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Daily Rules, Proposed Rules, and Notices of the Federal Government

SECURITIES AND EXCHANGE COMMISSION

17 CFR Parts 240 and 249b

[Release No. 34-61051; File No. S7-28-09]

RIN 3235-AK14

Proposed Rules for Nationally Recognized Statistical Rating Organizations

AGENCY: Securities and Exchange Commission ("Commission").
ACTION: Proposed rules.
SUMMARY: The Commission is proposing rule amendments and a new rule that would impose additional requirements on nationally recognized statistical rating organizations ("NRSROs"). The proposed amendments and rule would require an NRSRO: to furnish a new annual report describing the steps taken by the firm's designated compliance officer during the fiscal year with respect to compliance reviews, identifications of material compliance matters, remediation measures taken to address those matters, and identification of the persons within the NRSRO advised of the results of the reviews; to disclose additional information about sources of revenues on Form NRSRO; and to make publicly available a consolidated report containing information about revenues of the NRSRO attributable to persons paying the NRSRO for the issuance or maintenance of a credit rating. The Commission is proposing these rules, in conjunction with a separate release being issued today adopting certain rule amendments, to further address concerns about the integrity of the credit rating procedures and methodologies at NRSROs. Finally, at this time, the Commission is announcing that it is deferring consideration of action with respect to a proposed rule that would have required an NRSRO to include, each time it published a credit rating for a structured finance product, a report describing how the credit ratings procedures and methodologies and credit risk characteristics for structured finance products differ from those of other types of rated instruments, or, alternatively, to use distinct ratings symbols for structured finance products that differentiated them from the credit ratings for other types of financial instruments. The Commission is also soliciting comments regarding alternative measures that could be taken to differentiate NRSROs' structured finance credit ratings from the credit ratings they issue for other types of financial instruments through, for example, enhanced disclosures of information. The Commission also is soliciting comment on whether the rule amendments being adopted today in a separate release designed to remove impediments to determining and monitoring non-issuer-paid credit ratings for structured finance products should be extended to create a mechanism for determining non-issuer-paid credit ratings for structured finance products that were issued prior to the rule becoming effective (e.g.,to allow for non-issuer-paid credit ratings for structured finance products of the 2004-2007 vintage). The Commission strongly encourages market participants and all others to provide their views.
DATES: Comments should be received on or before February 2, 2010.
ADDRESSES: Comments may be submitted by any of the following methods:
Electronic Comments

* Use the Commission's Internet comment form (http://www.sec.gov/rules/proposed.shtml); or

* Send an e-mail torule-comments@sec.gov.Please include File Number S7-28-09 on the subject line; or

* Use the Federal eRulemaking Portal (http://www.regulations.gov). Follow the instructions for submitting comments.

Paper Comments

* Send paper comments in triplicate to Elizabeth M. Murphy, Secretary, Securities and Exchange Commission, 100 F Street, NE., Washington, DC 20549-1090.

All submissions should refer to File Number S7-28-09. This file number should be included on the subject line if e-mail is used. To help us process and review your comments more efficiently, please use only one method. The Commission will post all comments on the Commission's Internet Web site (http://www.sec.gov/rules/proposed.shtml). Comments are also available for public inspection and copying in the Commission's Public Reference Room, 100 F Street, NE., Washington, DC 20549, on official business days between the hours of 10 a.m. and 3 p.m. All comments received will be posted without change; we do not edit personal identifying information from submissions. You should submit only information that you wish to make publicly available.
FOR FURTHER INFORMATION CONTACT: Michael A. Macchiaroli, Associate Director, at (202) 551-5525; Thomas K. McGowan, Deputy Associate Director, at (202) 551-5521; Randall W. Roy, Assistant Director, at (202) 551-5522; Joseph I. Levinson, Special Counsel, at (202) 551-5598; Sheila Dombal Swartz, Special Counsel, at (202) 551-5545; Rose Russo Wells, Special Counsel, at (202) 551-5527; Rebekah E. Goshorn, Attorney, at (202) 551-5514; Marlon Q. Paz, Senior Counsel to the Director, at (202) 551-5756; Division of Trading and Markets, Securities and Exchange Commission, 100 F Street, NE., Washington, DC 20549-7010.
SUPPLEMENTARY INFORMATION:

I. Background

On February 2, 2009, the Commission adopted amendments to its existing rules governing the conduct of NRSROs under the Securities Exchange Act of 1934 (“Exchange Act”).1 The Commission proposed these rule amendments in June 2008 to further the purposes of the Credit Rating Agency Reform Act of 2006 (“Rating Agency Act”) to improve ratings quality for the protection of investors and in the public interest by fostering accountability, transparency, and competition in the credit rating industry.2 The amendments also were designed to further address concerns about the integrity of the process by which NRSROs rate structured finance products, particularly mortgage related securities.3 Concurrent with theadoption of those final rule amendments, the Commission proposed, in a separate release, additional amendments to Rule 17g-2(d) and re-proposed amendments to paragraphs (a) and (b) of Rule 17g-5 as well as a new paragraph (e) to Rule 17g-5 and a conforming amendment to Regulation FD.4 In separate releases, the Commission is adopting, with revisions, the rule amendments proposed in theFebruary 2009 Proposing Release, 5 and proposing amendments to Regulation S-K, and rules and forms under the Securities Act, the Exchange Act and the Investment Company Act to require disclosure regarding credit ratings that a registrant uses in connection with a registered offering.6 The Commission also is adopting amendments to remove references to NRSROs in certain Commission rules and forms and re-opening the comment period to extend the time to comment on proposals to remove references to NRSROs in other Commission rules.7

1 See Amendments to Rules for Nationally Recognized Statistical Rating Organizations,Exchange Act Release No. 59342 (February 2, 2009), 74 FR 6485 (February 9, 2009) (“February 2009 Adopting Release”).

