Securities and Exchange Commission:

Action Needed to Improve Rating Agency Registration Program and Performance-Related Disclosures

GAO-10-782: Published: Sep 22, 2010. Publicly Released: Sep 22, 2010.

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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.

Status Legend:

More Info
  • Review Pending-GAO has not yet assessed implementation status.
  • Open-Actions to satisfy the intent of the recommendation have not been taken or are being planned, or actions that partially satisfy the intent of the recommendation have been taken.
  • Closed-implemented-Actions that satisfy the intent of the recommendation have been taken.
  • Closed-not implemented-While the intent of the recommendation has not been satisfied, time or circumstances have rendered the recommendation invalid.
    • Review Pending
    • Open
    • Closed - implemented
    • Closed - not implemented

    Recommendations for Executive Action

    Recommendation: 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.

    Agency Affected: United States Securities and Exchange Commission

    Status: Open

    Comments: When we confirm what actions the agency has taken in response to this recommendation, we will provide updated information.

    Recommendation: 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.

    Agency Affected: United States Securities and Exchange Commission

    Status: Open

    Comments: When we confirm what actions the agency has taken in response to this recommendation, we will provide updated information.

    Recommendation: 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.

    Agency Affected: United States Securities and Exchange Commission

    Status: Open

    Comments: When we confirm what actions the agency has taken in response to this recommendation, we will provide updated information.

    Recommendation: 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.

    Agency Affected: United States Securities and Exchange Commission

    Status: Open

    Comments: When we confirm what actions the agency has taken in response to this recommendation, we will provide updated information.

    Recommendation: 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.

    Agency Affected: United States Securities and Exchange Commission

    Status: Open

    Comments: When we confirm what actions the agency has taken in response to this recommendation, we will provide updated information.

    Recommendation: 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.

    Agency Affected: United States Securities and Exchange Commission

    Status: Open

    Comments: When we confirm what actions the agency has taken in response to this recommendation, we will provide updated information.

    Recommendation: 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.

    Agency Affected: United States Securities and Exchange Commission

    Status: Open

    Comments: When we confirm what actions the agency has taken in response to this recommendation, we will provide updated information.

    Recommendation: 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.

    Agency Affected: United States Securities and Exchange Commission

    Status: Open

    Comments: When we confirm what actions the agency has taken in response to this recommendation, we will provide updated information.

    Recommendation: 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.

    Agency Affected: United States Securities and Exchange Commission

    Status: Open

    Comments: When we confirm what actions the agency has taken in response to this recommendation, we will provide updated information.

    Recommendation: 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.

    Agency Affected: United States Securities and Exchange Commission

    Status: Open

    Comments: When we confirm what actions the agency has taken in response to this recommendation, we will provide updated information.

    Recommendation: 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.

    Agency Affected: United States Securities and Exchange Commission

    Status: Open

    Comments: When we confirm what actions the agency has taken in response to this recommendation, we will provide updated information.

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