Securities and Exchange Commission: Action Needed to Improve Rating Agency Registration Program and Performance-Related Disclosures
Highlights
In 2006, Congress passed the Credit Rating Agency Reform Act (Act), which intended to improve credit ratings by fostering accountability, transparency, and competition. The Act established Securities and Exchange Commission (SEC) oversight over Nationally Recognized Statistical Rating Organizations (NRSRO), which are credit rating agencies that are registered with SEC. The Act requires GAO to review the implementation of the Act. This report (1) discusses the Act's implementation; (2) evaluates NRSROs' performance-related disclosures; (3) evaluates removing NRSRO references from certain SEC rules; (4) evaluates the impact of the Act on competition; and (5) provides a framework for evaluating alternative models for compensating NRSROs. To address the mandate, GAO reviewed SEC rules, examination guidance, completed examinations, and staff memoranda; analyzed required NRSRO disclosures and market share data; and interviewed SEC and NRSRO officials and market participants.
SEC's implementation of the Act involved developing an NRSRO registration program and an examination program. As currently implemented and staffed, both programs require further attention. (1) The process for reviewing NRSRO applications limits SEC staff's ability to fully ensure that applicants meet the Act's requirements. While SEC had registered 10 of 11 credit rating agency applicants as of July 2010, some staff memoranda to the Commission summarizing their review of applications described concerns that were not addressed prior to registration. According to staff, the 90-day time frame for SEC action on an application and the lack of an express authority to examine the applicants prior to registration prevented the concerns from being addressed prior to approval. Unlike other registration application programs that have built in greater authority and flexibility for their staff to clarify outstanding questions regarding applications before approval, the NRSRO registration program requires SEC to act within 90 days of receiving the application. As a result, staff recommended granting registration with ongoing concerns about NRSROs meeting the Act's requirements. (2) With its current level of staffing for NRSRO examinations, SEC's Office of Compliance Inspections and Examinations (OCIE) would likely not have been able to meet its routine examination schedule of examining the three largest NRSROs every 2 years and others every 3 years. OCIE has requested additional resources to fully staff the NRSRO examination program. While the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank Act) requires SEC to establish an Office of Credit Ratings to conduct annual examinations of each NRSRO and staff the office sufficiently to carry out these examinations, SEC may face challenges in meeting the required examination timetable and providing quality supervision over NRSROs unless it develops a plan that clearly identifies staffing needs, such as requisite skills and training. While SEC has increased the amount of performance-related data NRSROs are required to disclose, the usefulness of the data is limited. First, SEC requires NRSROs to disclose certain performance statistics, increasing the amount of performance information available for some NRSROs. However, because SEC does not specify how NRSROs should calculate these statistics, NRSROs use varied methodologies, limiting their comparability. Second, SEC issued two rules requiring NRSROs to make certain ratings history data publicly available. However, the data sets do not contain enough information to construct comparable performance statistics and are not representative of the population of the credit ratings at each NRSRO. Without better disclosures, the information being provided will not serve its intended purpose of increasing transparency. In July 2008, SEC proposed amendments that would have removed references to NRSRO ratings from several rules. Since the implementation of the Act, the number of NRSROs has increased from 7 to 10; however, industry concentration as measured by NRSRO revenues, the number of entities rated, and the dollar volume of new asset-backed debt rated remains high. As part of an April 2009 roundtable held to examine oversight of credit rating agencies, SEC requested perspectives from users of ratings and others on whether it should consider additional rules to better align the raters' interest with those who rely on those ratings, and specifically, whether one business model represented a better way of managing conflicts of interest than another. SEC should identify the additional time frames and authorities it needs to review NRSRO applications, develop a plan to help ensure the NRSRO examination program is sufficiently staffed, improve NRSROs' performance-related disclosure requirements, and develop a plan to approach the removal of NRSRO references from its rules. SEC generally agreed with these recommendations.
Recommendations
Recommendations for Executive Action
| Agency Affected | Recommendation | Status |
|---|---|---|
| United States Securities and Exchange Commission | To address the concern that the current process for registering credit rating agencies may result in SEC approving applicants that do not meet the Act's requirements, the Chairman of the Securities and Exchange Commission should identify the additional authorities and time frames necessary to ensure that staff can verify the accuracy of the information provided on Form NRSRO and that the applicant meets all of the Act's requirements; the Chairman should also work with Congress to ensure that SEC has the authority needed to effectively carry out its oversight responsibilities. |
SEC's Trading and Markets staff provided an information memorandum to the Commission dated December 20, 2010, that, among other things, identified options for the Commission to consider for implementing a pre-registration examination program for NRSRO applications. As part of these options, Trading and Markets staff identified the additional authorities and time frames necessary for their implementation that the Commission could consider requesting from Congress. As of April 28, 2014, SEC has not received additional applications from credit rating agencies seeking NRSRO status.