2Exchange Act Release No. 57967 (June 16, 2008), 73 FR 36212 (June 25, 2008) (“June 2008 Proposing Release”). The Commission adopted the initial set of NRSRO rules in June 2007.See Oversight of Credit Rating Agencies Registered as Nationally Recognized Statistical Rating Organizations,Exchange Act Release No. 55857 (June 5, 2007), 72 FR 33564 (June 18, 2007) (“June 2007 Adopting Release”). In July 2008, the Commission also proposed a series of amendments to rules under the Exchange Act, Securities Act of 1933 (“Securities Act”), and Investment Company Act of 1940 (“Investment Company Act”) that would eliminate references to ratings issued by NRSROs in certain rules and forms.See References to Ratings of Nationally Recognized Statistical Rating Organizations,Exchange Act Release No. 58070 (July 1, 2008), 73 FR 40088 (July 11, 2008);Securities Ratings,Securities Act Release No. 8940 (July 1, 2008), 73 FR40106 (July 11, 2008);References to Ratings of Nationally Recognized Statistical Rating Organizations,Investment Company Act Release No. 28327 (July 1, 2008), 73 FR 40124 (July 11, 2008).

3The term “structured finance product” as used throughout this release refers broadly to any security or money market instrument issued by an asset pool or as part of any asset-backed or mortgage-backed securities transaction. This broad category of financial instrument includes, but is not limited to, asset-backed securities such as residential mortgage-backed securities (“RMBS”) and to other types of structured debt instruments such as collateralized debt obligations (“CDOs”), including synthetic and hybrid CDOs, or collateralized loan obligations (“CLOs”).

4 See Re-proposed Rules for Nationally Recognized Statistical Rating Organizations,Exchange Act Release No. 59343 (February 2, 2009), 74 FR 6456 (February 9, 2009) (“February 2009 Proposing Release”).

5Exchange Act Release No. 61050 (“Companion Release”).

6Securities Act No. 9070 (October 7, 2009) 74 FR 53086 (October 15, 2009).

7 SeeExchange Act Release No. 60789 (October 5, 2009), 74 FR 53258 (October 9, 2009) (adopting release to remove references to NRSROs);see alsoSecurities Act Release No. 9069 (October 5, 2009) 74 FR 53274 (October 9, 2009) (release to re-open for comment proposals to remove references to NRSROs).

In this release, the Commission is proposing amendments to Rule 17g-3 to require an NRSRO to furnish a new unaudited annual report to the Commission describing the steps taken by the NRSRO's designated compliance officer8 during the fiscal year to fulfill the compliance officer's responsibilities as set forth in Section 15E(j) of the Exchange Act.9 That statutory provision requires an NRSRO to designate an individual responsible for (1) administering the policies and procedures that are required to be established pursuant to Sections 15E(g) and (h) of the Exchange Act; and (2) ensuring compliance with securities laws and rules and regulations, including those promulgated by the Commission pursuant to Section 15E of the Exchange Act.10 Pursuant to the proposed amendment to Rule 17g-3, an NRSRO would be required to furnish a report to the Commission describing compliance reviews undertaken by the compliance officer during the fiscal year, material compliance matters identified during the reviews, measures implemented to remediate the material compliance issues identified, and persons within the NRSRO who were advised of the results of the reviews.

8 See15 U.S.C. 78o-7(j).Section 15E(j) of the Exchange Act requires an NRSRO to “designate an individual responsible for administering the policies and procedures that are required to be established pursuant to [Section 15E(g) and Section 15E(h) of the Exchange Act], and for ensuring compliance with the securities laws and rules and regulations thereunder, including those promulgated by the Commission pursuant to [Section 15E of the Exchange Act].” 15 U.S.C. 78o-7(j).

9 See15 U.S.C. 78o-7(j).

10 Id.

In addition, the Commission is proposing in this release to amend the Instructions to Exhibit 6 to Form NRSRO to require a credit rating agency applying to be registered as an NRSRO or an NRSRO providing its annual update to Form NRSRO to publicly disclose: (1) The percentage of the net revenue of the applicant/NRSRO attributable to the 20 largest users of credit rating services of the applicant/NRSRO; and (2) the percentage of the revenue of the applicant/NRSRO attributable to services and products other than credit rating services. The Commission notes that the first proposed disclosure would be an aggregate in that it would be the sum of the amount of net revenue attributed to the 20 largest users of credit rating services (i.e.not 20 separate net revenue amounts). In conjunction with this proposed amendment to the Instructions to Exhibit 6, the Commission is proposing to move the definitions of certain terms currently included in the Instructions to Exhibit 10 to the Explanation of Terms section of the Form NRSRO Instructions in order to make those definitions applicable to Form NRSRO as a whole.

Finally, the Commission is proposing a new rule—Rule 17g-7—that would require an NRSRO, on an annual basis, to make publicly available on its Internet Web site a consolidated report that shows three items of information with respect to each person that paid the NRSRO to issue or maintain a credit rating. First, the NRSRO would be required to disclose the percent of the net revenue attributable to the person that were earned by the NRSRO for that fiscal year from providing services and products other than credit rating services. Second, the NRSRO would have to indicate the relative standing of the person in terms of the person's contribution to the revenue of the NRSRO for the fiscal year as compared with other persons who provided the NRSRO with revenue. Third, the NRSRO would be required to identify all outstanding credit ratings paid for by the person.

As discussed in detail below, the proposed amendments seek to further advance the goals of the Commission's current oversight program for NRSROs, including increasing transparency and disclosure, and diminishing conflicts, as well as continuing to further the goals of the Rating Agency Act “to improve ratings quality for the protection of investors and in the public interest by fostering accountability, transparency, and competition in the credit rating agency industry.”11

11 SeeReport of the Senate Committee on Banking, Housing, and Urban Affairs to Accompany S. 3850, Credit Rating Agency Reform Act of 2006, S. Report No. 109-326, 109th Cong., 2d Sess. (Sept. 6, 2006) (“Senate Report”), p. 2.

