---------------------------------------------------------------------------

    One NRSRO stated that it would be helpful for the Commission to
provide guidance as to when either a material change or significant
error would trigger the disclosures.\1018\ This commenter stated that
significant errors should be disclosed if there is a reasonable
likelihood that correction of the error will result in a change to
current credit ratings. In contrast, another commenter stated that the
Commission should not attempt to define the phrase significant error as
any imposition of an arbitrary definition could result in situations
where an NRSRO must identify errors that are minor and a correction
does not result in a rating action.\1019\
---------------------------------------------------------------------------

    \1018\ See DBRS Letter.
    \1019\ See S&P Letter.
---------------------------------------------------------------------------

    The question of whether a change is material or an error is
significant will depend on the facts and circumstances and, most
importantly, on the impacted rating procedure or methodology (which
vary across NRSROs). In general, the Commission believes that a change
to a rating procedure or methodology would be material if there is a
substantial likelihood that reasonable users of the NRSRO's credit
ratings would find notice of the change important information in terms
of assessing the rating procedure or methodology.\1020\ The Commission
believes that an error in a rating procedure or methodology would be
significant if there is a substantial likelihood that reasonable users
of the NRSRO's credit ratings would find notice of the error important
information in terms of assessing the impact the error had on credit
ratings determined using the rating procedure or methodology that
contained the error.\1021\
---------------------------------------------------------------------------

    \1020\ See DBRS Letter (suggested that a change to a rating
methodology should be considered material if there is a substantial
likelihood that a reasonable investor or other user of the credit
ratings would consider the change to be important in evaluating the
affected credit ratings).
    \1021\ See id. (stating an error should be disclosed if there is
a reasonable likelihood that correction of the error will result in
a change to current credit ratings).
---------------------------------------------------------------------------

    Finally, paragraph (a)(5) of Rule 17g-8, as proposed, would
implement section 15E(r)(3)(A) of the Exchange Act.\1022\ This section
provides that the Commission's rules shall require an NRSRO to notify
users of credit ratings of the version of a procedure or methodology,
including the qualitative methodology or quantitative inputs, used with
respect to a particular credit rating.\1023\ As proposed, paragraph
(a)(5) would require the NRSRO to establish, maintain, enforce, and
document policies and procedures reasonably designed to ensure that the
NRSRO discloses the version of a credit rating procedure or
methodology, including the qualitative methodology or quantitative
inputs, used with respect to a particular credit rating.\1024\
---------------------------------------------------------------------------

    \1022\ See paragraph (a)(5) of Rule 17g-8, as proposed;
Nationally Recognized Statistical Rating Organizations, 76 FR at
33454-33455.
    \1023\ See 15 U.S.C. 78o-7(r)(3)(A).
    \1024\ See paragraph (a)(5) of Rule 17g-8, as proposed;
Nationally Recognized Statistical Rating Organizations, 76 FR at
33543. In addition, because this would be a rating-by-rating
disclosure, the Commission proposed, as discussed below in section
II.G.3. of this release, that disclosure of the version of a credit
rating procedure or methodology be part of the rule implementing
section 15E(s) of the Exchange Act. See 15 U.S.C. 78o-7(s). Section
15E(s) specifies, among other things, that the Commission adopt
rules requiring an NRSRO to generate a form to be included with the
publication of a credit rating. See Nationally Recognized
Statistical Rating Organizations, 76 FR at 33459-33460 (discussing
paragraph (a)(1)(ii)(B) of Rule 17g-7, as proposed).

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

    The Commission is adopting paragraph (a)(5) of Rule 17g-8 as
proposed.\1025\ Specifically, the final rule requires an NRSRO to have
policies and procedures that are reasonably designed to ensure that it
discloses the version of a credit rating procedure or methodology,
including the qualitative methodology or quantitative inputs, used with
respect to a particular credit rating.\1026\
---------------------------------------------------------------------------

    \1025\ See paragraph (a)(5) of Rule 17g-8.
    \1026\ See id.
---------------------------------------------------------------------------

    One commenter requested clarification that the requirement to
publish the version of the criteria used for a particular credit rating
applies only when there is an action on the credit rating, such as an
upgrade, downgrade, or withdrawal.\1027\ A second commenter stated that
the rule should require the NRSRO to publicly provide, along with the
publication of the credit rating, disclosure about the credit rating
and the methodology used to determine it.\1028\
---------------------------------------------------------------------------