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| United States Securities and Exchange Commission | To ensure that SEC has sufficient staff with the skills necessary to address the requirement in the Dodd-Frank Act that SEC establish an Office of Credit Ratings and examine each NRSRO every year, the Chairman of the Securities and Exchange Commission develop and implement a plan for the establishment of this office that includes the identification of the number of staff and the skills required of these staff to meet the required examination timetable and provide quality oversight of the NRSROs, including plans for the recruitment of any new hires and appropriate training. |
SEC's Division of Trading and Markets had hired for the Office of Credit Ratings (OCR) the number and types of people with skills that conformed to statutory requirements. The supervisory program analyst is responsible for the planning for the OCR,which includes, among other things, serving as the principal adviser to executive management on behalf of OCR for critical program operations, such as human resources. This person serves as the technical resource and point of contact for human resources management, prepares human resources support justifications and reports, and coordinates realignment of functions and associated reorganizations within the organization. Each year this person meets with the director and branch chiefs to discuss their staffing needs in the context of program efforts. The supervisory program analyst is responsible for documenting these discussions and coming up with the budget request, which includes staffing, and acting as liaison with the budget office.
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| United States Securities and Exchange Commission | To address the inconsistencies in the NRSROs' methodologies for calculating required performance statistics and total outstanding ratings for initial and updated Form NRSRO filings, address limitations in the required 10 percent and 100 percent rating history disclosures, and increase the comparability and usefulness of these disclosures, the Chairman of the Securities and Exchange Commission should, for the disclosures of required performance statistics, provide specific guidance for NRSROs for calculating and presenting these performance statistics, considering the impact of different methodologies on the information content of the performance statistics and the purpose for which SEC intends the statistics to be used. |
In August 2014, SEC finalized rules that amended the instructions to Exhibit 1 to Form NRSRO that provide specific guidance for NRSROs for consistently calculating and presenting performance statistics.
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| United States Securities and Exchange Commission | To address the inconsistencies in the NRSROs' methodologies for calculating required performance statistics and total outstanding ratings for initial and updated Form NRSRO filings, address limitations in the required 10 percent and 100 percent rating history disclosures, and increase the comparability and usefulness of these disclosures, the Chairman of the Securities and Exchange Commission should, for the disclosures of required performance statistics, evaluate the appropriateness of SEC's currently designated asset classes for presenting performance statistics, and where SEC determines that the asset classes are not appropriate, modify the requirements accordingly. |
SEC has evaluated the appropriateness of the designated asset classes for presenting performance statistics. The agency has determined that the previously designated reporting classes were not appropriate and that the new ones would enhance the quality of the performance statistics. Accordingly, in August 2014, SEC finalized rules that modified the asset classes and subclasses for which the NRSROs should develop performance statistics.
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| United States Securities and Exchange Commission | To address the inconsistencies in the NRSROs' methodologies for calculating required performance statistics and total outstanding ratings for initial and updated Form NRSRO filings, address limitations in the required 10 percent and 100 percent rating history disclosures, and increase the comparability and usefulness of these disclosures, the Chairman of the Securities and Exchange Commission should, for the disclosures of required 10 percent and 100 percent ratings histories, ensure that the data elements required as part of the datasets allow users to construct complete ratings histories, identifying the beginning of ratings histories, and distinguish between different types of ratings. |
In August 2014, SEC finalized rules that discontinued the 10 percent sample requirement and address the identified limitations with respect to the 100 percent rating history disclosure requirement.
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| United States Securities and Exchange Commission | To address the inconsistencies in the NRSROs' methodologies for calculating required performance statistics and total outstanding ratings for initial and updated Form NRSRO filings, address limitations in the required 10 percent and 100 percent rating history disclosures, and increase the comparability and usefulness of these disclosures, the Chairman of the Securities and Exchange Commission should, for the disclosures of required 10 percent and 100 percent ratings histories, consider requiring NRSROs to publish a codebook to explain the variables included in the datasets. |
In August 2014, SEC finalize rules that discontinued the 10 percent sample requirement. The final rules do not require NRSROs to publish a codebook that would explain the variables included in the 100 percent data set, but instead specifies the data fields the NRSROs are to include, in effect achieving the same result.