The Commission believes that the proposed amendment to Rule 17g-3 to require NRSROs to furnish the Commission with an additional unaudited annual report would further improve the integrity of the ratings process and enhance accountability by requiring the designated compliance officer to annually report on actions taken to fulfill the officer's statutory responsibilities. While each NRSRO has a designated compliance officer under Section 15E(j) of the Exchange Act, the requirement to provide the Commission with such a report would, the Commission believes, help establish or further reinforce a discipline and rigor in the compliance officer's performance of his or her duties.12 It also is designed to strengthen the Commission's existing oversight of NRSROs by highlighting possible problem areas in an NRSRO's rating processes and by providing an additional tool for the Commission to determine whether the NRSRO's designated compliance officer is fulfilling the responsibilities prescribed in Section 15E of the Exchange Act.13 In addition, this information is designed to assist the Commission staff in its examination of NRSROs. The proposed amendments to the Exhibit 6 Instructions to Form NRSRO that would require additional disclosures are designed to further increase transparency by allowing users of credit ratings to more effectively evaluate the integrity of an NRSRO's credit ratings and analyze whether the NRSRO is effectively managing its conflicts of interests. Finally, the Commission believes that proposed new Rule 17g-7also would further increase transparency as well as enhance disclosures with respect to an NRSRO's management of its conflicts of interest by providing users of credit ratings with information about the potential risk of undue influence that arises when an NRSRO is paid to determine a credit rating for a specific obligor, security, or money market instrument.

12The Commission also notes that other areas of the Commission's rules and regulations also require an annual report by a chief compliance officer with respect to investment companies and investment advisers.See generally,Rule 38a-1, 17 CFR 270.38a-1, and Rule 206(4)-7, 17 CFR 275.206(4)-7.

1315 U.S.C. 78o-7(j).

In addition to the proposed rule amendments, the Commission is announcing today that it is deferring the consideration of action with regard to the rule proposed in theJune 2008 Proposing Releasethat would have required an NRSRO to include, each time it published a credit rating for a structured finance product, a report describing how the credit ratings procedures and methodologies and credit risk characteristics for structured finance products differ from those of other types of rated instruments, or, alternatively, to use distinct ratings symbols for structured finance products that differentiated them from the credit ratings for other types of financial instruments. Instead, the Commission is soliciting comment regarding alternative measures that could be taken to differentiate NRSROs' structured finance credit ratings from the credit ratings they issue for other types of financial instruments through, for example, enhanced disclosures of information. The Commission also is soliciting comment on whether the rule amendments being adopted today in theCompanion Releasedesigned to remove impediments to determining and monitoring non-issuer-paid credit ratings for structured finance products should be extended to create a mechanism for determining non-issuer-paid credit ratings for structured finance products that were issued prior to the rule becoming effective (e.g.,to allow for non-issuer-paid credit ratings for structured finance products of the 2004-2007 vintage). Specifically, the Commission is soliciting comment on whether the rule's goal could be furthered by applying its requirements or similar requirements to structured finance products that were issued prior to the compliance date of the rule as amended.

II. Proposed Amendment to Rule 17g-3

The Commission adopted Rule 17g-3 pursuant to authority in Section 15E(k)14 of the Exchange Act, which requires an NRSRO to furnish to the Commission, on a confidential basis15 and at intervals determined by the Commission, such financial statements and information concerning its financial condition as the Commission, by rule, may prescribe as necessary or appropriate in the public interest or for the protection of investors. The statute also provides that the Commission may, by rule, require that the financial statements be certified by an independent public accountant.16 In addition, Section 17(a)(1) of the Exchange Act17 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.18

1415 U.S.C. 78o-7(k).

15An NRSRO can request that the Commission keep this information confidential.SeeSection 24 of the Exchange Act (15 U.S.C. 78x), 17 CFR 240.24b-2, 17 CFR 200.80 and 17 CFR 200.83.

16 Id.

1715 U.S.C. 78q(a)(1).

18 SeeSection 5 of the Rating Agency Act and 15 U.S.C. 78q(a)(1).

Rule 17g-3 currently requires an NRSRO to furnish to the Commission on an annual basis the following reports: audited financial statements; unaudited consolidating financial statements of the parent of the NRSRO, if applicable; an unaudited report concerning revenues by category of revenue; an unaudited report concerning compensation of the NRSRO's credit analysts; an unaudited report listing the largest customers of the NRSRO; and an unaudited report on the number of credit rating actions taken during the fiscal year in each class of credit ratings for which the NRSRO is registered with the Commission.19 The rule further requires an NRSRO to furnish the Commission these reports within 90 days of the end of its fiscal year.20

1917 CFR 240.17g-3(a)(1)-(6).

2017 CFR 240.17g-3(a).

The Commission's staff understands that the designated compliance officer of some NRSROs may, in some cases, not be fulfilling the compliances officer's statutorily mandated duties, as prescribed by Section 15E(j) of the Exchange Act.21 Further, during examinations in 2008 of three of the largest NRSRO's, Commission staff also identified issues with respect to each NRSROs policies and procedures and improvements that could be made.22 In light of these concerns and the importance of an effective NRSRO compliance program, the Commission is proposing to amend Rule 17g-3 by adding paragraph (a)(7), which would require an NRSRO to furnish to the Commission an additional unaudited annual report. This report would be furnished to the Commission, on a confidential basis, consistent with the other reports required under Rule 17g-3.23

2115 U.S.C. 78o-7(j).

22 See generally, Summary Report of Issues Identified in the Commission Staff's Examinations of Select Credit Rating Agencies(July 8, 2008). The report is available on the Commission's Internet Web site, located athttp://www.sec.gov/news/studies/2008/craexamination070808.pdf.

23 See supranotes 14 and 15;see also June 2007 Adopting Release,72 FR at 33590, footnote 300 andJune 2008 Proposing Release,73 FR 36234, footnote 143.

Proposed new paragraph (a)(7)(i) of Rule 17g-3 would provide that the new report must describe the steps taken by the NRSRO's designated compliance officer during the fiscal year to: (1) Administer the policies and procedures that are required to be established pursuant to Sections 15E(g) and (h) of the Exchange Act; and (2) ensure compliance with securities laws and rules and regulations, including those promulgated by the Commission pursuant to Section 15E of the Exchange Act.24 Proposed new paragraph (a)(7)(ii) of Rule 17g-3 would provide that the new report must include: (1) A description of any compliance reviews of the activities of the NRSRO; (2) the number of material compliance matters identified during each review of the activities of the NRSRO and a brief description of each such matter; (3) a description of any remediation measures implemented to address material compliance matters identified during the reviews of the activities of the NRSRO; and (4) a description of the persons within the NRSRO who were advised of the results of the reviews.25 Finally, the Commission is proposing to amend paragraph (b) to Rule 17g-3 to require that the proposed new report required under paragraph (a)(7) be accompanied by a statement signed by the NRSRO's designated compliance officer stating that the person has responsibility for the report and, to the best of the knowledge of the designated compliance officer, the report fairlypresents, in all material respects, steps taken by the designated compliance officer for the period presented.