    \1027\ See S&P Letter.
    \1028\ See Gardner Letter.
---------------------------------------------------------------------------

    The Commission is implementing section 15E(r)(3)(A) of the Exchange
Act through paragraph (a)(5) of Rule 17g-8 and paragraph (a)(1)(ii)(B)
of Rule 17g-7. Paragraph (a)(1)(ii)(B) of Rule 17g-7, as discussed
below in section II.G.3. of this release, requires that the form to be
included with the publication of certain rating actions include a
disclosure of the version of the credit rating procedure or methodology
used to determine the credit rating.\1029\ The policies and procedures
required by paragraph (a)(5) of Rule 17g-8 must address the NRSRO's
compliance with the disclosure requirement in Rule 17g-7. In response
to the comments about when the version of the credit rating procedure
or methodology used to determine the credit rating must be disclosed,
Rule 17g-7 specifies when the form containing the disclosure of the
version of the credit rating procedure or methodology used to determine
the credit rating must be published by the NRSRO: Upon the taking of
one of the rating actions identified in the rule (for example, an
initial credit rating or an upgrade or a downgrade of an outstanding
credit rating).\1030\
---------------------------------------------------------------------------

    \1029\ See paragraph (a)(1)(ii)(B) of Rule 17g-7.
    \1030\ See id.
---------------------------------------------------------------------------

    A third commenter expressed concern that the proposal would provide
NRSROs with a defense for developing poor opinions on
creditworthiness.\1031\ More specifically, the commenter stated that,
based on his experience, reference to published methodologies has given
at least one NRSRO a defense for having formed poor opinions on CDOs
and RMBS.\1032\ The commenter also questioned the underlying rationale
of the rule insofar as NRSRO methodologies are already freely
accessible and transparent.\1033\ In response, the Commission notes
that the statutory directive is clear: The rule must require each NRSRO
to notify users of credit ratings of the version of a procedure or
methodology, including the qualitative methodology or quantitative
inputs, used with respect to a particular credit rating.\1034\ To
address the commenter's concern, the Commission would need to do the
opposite and prohibit an NRSRO from notifying users of credit ratings
of the version of a procedure or methodology, including the qualitative
methodology or quantitative inputs, used with respect to a particular
credit rating. This would be inconsistent with the statutory
requirement that the rule provide for notification.
---------------------------------------------------------------------------

    \1031\ See Harrington Letter.
    \1032\ See id.
    \1033\ See id.
    \1034\ See 15 U.S.C. 78o-7(r)(3)(A).
---------------------------------------------------------------------------