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| United States Securities and Exchange Commission | To address the inconsistencies in the NRSROs' methodologies for calculating required performance statistics and total outstanding ratings for initial and updated Form NRSRO filings, address limitations in the required 10 percent and 100 percent rating history disclosures, and increase the comparability and usefulness of these disclosures, the Chairman of the Securities and Exchange Commission should, for the disclosures of required 10 percent and 100 percent ratings histories, clarify that NRSROs should include defaults in the ratings histories disclosed. |
In August 2014, SEC finalized rules that discontinue the 10 percent sample requirement. With respect to the 100 percent rating history disclosure requirement, the final rules require the NRSROs to include defaults in the ratings histories disclosed.
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| United States Securities and Exchange Commission | To address the inconsistencies in the NRSROs' methodologies for calculating required performance statistics and total outstanding ratings for initial and updated Form NRSRO filings, address limitations in the required 10 percent and 100 percent rating history disclosures, and increase the comparability and usefulness of these disclosures, the Chairman of the Securities and Exchange Commission should, for the disclosures of required 10 percent and 100 percent ratings histories, review its guidance to NRSROs for generating the 10 percent samples and modify it as needed to ensure that the samples are 10 percent of the type of ratings typically analyzed in each asset class, that withdrawn ratings are not removed from these samples, and that the samples are periodically redrawn. |
In August 2014, SEC finalized rules that discontinue the 10 percent sample requirement, thus addressing our concerns.
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| United States Securities and Exchange Commission | To address the inconsistencies in the NRSROs' methodologies for calculating required performance statistics and total outstanding ratings for initial and updated Form NRSRO filings, address limitations in the required 10 percent and 100 percent rating history disclosures, and increase the comparability and usefulness of these disclosures, the Chairman of the Securities and Exchange Commission should, for the disclosures of required 10 percent and 100 percent ratings histories, review its guidance to NRSROs for generating the 100 percent rating history disclosures and modify it as needed to ensure that these histories include those ratings that are typically analyzed in each asset class; and that withdrawn ratings are not removed from these disclosures. |
In August 2014, SEC finalized rules that require the NRSROs to include in their 100 percent rating history disclosures those ratings that are typically analyzed in each asset class. The final rules also require NRSROs to maintain withdrawn ratings in these disclosures.
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| United States Securities and Exchange Commission | To address the inconsistencies in the NRSROs' methodologies for calculating required performance statistics and total outstanding ratings for initial and updated Form NRSRO filings, address limitations in the required 10 percent and 100 percent rating history disclosures, and increase the comparability and usefulness of these disclosures, the Chairman of the Securities and Exchange Commission should, for the disclosures of total outstanding ratings required on Form NRSRO, provide specific guidance to NRSROs to calculate their total outstanding ratings. |
In August 2014, SEC finalized rules that amended Items 6A and 7A of Form NRSRO as well as Instruction H to Form NRSRO to clarify how NRSROs should count the number of credit ratings outstanding in a given class of credit ratings for the purposes of Form NRSRO.
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| United States Securities and Exchange Commission | To address the Dodd-Frank Act's requirement for SEC to remove any references to or requirements of reliance on credit ratings in its rules and substitute alternative standards of credit worthiness that it deems appropriate, the Chairman of the Securities and Exchange Commission should develop and implement a plan for approaching the removal of NRSRO references from SEC rules to help ensure that (1) any adopted alternative standards of creditworthiness for a particular rule facilitate its purpose and (2) examiners have the requisite skills to determine that the adopted standards have been applied. |
In 2011, various divisions within the Securities and Exchange Commission proposed rules to remove any references to or requirements of reliance on credit ratings and replaced the ratings requirement with an alternative standard of credit worthiness. Throughout 2013 and 2014, most of these rules were adopted. We have reviewed the final rules and note that in each, the Commission obtained input from the public and adopted standards to fit the specific rule. For example, for the rule that determines the haircuts firms take on certain securities for net capital calculations, the Commission revised the rule to require that the security has only a minimal amount of credit risk. The rule also requires firms to establish, document, maintain, and enforce policies and procedures that are reasonably designed for the purpose of determining and monitoring the creditworthiness of each security. In a different rule regarding the offering of securities from a public offering filing that has already been declared effective by the SEC, the Commission adopted 5 forms of criteria to be used in determining if the security is eligible for such an offering. We also received emails from the various divisions stating that they have completed removing references to NRSRO ratings from their rules. With respect to the second part of our recommendation, SEC's Office of Inspections Examinations and Compliance participated in a rulemaking process to ensure rules were designed and written in a manner such that examiners would be able to determine that the adopted standards had been applied.
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