24Section 15E(g) of the Exchange Act provides, in pertinent part, that an NRSRO must establish, maintain, and enforce written policies and procedures reasonably designed, taking into consideration the nature of the business of such NRSRO, to prevent the misuse of material, nonpublic information. 15 U.S.C. 78o-7(g). Section 15E(h) of the Exchange Act, provides, in pertinent part, that an NRSRO must establish, maintain, and enforce written policies and procedures reasonably designed, taking into consideration the nature of the business of such NRSRO and affiliated persons and affiliated companies thereof, to address and manage any conflicts of interest that can arise from such business. 15 U.S.C. 78o-7(h).

25 Seeproposed Rule 17g-3(a)(7)(ii).

The proposed new report would be unaudited, consistent with the other unaudited reports currently required under Rule 17g-3.26 As discussed below, the Commission preliminarily believes that the proposed amendment would improve the integrity of the credit ratings process by establishing a more structured discipline under which the NRSRO's designated compliance officer would need to report to the Commission the steps taken to fulfill the officer's statutory responsibilities. The act of reporting these steps is designed to promote the active engagement of the designated compliance officer in reviewing an NRSRO's compliance with the securities laws and its own internal policies and procedures. The Commission preliminarily believes that because the compliance officer would be required to report these steps, the act of reporting should, in turn, foster improved compliance. Furthermore, the requirement in the report to identify the persons within the NRSRO advised of the results of the review could also promote the appropriate escalation of compliance issues to the management of the NRSRO.

2617 CFR 240.17g-3(a)(2)-(6). Under Rule 17g-3, the only required audited report is the NRSRO's financial statements as of its most recent fiscal year. 17 CFR 240.17g-3(a)(1).

The report also is designed to further strengthen the Commission's oversight of NRSROs by highlighting possible problem areas in an NRSRO's rating processes and providing an additional tool for the Commission to determine whether the NRSRO's designated compliance officer is fulfilling the responsibilities prescribed in Section 15E of the Exchange Act.27 For example, if an NRSRO reports a large number of material compliance matters in a particular area, the Commission examination staff could focus on that particular area as part of their next review of the NRSRO. Alternatively, if a report indicates no problems, but a subsequent Commission staff examination reveals material compliance matters, this could be brought to the attention of the NRSRO's management for appropriate action.

2715 U.S.C. 78o-7(j).

The report is also designed to assist the Commission in its oversight of NRSROs to the extent they reveal trends across NRSROs or material compliance matters that could migrate from one NRSRO to other NRSROs because, for example, they arise from rating similar products or debt issued by a particular issuer that engages more than one NRSRO.

Finally, the Commission preliminarily believes that the proposed report would also help facilitate the Commission's examination staff efforts to conduct each exam of an NRSRO in an organized and efficient manner and thus to allocate resources to maximize investor protection.28 The Commission notes that the proposed report would not be the sole factor the Commission's exam staff would use to determine the particular focus of an exam, but would be one of many factors used to make that determination.

28The Commission also notes that other areas of the Commission's rules and regulations also require an annual report by a chief compliance officer with respect to investment companies and investment advisers.See generally,Rule 38a-1, 17 CFR 270.38a-1, and Rule 206(4)-7, 17 CFR 275.206(4)-7.

A. Proposed New Paragraph 17g-3(a)(7)(i)

As stated above, the proposed amendments to Rule 17g-3 would require an NRSRO to provide the Commission with an unaudited annual report describing the steps taken by the NRSRO's designated compliance officer during the fiscal year.29 Specifically, the amendments would add a new paragraph (a)(7)(i) to Rule 17g-3, which would require an NRSRO to provide the Commission with a report describing the steps taken by the NRSRO's designated compliance officer during the fiscal year to:

29 See15 U.S.C. 78o-7(j).

• Administer the policies and procedures that are required to be established pursuant to paragraphs (g) and (h) of Section 15E of the Exchange Act (15 U.S.C. 78o-7(g) and (h));30 and

30 Seeproposed Rule 17g-3(a)(7)(i)(A).

• Ensure compliance with the securities laws and rules and regulations thereunder, including those promulgated by the Commission pursuant to Section 15E of the Exchange Act.31

31 Seeproposed Rule 17g-3(a)(7)(i)(B).

These are the areas of responsibility for the designated compliance officer prescribed in Section 15E(j) of the Exchange Act.32 The report would require a description of the steps taken by the compliance officer during the most recently ended fiscal year to fulfill these responsibilities. As noted above, the purpose of the report is to impose a yearly discipline under which the compliance officer must describe the steps taken to fulfill the officer's statutory responsibilities. The Commission's goal in proposing this amendment is to further enhance the compliance function within the NRSRO by prescribing a process that promotes the active engagement of the compliance officer in reviewing the NRSRO's compliance with internal policies and procedures and with the securities laws and rules and regulations.

3215 U.S.C. 78o-7(j).

The first area of responsibility of the compliance officer under Section 15E(j) of the Exchange Act—to administer the policies and procedures that are required pursuant to Sections 15E(g) and (h) of the Exchange Act—is identified in proposed new paragraph (a)(7)(i)(A) of Rule 17g-3. Sections 15E(g) and (h) of the Exchange Act require an NRSRO to establish, maintain, and enforce written policies and procedures reasonably designed, taking into consideration the nature of the business of the NRSRO, to prevent the misuse of material nonpublic information and to address and manage any conflicts of interest, respectively.33 The Commission preliminarily believes that requiring the designated compliance officer to describe the steps taken during the fiscal year in this area of responsibility could, to the extent it encourages the compliance officer to undertake more rigorous compliance reviews, uncover compliance weaknesses with respect to the treatment of material nonpublic information and the management of conflicts of interest by the NRSRO. This would afford the NRSRO the opportunity to consider whether corrective action is necessary to remediate such weaknesses.