2. Amendment to Rule 17g-2
    The Commission proposed adding paragraph (b)(13) to Rule 17g-2 to
identify the policies and procedures an NRSRO is required to establish,
maintain, enforce, and document pursuant to paragraph (a) of Rule 17g-8
as a record that must be retained.\1035\ The one comment letter that
addressed the proposal supported it.\1036\ The Commission is adding
paragraph (b)(13) to Rule 17g-2 as proposed.\1037\ This will provide a
means for the Commission to monitor the NRSROs' compliance with
paragraph (a) of Rule 17g-8. The record must be retained until three
years after the date the record is replaced with an updated record in
accordance with the amendment to paragraph (c) of Rule 17g-2 discussed
above in section II.A.2. of this release.\1038\
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    \1035\ See paragraph (b)(13) of Rule 17g-2, as proposed;
Nationally Recognized Statistical Rating Organizations, 76 FR at
33539. See also section 17(a)(1) of the Exchange Act, which requires
an NRSRO to make and keep such records, and make and disseminate
such reports, as the Commission prescribes by rule as necessary or
appropriate in the public interest, for the protection of investors,
or otherwise in furtherance of the Exchange Act. 15 U.S.C.
78q(a)(1).
    \1036\ See DBRS Letter.
    \1037\ See paragraph (b)(13) of Rule 17g-2.
    \1038\ See paragraphs (b)(13) and (c) of Rule 17g-2.
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3. Economic Analysis
    This section builds on the economic analysis in section I.B. of
this release by presenting a focused analysis of the potential economic
effects that may derive from the specific amendments and new rule
relating to credit rating methodologies.\1039\ The economic baseline
that existed before today's amendments was one in which an NRSRO's
board of directors must oversee the establishment, maintenance, and
enforcement of the NRSRO's policies and procedures for determining
credit ratings pursuant to Exchange Act section 15E(t)(3)(A).\1040\ The
baseline that existed before today's amendments and new rule also was
one in which NRSROs must establish, maintain, enforce, and document an
effective internal control structure governing the implementation of
and adherence to their methodologies for determining credit
ratings.\1041\ NRSROs--under the baseline requirements--were not
explicitly required to establish, maintain, enforce, document, and
retain a record of policies and procedures relating to: (1) Board
approval of the procedures and methodologies for determining credit
ratings;\1042\ (2) the development and modification of the procedures
and methodologies for determining credit ratings;\1043\ (3) applying
material changes to the procedures and methodologies for determining
credit ratings;\1044\ (4) publishing material changes to and notices of
significant errors in the procedures and methodologies for determining
credit ratings;\1045\ and (5) disclosing the version a procedure or
methodology for determining credit ratings used with respect to a
particular credit rating.\1046\
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    \1039\ The economic analysis in section I.B. of this release
discusses the primary economic impacts that may derive from the
amendments and new rules being adopted today.
    \1040\ See 15 U.S.C. 78o-7(t)(3)(A).
    \1041\ See 15 U.S.C. 78o-7(c)(3)(A).
    \1042\ See paragraph (a)(1) of Rule 17g-8.
    \1043\ See paragraph (a)(2) of Rule 17g-8. As noted above, an
NRSRO must establish, maintain, enforce, and document an effective
internal control structure governing the implementation of their
methodologies for determining credit ratings. See 15 U.S.C. 78o-
7(t)(3)(A).
    \1044\ See paragraph (a)(3) of Rule 17g-8.
    \1045\ See paragraph (a)(4) of Rule 17g-8.
    \1046\ See paragraph (a)(5) of Rule 17g-8.
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    Relative to this baseline, the Commission believes that the
amendments and new rule may result in a number of benefits. For
example, implementing policies and procedures designed to ensure that
the NRSRO's board of directors (or a body performing a similar
function) oversees the establishment, maintenance, and enforcement of
the NRSRO's policies and procedures for determining credit ratings in
accordance with 15E(t)(3)(A) of the Exchange Act should promote the
quality and consistency of the