33 Id.

The second area of responsibility of the compliance officer under Section 15E(j) of the Exchange Act—to ensure compliance with the securities laws and rules and regulations thereunder, including those promulgated by the Commission pursuant to Section 15E of the Exchange Act—is identified in proposed new paragraph (a)(7)(i)(B) of Rule 17g-3. The Commission preliminarily believes that requiring the designated compliance officer to describe the steps taken during the fiscal year to meet this responsibility could, to the extent it encourages the compliance officer to undertake more rigorous compliance reviews, assist the NRSRO in identifying areas where its activities may be in contravention of securities laws and regulations and, therefore, allow it to take appropriate action. The goal of the proposed compliance report is to enhance the compliance function and potentially mitigate compliance failures when they occur. The Commission preliminarily

believes that the proposed report the designated compliance officer would be required to furnish may serve as an incentive to further strengthen the NRSRO's existing compliance program.

The Commission notes that the size and scope of an NRSRO's existing compliance program would vary depending on the size and complexity of the NRSRO. Larger NRSROs with comprehensive compliance programs may already periodically review portions of their compliance programs. In contrast, smaller NRSROs may have less extensive compliance programs because they have simpler organizational structures, fewer employees and fewer sources of revenue than larger NRSROs, which may be part of a complex global organization with thousands of employees. Therefore, while the Commission believes that the proposed report would serve as incentive to further strengthen each NRSRO's existing compliance program, the extent of the effect of the proposed report on improving an NRSRO's existing compliance program may vary from one NRSRO to another.

B. Proposed New Paragraph 17g-3(a)(7)(ii)

The proposed amendment to Rule 17g-3 also would set forth specific items to be included in the proposed new report under Rule 17g-3(a)(7). In requiring the inclusion of certain information, the Commission does not intend to dictate how a designated compliance officer should fulfill the officer's responsibilities as set forth in the Rating Agency Act. The Commission expects the designated compliance officer to design and execute a compliance program taking into account: The business of the NRSRO; the procedures and methodologies used by the NRSRO to determine credit ratings; the NRSRO's size; the NRSRO's (and its affiliates') conflicts of interest; and the complexity of the NRSRO's operations. The Commission believes that the information that would be required in the report is the type of information a compliance program would generate regardless of the specific design of a particular program.

More specifically, the amendments to Rule 17g-3 would include new paragraph (a)(7)(ii), which would require that the report include:

• A description of any compliance reviews of the activities of the NRSRO;

• The number of material compliance matters identified during each review of the activities of the NRSRO and a brief description of each such matter;

• A description of any remediation measures implemented to address material compliance matters identified during the reviews of the activities of the NRSRO; and

• A description of the persons within the NRSRO who were advised of the results of the reviews.

The first item the Commission is proposing to require in the report is a description of any compliance reviews of the activities of the NRSRO.34 One of the functions of a typical compliance department is to proactively review business activities to identify potential regulatory, compliance, and reputational risks and to design ways to minimize such risks.35 The Commission intends that the designated compliance officer would describe all such reviews conducted during the most recently ended fiscal year. Therefore, this description would provide the Commission with an understanding of the scope of the designated compliance officer's reviews of the NRSRO's activities and possibly highlight any areas that were not reviewed.

34 Seeproposed Rule 17g-3(a)(7)(ii)(A).

35 See e.g., White Paper on the Role of Compliance,Securities Industry Association, Compliance and Legal Division (October 2005); available athttp://www.sifmacl.org/attachments/articles/8/Role%20of%20Compliance.pdf.

The second item the Commission is proposing be included in the report is the number of material compliance matters identified during each review of the activities of the NRSRO and a brief description of each such matter. The Commission preliminarily intends a “material compliance matter” to mean a determination by the NRSRO or a person within the NRSRO that there has been a violation of the securities laws36 or the rules thereunder or a failure to adhere to the policies, procedures, or methodologies established, maintained and enforced by the NRSRO to, for example, determine credit ratings, prevent the misuse of material nonpublic information, manage conflicts of interest, and comply with the Commission's NRSRO rules.37 A material compliance matter also would include a determination that there was a weakness in the design or implementation of the policies and procedures of the NRSRO.38 The proposed requirement to report a material compliance matter would be designed to alert the Commission to issues identified by the designated compliance officer that may raise questions about the integrity of the NRSRO's activities and operations. It also could assist the Commission's oversight of NRSROs to the extent a reported material compliance matter is one that could arise in other NRSROs because, for example, it relates to a new type of debt instrument that is being rated by more than one NRSRO or involves potentially inappropriate interactions with an issuer that hired several NRSROs to rate its securities. Finally, the Commission preliminarily believes that requiring the proposed report to include the number of material compliance matters identified would provide Commission examiners with an additional tool to assist them in identifying possible trends and issues with respect to material compliance matters at an NRSRO after the first year of reporting. For example, numerous material compliance violations over a period of years could be indicative of possible lax compliance at an NRSRO.

36The term “securities laws” is defined in Section 3(a)(47) of the Exchange Act.

37 See e.g.,17 CFR 270.38a-1(e)(2). Rule 38a-1 prescribes compliance procedures and practices for investment companies registered with the Commission under the Investment Company Act of 1940. Paragraph (a)(4) of Rule 38a-1 requires the investment company to designate an individual responsible for administering the fund's policies and procedures to, among other things, prevent violation of the Federal Securities Laws by the fund (the fund's “chief compliance officer”). Paragraph (a)(4)(iii) of Rule 38a-1 requires the fund's chief compliance officer to provide a written report to the fund's board, at least annually, that addresses, among other things, each “Material Compliance Matter” that occurred since the last report. Paragraph (e)(2) of Rule 38a-1 defines a “Material Compliance Matter” to be, among other things, a violation of the Federal Securities Law by the fund or its employees, a violation of the policies and procedures of the fund, or a weakness in the implementation or design of the policies and procedures of the fund.

38 Id.

The third item the Commission is proposing be included in the report is a description of any remediation measures implemented to address material compliance matters identified during the reviews of the activities of the NRSRO.39 The Commission preliminarily intends “remediation measures” to include changes made by the NRSRO in response to the identification of a material compliance matter that are designed to prevent the re-occurrence of a similar material compliance matter. The reporting of these measures would assist the Commission in evaluating the risk of re-occurrences. It also could shed a light on potential “best practices” for mitigating the risk of future material compliance matters. Further, it is designed to reinforce the discipline of an NRSRO to review for potential material compliance matters and take steps to address them when they occur.

39 Seeproposed Rule 17g-3(a)(7)(ii)(C).

The fourth item the Commission is proposing to include in the report is a description of the persons within the NRSRO who were advised of the resultsof the reviews. The Commission intends that the description of the persons who were advised of the results of the reviews at the NRSRO would include only key personnel,i.e.,those who have the authority to act on the results of the reviews or direct others to act. The Commission does not intend that the persons advised of the results of the reviews would be so broad in scope as to include persons such as administrative employees, for example, who may have typed a report related to a material compliance matter.

The information with respect to those persons who were advised of the results of reviews is designed to provide the Commission with an understanding of how the NRSRO responds to material compliance matters and the role and structure of the compliance program within the NRSRO. For example, it would indicate whether the compliance officer reported the matters to the NRSRO's board or senior management or only to the business unit that underwent the compliance review. This is designed to promote the appropriate escalation of compliance issues to the management of the NRSRO. The Commission also believes that this proposed information would be a useful tool for examiners to focus examination resources on practices related to material compliance matters reported and assist in making risk-based decisions on whether to initiate an examination of a particular NRSRO. The Commission notes that this information would only be one of many factors the Commission's exam staff may use to determine the particular focus of an exam.

C. Proposed Amendment to Paragraph 17g-3(b)

The Commission also is proposing to amend paragraph (b) of Rule 17g-3 to create two subparagraphs, Rule 17g-3(b)(1) and (b)(2).40 Subparagraph (b)(1) would carry forward, unchanged, the requirement in current Rule 17g-3(b). The current text of Rule 17g-3(b) requires that an NRSRO must attach to each financial report furnished pursuant to paragraphs (a)(1) through (a)(6) of Rule 17g-3 a signed statement by a duly authorized person associated with the NRSRO stating that the person has responsibility for the financial report and, to the best knowledge of the person, the financial report fairly presents, in all material respects, the financial conditions, results of operations, cash flows, revenues, analyst compensation, and credit rating actions of the NRSRO for the period presented. This requirement does not specify who within the NRSRO should have responsibility for the reports and for providing the required signed statement.

40 Seeproposed Rule 17g-3(b)(1) and (2).

Proposed subparagraph (b)(2) would establish a similar requirement for a signed statement to accompany the report under proposed new paragraph (a)(7) to Rule 17g-3, but would specify that the designated compliance officer is required to provide that statement. Specifically, proposed paragraph (b)(2) of Rule 17g-3 would require that an NRSRO attach to the report furnished pursuant to proposed paragraph (a)(7) of Rule 17g-3 a signed statement by the designated compliance officer of the NRSRO stating that the officer has responsibility for the report and, to the best knowledge of the designated compliance officer, the report fairly presents, in all material respects, the information in paragraph (a)(7)(ii) of Rule 17g-3 for the period presented. The Commission preliminarily believes that the designated compliance officer should have responsibility for providing the statement since the information to be submitted in the report is directly within that individual's statutorily mandated responsibilities under Section 15E(j) of the Exchange Act; namely, to administer the NRSRO's policies and procedures and to ensure compliance with the securities laws and regulations.

D. Summary of Amendments to Rule 17g-3 and Request for Comment

The Commission is proposing these amendments to Rule 17g-3 under its authority to require an NRSRO to “make and disseminate such reports as the Commission, by rule, may prescribe as necessary or appropriate in the public interest, for the protection of investors, or otherwise in furtherance of the purposes of [the Exchange Act].”41 The Commission preliminarily believes these proposed amendments are necessary or appropriate in the public interest, for the protection of investors and in furtherance of the Exchange Act because they are designed to further improve the quality of credit ratings and help protect the integrity of the credit rating process by requiring that an NRSRO describe the steps taken during the fiscal year by the designated compliance officer to administer required policies and procedures and to ensure compliance with the securities laws and regulations.

41 SeeSection 17(a)(1) of the Exchange Act (15 U.S.C. 78q(a)(1)).

The Commission preliminarily believes that requiring the designated compliance officer to provide such a report would encourage a more rigorous compliance program and, thereby, promote the identification of compliance failures and weaknesses in the NRSRO's policies and procedures. In addition, the reporting requirements may encourage an NRSRO to promptly resolve compliance issues identified, and thereby improve the quality and integrity of the NRSRO's credit ratings and credit rating processes.42

42The Commission notes that this information would only be one of many factors the Commission's exam staff may use to determine the particular focus of an exam.

The proposed rule amendments also would further enhance the Commission's oversight of NRSROs by providing the Commission staff an additional resource with which to evaluate the performance of the designated compliance officers in carrying out their statutory responsibilities prescribed in Section 15E(j) of the Exchange Act. Finally, the proposed report would help identify areas within the NRSRO that Commission staff examiners may want to include within the scope of their examinations and that could be indicative of potentially broader issues across NRSROs.

The Commission generally requests comment on all aspects of these proposed amendments. In addition, the Commission requests comment on the following questions related to the proposal:

• Should the proposal require that the report be furnished to the NRSRO's board or a body performing similar functions of a board or to the NRSRO's senior management in addition to requiring that it be furnished to the Commission or as an alternative to it being furnished to the Commission? Could the requirement to furnish the report to the Commission alter the way the compliance officer conducts compliance reviews or reports the results of those reviews to others within the NRSRO? Would the requirement that it be furnished to the Commission potentially impact the designated compliance officer's incentive to perform a comprehensive and in depth review of the NRSRO's activities, policies, and procedures or to identify material compliance matters? Would requiring the report instead be sent to the board, to a similar body, or to senior management result in a more or less comprehensive review?