procedures and methodologies. Similarly, taking steps to ensure that
the procedures and methodologies for determining credit ratings are
developed and modified pursuant to the NRSRO's policies and procedures
also should promote the quality and consistency of the procedures and
methodologies.
    Taking steps to ensure that material changes to the procedures and
methodologies the NRSRO uses to determine credit ratings are applied
consistently to all current and future credit ratings to which the
changed procedures or methodologies apply should help ensure consistent
and timely application of such changes and promote the integrity of the
credit rating process. This should benefit users of credit ratings. In
addition, taking steps to ensure that an NRSRO promptly publishes on an
easily accessible portion of its Internet Web site information about
material changes to the procedures and methodologies the NRSRO uses to
determine credit ratings, the reason for the changes, and the
likelihood the changes will result in changes to any current credit
ratings should benefit investors and other users of credit ratings by
increasing the transparency of the NRSROs' credit rating activities and
providing additional information with which to assess the quality of a
given NRSRO's credit rating processes. Similarly, taking steps to
ensure that an NRSRO promptly publishes on an easily accessible portion
of its corporate Internet Web site notice of the existence of a
significant error identified in a procedure or methodology used to
determine credit ratings also should benefit investors and other users
of credit ratings by increasing the transparency of the NRSROs' credit
rating activities and providing additional information with which to
assess the quality of a given NRSRO's credit rating processes.
    The records NRSROs must keep pursuant to Rule 17g-2 will be used by
Commission examiners to evaluate whether a given NRSRO's policies and
procedures are reasonably designed and the NRSRO is complying with
them. Compliance with these policies and procedures may increase the
likelihood that NRSROs apply sound procedures and methodologies
consistently to all applicable credit ratings and inform investors of
these procedures and methodologies.
    Relative to the baseline, the Commission anticipates that the final
rule will result in costs. NRSROs will need to expend resources to
develop, document, enforce, and periodically modify the policies and
procedures they establish pursuant to paragraph (a) of Rule 17g-8.
    As stated above, some commenters opposed the proposed rule on the
basis of cost.\1047\ One of these commenters stated that certain
aspects of the proposals, including those regarding credit rating
methodologies, would compound barriers to entry, and that many of the
rules would be expensive and burdensome to implement.\1048\ More
specifically, this commenter stated that the Commission should take
into account the dominance of very large players and expand small NRSRO
exemptions designed to level the competitive field.\1049\
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    \1047\ See A.M. Best Letter; Kroll Letter.
    \1048\ See Kroll Letter.
    \1049\ See Kroll Letter.
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    In response, the Commission acknowledges that these requirements
will result in costs, which could create competitive barriers. However,
the Commission reiterates that the final rule is designed to meet the
rulemaking mandate in section 15E(r) of the Exchange Act in a manner
that provides flexibility to NRSROs in terms of designing the required
policies and procedures. Consequently, an NRSRO can tailor its policies
and procedures to its business model, size, and the scope of its
activities as well as to its methodologies and procedures for
determining credit ratings, which, to some degree, may mitigate
concerns about the costs of the final rule and its potential to create
barriers to entry for small credit rating agencies. These costs would
likely be higher for NRSROs with more complex operations in terms of
the quantity of credit ratings they issue, the different types of
credit ratings they issue, and the number of locations from which they
determine and issue credit ratings. Based on analysis for purposes of
the PRA, the Commission estimates that paragraph (a) of Rule 17g-8 will
result in total industry-wide one-time costs to NRSROs of approximately
$566,000 and total industry-wide annual costs to NRSROs of
approximately $142,000.\1050\
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    \1050\ See section V.G. of this release (discussing
implementation and annual compliance considerations). The one-time
and annual costs are determined by monetizing internal hour burdens
and adding external costs identified in the PRA analysis in section
IV.D.7. of this release.
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    Relative to the baseline, the amendments to Rule 17g-2 prescribing
retention requirements for the documentation of the policies and
procedures will result in costs to NRSROs. NRSROs already have
recordkeeping systems in place to comply with the recordkeeping
requirements in Rule 17g-2 before today's amendments. Therefore, the
recordkeeping costs of this rule will be incremental to the costs
associated with these existing requirements. Specifically, the
incremental costs will consist largely of updating their record
retention policies and procedures and retaining and producing the
additional record. Based on analysis for purposes of the PRA, the
Commission estimates that paragraph (b)(13) of Rule 17g-2 and the
amendment to paragraph (c) of Rule 17g-2 will result in total industry-
wide one-time costs to NRSROs of approximately $12,000 and total
industry-wide annual costs to NRSROs of approximately $3,000.\1051\
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    \1051\ See section V.G. of this release (discussing
implementation and annual compliance considerations). The one-time
and annual costs are determined by monetizing internal hour burdens
and adding external costs identified in the PRA analysis in section
IV.D.3. of this release.
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    The Commission believes that NRSROs will incur costs to apply
material changes to ratings procedures and methodologies consistently
to all current credit ratings to which the changed procedures or
methodologies apply. This cost will likely vary significantly per
occurrence depending on the number of credit ratings and the type of
instruments affected by the change as well as the nature and extent of
the change. In addition, the Commission believes that an NRSRO will
incur costs when promptly publishing on an easily accessible portion of
its Internet Web site information about material changes to procedures
and methodologies, the likelihood such changes will result in changes
to any current ratings, and notice of significant errors identified in
a procedure or methodology in accordance with paragraphs (a)(4)(i) and
(ii) of Rule 17g-8. Based on analysis for purposes of the PRA, the
Commission estimates that paragraphs (a)(4)(i) and (ii) of Rule 17g-8
will result in costs to NRSROs of approximately $5,700 per publication
on their Web site.\1052\
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    \1052\ See section V.G. of this release (discussing
implementation and annual compliance considerations). The cost per
publication is determined by monetizing internal hour burdens and
adding external costs identified in the PRA analysis in section
IV.D.7. of this release.
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    A possible additional cost is that the final rule potentially could
decrease the quality of credit ratings in circumstances where the
subjective judgment of participants in the rating process could improve
the quality of ratings. In order to ensure that material changes to
ratings procedures and methodologies are applied consistently to all
current credit ratings to which the changed procedures or methodologies
apply ``within a reasonable timeframe''