• Should the Commission require other items to be included in the report in addition to those prescribed in proposed paragraph (a)(7)(ii) of Rule 17g-3? Commenters believing thiswould be beneficial should specifically identify the additional items and describe how the additional information would be useful to the Commission or to the NRSRO.

• Should the Commission exclude any of the items currently identified in proposed paragraph (a)(7)(ii) of Rule 17g-3? Commenters believing this would be beneficial should specifically identify the items to be deleted and describe why they would not be useful information for the Commission or the NRSRO?

• Should the Commission define the term “material compliance matter” in Rule 17g-3? If so, what should the definition be? Alternatively, is the interpretation of the term “material compliance matter” set forth in the release sufficient and appropriate? Should there be limitations on what constitutes a material compliance matter? If so, what should these limitations be? For example, are there securities laws violations that do not rise to the level of concern that they would need to be reported? If so, should such violations be reported if the number of occurrences passes a certain threshold? How should the Commission evaluate what that threshold would be (e.g.taking into account the number of occurrences and the severity of the violation)?

• As noted above, the Commission has proposed an interpretation of the category of person that would trigger the reporting requirement if such person were apprised of the finding of the compliance officer. Is the proposed interpretation sufficiently clear to indicate when the reporting requirement applies? For example, should the rule specify that it is a decision maker, someone with authority to implement remedial measures, or some other defined category of person? How should that category be defined?

• Should the Commission permit or require someone other than the designated compliance officer certify the report? If so, which person(s) should it be?

• To what extent, if any, should the designated compliance officer be able to rely on subcertifications? What purpose would the subcertifications serve? In some cases, would the designated compliance office not have all the relevant information in order to sign the statement required by proposed Rule 17g-3(b)(2) without subcertifications? If this is true, would this in some way negate any of the objectives of the proposed amendments to Rule 17g-3?

• What effect would the proposed requirement to furnish the report to the Commission have on the designated compliance officer's duties? How could any adverse effects be addressed?

• Should the Commission as an alternative to the proposed report from the compliance officer consider proposing a requirement that an independent third party perform a review of the NRSRO's adherence to its policies and procedures and its compliance with the securities laws. Commenters who believe such a requirement would be appropriate are asked to provide data with respect to the costs and benefits associated with such a review.

III. Amendments to the Instructions to Form NRSRO

The Commission is proposing to amend the instructions for Exhibit 6 to Form NRSRO to require a credit rating agency in an application for registration as an NRSRO or an NRSRO providing its annual update to disclose: (1) The percentage of the net revenue of the applicant/NRSRO attributable to the 20 largest users of credit rating services of the applicant/NRSRO; and (2) the percentage of the net revenue of the applicant/NRSRO attributable to other services and products of the applicant/NRSRO. In conjunction with this proposed amendment to the instructions to Exhibit 6, the Commission is proposing to move the definitions of certain terms currently included in the instructions to Exhibit 10 to the “Explanation of Terms” section of the Form NRSRO Instructions in order to make those definitions applicable to Form NRSRO as a whole.

A credit rating agency that seeks to register as an NRSRO must furnish an application for registration to the Commission. Section 15E(a)(1)(A) of the Exchange Act provides that the credit rating agency must furnish the application in a form prescribed by Commission rule.43 After registration, the credit rating agency—now an NRSRO—must publicly disclose most of the information in its application.44 Section 15E(b)(1) of the Exchange Act requires the NRSRO to promptly amend the application if, after registration, any information or document provided as part of the application becomes materially inaccurate.45 Section 15E(b)(2) of the Exchange Act provides that the information on credit ratings performance statistics required to be disclosed in the application pursuant to Section 15E(a)(1)(B) of the Exchange Act must be updated annually.46 In addition, Section 15E(b)(2) of the Exchange Act requires an NRSRO to furnish the Commission with an amendment to its registration not later than 90 days after the end of each calendar year (the “annual certification”).47 This section further provides that the NRSRO must (1) certify that the information and documents provided in the application for registration continue to be accurate and (2) list any material change to the information and documents during the previous calendar year.48

4315 U.S.C. 78o-7(a)(1)(A).

4417 CFR 240.17g-1(i).

4515 U.S.C. 78o-7(b)(1).

46 Id.

4715 U.S.C. 78o-7(b)(2).

48 Id.

With respect to the contents of the application, Section 15E(a)(1)(B) of the Exchange Act prescribes certain minimum information the applicant must provide in the application. Furthermore, Section 15E(a)(1)(B)(x) of the Exchange Act provides that the Commission can require any other information and documents as the Commission, by rule, may prescribe as necessary or appropriate in the public interest or for the protection of investors.49 In the Commission's initial rulemaking implementing the Rating Agency Act—which established the registration and oversight program for NRSROs—the Commission adopted Rule 17g-1 and Form NRSRO and its accompanying instructions.50 In February 2009, the Commission amended Form NRSRO to require additional disclosures.51

4915 U.S.C. 78o-7(a)(1)(B).

50 See June 2007 Adopting Release,72 FR at 33566-33582.

51 See February 2009 Adopting Release,74 FR at 6457-6460.

Rule 17g-1 prescribes, among other things, how a credit rating agency must apply to be registered with the Commission as an NRSRO, keep its information up-to-date after registration, and comply with the statutory requirement to furnish the Commission with an annual certification.52 In particular, all of these actions must be accomplished by furnishing the Commission with a Form NRSRO. As described below, Form NRSRO requires information about the credit rating agency applying for registration and, after registration, about the NRSRO, including the information required under 15E(a)(1)(B) of the Exchange Act and additional information prescribed by the Commission.53

52 See17 CFR 240.17g-1.

5315 U.S.C. 78o-7(a)(1)(B).

Form NRSRO contains 8 line items and 13 exhibits. The line items require information about the applicant/NRSRO such as its address; corporate form; credit rating affiliates that would be, orare, a part of its registration; the classes of credit ratings for which it is seeking to be, or is, registered as an NRSRO; the number of credit ratings it has issued in each class and the date it began issuing credit ratings in each class; and whether it or a person associated with it has committed or omitted any act, been convicted of any crime, or is subject to any order or findings identified in Section 15(d) of the Exchange Act.54

5415 U.S.C. 78o(d).

The 13 exhibits to Form NRSRO elicit the information required under Sections 15E(a)(1)(B)(i) through (ix) of the Exchange Act and additional information prescribed by the Commission.55 Exhibits 1 through 9 require certain information about the applicant/NRSRO, including credit rating performance statistics, its methodologies and procedures used to determine credit ratings, its policies and procedures designed to prevent the misuse of material non-public information, its organizational structure, its code of ethics, the conflicts of interest inherent in its business operations, its policies and procedures for managing those conflicts of interest, summary data about the qualifications of its credit analysts, and the identity of its chief compliance officer. An NRSRO must make Exhibits 1 through 9 publicly available after it is registered.

5515 U.S.C. 78o-7(a)(1)(B)(i)-(x).

Exhibits 10 through 13 require financial information about the applicant credit rating agency that the Commission evaluates in deciding whether it can make the finding required under Section 15E(a)(2)(C)(ii) of the Exchange Act56 that the applicant fails to maintain adequate financial and managerial resources to consistently produce credit ratings with integrity and to materially comply with the procedures and methodologies disclosed pursuant to Section 15E(a)(1)(B) of the Exchange Act57 and established pursuant Sections 15E(g), (h), (i) and (j) of the Exchange Act.58 These Exhibits are not required to be publicly disclosed by the NRSRO after the applicant is granted registration as an NRSRO. If registration is granted, the NRSRO is required to furnish financial information to the Commission in an annual report required by Rule 17g-3 that is similar to the information required in Exhibits 10 through 13.59 The rules do not require that the annual reports furnished to the Commission pursuant to Rule 17g-3 be made publicly available by the NRSRO.60

5615 U.S.C. 78o-7(a)(2)(C)(ii).

5715 U.S.C. 78o-7(a)(1)(B).

5815 U.S.C. 78o-7(g), (h), (i) and (j).

59 See17 CFR 240.17g-3 and 15 U.S.C. 78o-7(k).

60 SeeRule 17g-3 and 15 U.S.C. 78o-7(k);see also June 2007 Adopting Release,72 FR at 33590.

The Commission is proposing amending the instructions for Exhibit 6 to augment the information about conflicts of interest currently required to be disclosed in Form NRSRO. The Commission prescribed the current requirements for Exhibit 6 to implement Section 15E(a)(1)(B)(vi) of the Exchange Act, which requires that an application for registration contain information regarding any conflict of interest relating to the issuance of credit ratings by the applicant/NRSRO.61 The Exchange Act does not define or identify the types of conflicts of interest that should be disclosed pursuant to Section 15E(a)(1)(B)(vi) of the Exchange Act.62 The Commission, in adopting Form NRSRO and its accompanying instructions, required that an applicant/NRSRO provide in Exhibit 6 a list of the types of conflicts of interest relating to its issuance of credit ratings.63 To assist the applicant/NRSRO and promote consistent disclosures, the instructions to the Exhibit contain a list of potential conflicts of interest that may apply to an applicant/NRSRO based on its business model and activities.64 The instructions further provide that the applicant/NRSRO can use the descriptions provided in the instructions to identify an applicable conflict of interest.65 An applicant/NRSRO also can choose to provide its own description of the conflict or provide further explanations to one of the descriptions in the instructions.66 Finally, Exhibit 6 to Form NRSRO is one of the public exhibits that the NRSRO is required to make readily accessible to the public and to keep current through furnishing updated information on Form NRSRO.67

61 See15 U.S.C. 78o-7(a)(1)(B)(vi);June 2007 Adopting Release,72 FR at 33577.

62 Id.

63 SeeForm NRSRO Instructions for Exhibit 6.

64 Id.

65 Id.

66 Id.

67 SeeForm NRSRO General Instructions.

One purpose of the disclosure in Exhibit 6 is to alert users of credit ratings to the potential conflicts of interest inherent in the NRSRO's business model.68 The information also is designed to allow users of credit ratings to assess an NRSRO's procedures for managing conflicts by comparing the types of conflicts disclosed in Exhibit 6 with its procedures for managing conflicts of interest disclosed in Exhibit 7.69

The disclosure also is designed to assist the Commission in evaluating whether an NRSRO has sufficient financial and managerial resources to comply with the procedures for managing conflicts of interest required under Section 15E(h) of the Exchange Act.70 Being informed of the conflicts of interest identified by the applicant/NRSRO in Exhibit 6 to Form NRSRO assists the Commission in evaluating whether the disclosed financial and managerial resources of the NRSRO appear to be sufficient in light of the magnitude and extent of any conflicts.71

68 See June 2007 Adopting Release,72 FR at 33577.

69 Id.

7015 U.S.C. 78o-7(h).

71 SeeSection 15E(a)(2)(C) of the Exchange Act (15 U.S.C. 780-7(a)(2)(C));June 2007 Adopting Release,72 FR at 33577.

The Commission is proposing to amend Exhibit 6 to require an applicant/NRSRO to disclose information regarding the revenues it receives from major clients as well as the revenues attributable to services other than determining credit ratings. The proposed new disclosure is designed to assist users of NRSRO credit ratings in assessing the conflicts of interest, including the potential magnitude of such conflicts, inherent in a given NRSRO's business operations. In particular, an NRSRO's disclosure of information about revenues received from major clients and revenues attributable to other services provided to clients would allow users of credit ratings to have more information about the dimensions of the conflict arising from NRSROs being paid to determine credit ratings as well as the conflict of offering other services to persons who pay for credit ratings. It would also provide investors and other users of credit ratings more specific information about the extent to which NRSRO revenues are from a concentrated group of clients. Users of NRSRO credit ratings could then use this information to evaluate the integrity of the credit ratings issued by the NRSRO and whether they believe the NRSRO is effectively managing these conflicts of interests. Also, an NRSRO's disclosure of this information in Exhibit 6 to Form NRSRO would allow users of credit rat