in accordance with the new rule, an NRSRO may establish credit rating
procedures and methodologies that diminish the ability of participants
in the rating process to exercise subjective judgment, which could
lengthen the rating process. As a result, the credit ratings may not
benefit fully from the expertise of the analysts in the rating process,
which could negatively impact the quality of the credit rating. This
concern may be mitigated by the fact that the new rule does not require
that the policies and procedures specify a specific timeframe to apply
the changed procedure or methodology but rather requires that the
change to be applied within a reasonable period of time, taking into
consideration the number of credit ratings impacted, the complexity of
the procedures and methodologies used to determine the credit ratings,
and the type of obligor, security, or money market instrument being
rated.
    The amendments and new rule should have a number of effects related
to efficiency, competition, and capital formation.\1053\ First, these
amendments could improve the quality and consistency of credit ratings
as well as increasing the information available to users of credit
ratings regarding rating procedures and methodologies. As a result,
users of credit ratings could make more efficient investment decisions
based on this higher-quality information. Market efficiency also could
improve if this information is reflected in asset prices. Consequently,
capital formation could improve as capital may flow to more efficient
uses with the benefit of this enhanced information. Alternatively, the
quality of credit ratings may decrease in certain circumstances if an
NRSRO establishes credit rating procedures and methodologies that
diminish the ability of participants in the rating process to exercise
subjective judgment. In this case, the quality of credit ratings may
decrease, which could decrease the efficiency of investment decisions
made by users of credit ratings. Market efficiency and capital
formation may also be adversely impacted if lower quality information
is reflected in asset prices, which may impede the flow of capital to
efficient uses. These amendments also will result in costs, some of
which may have a component that is fixed in magnitude and does not vary
with the size of the NRSRO. Therefore, the operating costs per credit
rating of smaller NRSROs may increase relative to that of larger
NRSROs. Consequently, the costs associated with these amendments may
have a disproportionate impact on smaller NRSROs as suggested by
commenters,\1054\ creating adverse effects on competition. For example,
one commenter suggested that these requirements would require an NRSRO
to review credit rating methodologies, which would place an undue
burden on smaller NRSROs.\1055\ As a result of these amendments, the
barriers to entry for credit rating agencies to register as an NRSRO
might be higher for credit rating agencies, while some NRSROs,
particularly smaller firms, may decide to withdraw from registration as
an NRSRO. As discussed earlier, these costs also will depend on the
complexity of operations within the NRSRO.
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    \1053\ See section I.B.3. of this release (providing a broader
discussion of the potential impacts of the amendments and new rules
on efficiency, competition, and capital formation).
    \1054\ See A.M. Best Letter; Kroll Letter.
    \1055\ See A.M. Best Letter.
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    Commenters have proposed a number of alternatives to the final
rule. One alternative would be to require that NRSROs permit users of
an NRSRO's credit ratings to sign up for alerts regarding material
changes and significant errors in an NRSRO's procedures and
methodologies, which, according to the commenter, ``would significantly
improve communication.'' \1056\ As stated above, the Commission
believes that publication on an easily accessible portion of the
NRSRO's Internet Web site is the most direct and cost effective way to
ensure that all potentially interested parties have access to the
required disclosures. Therefore, this alternative without a requirement
to also disclose the information on the NRSRO's Internet Web site could
potentially have the result that fewer users of credit ratings are
informed of changes and errors. For example, certain users of credit
ratings may opt not to sign up for email notification in order to avoid
receiving unwanted communications.
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    \1056\ See CFA/AFR Letter.
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    Another alternative would be for the Commission to establish a firm
deadline for the application of revised rating methodologies or
surveillance or monitoring procedures to current credit ratings to
ensure that NRSROs act promptly, as suggested by commenters.\1057\ As
stated above, the Commission is not persuaded that prescribing a
specific timeframe in which the review must take place is feasible or
appropriate. For example, some NRSROs have hundreds of thousands of
credit ratings outstanding in certain classes of credit ratings, while
others have fewer than one thousand.\1058\ In addition, there is
variation across NRSROs in the level of resources available to apply
these changes. For example, the number of credit analysts employed by
each NRSRO ranges from fewer than ten to more than a thousand.\1059\
Consequently, mandating a timeframe that is too short could negatively
impact the quality of the review of the credit ratings subject to the
changed surveillance or monitoring procedures and methodologies and
could result in adjustments to those credit ratings that are not the
result of thorough analysis. In this case, this alternative could
result in costs for users of credit ratings who may make credit-based
decisions using incomplete or inaccurate information. In addition, an
NRSRO with relatively fewer resources to make the required changes
might need to incur costs such as hiring more staff to meet the
deadline. If the mandated timeframe were too long, an NRSRO with
relatively greater resources could take longer than necessary to apply
the changed surveillance procedures and methodologies to impacted