SEC Publishes Annual Staff Report on Nationally Recognized Statistical Rating Organizations. A Scathing report with conflicts of interests, misuse of material, non-public information and lack internal control for determining credit ratings.
23 essential findings. This is bad.
Press release: https://www.sec.gov/news/press-release/2023-21
The Securities and Exchange Commission today published a staff report that provides a summary of the staff’s examinations of nationally recognized statistical rating organizations (NRSROs) and discusses the state of competition, transparency, and conflicts of interest among NRSROs.
"The Office of Credit Ratings is critical to the Commission’s work to protect investors and ensure the integrity of the rating process, including through the office’s oversight of Nationally Recognized Statistical Rating Organizations," said SEC Chair Gary Gensler. "Through the 2022 staff report, the OCR continues its work to ensure credit ratings are accurate, reliable, and fair."
"Our risk-based approach to NRSRO examinations protects investors by focusing on specific NRSRO activities and assessing compliance with applicable laws and rules," said Lori Price, Director of the Office of Credit Ratings. "The comprehensive staff report summarizes the findings from our annual examinations and also provides information about NRSROs, their credit ratings businesses, and the industry more broadly."
As described in the report, the staff’s NRSRO examinations during 2022 considered a number of factors, including:
- Rating surveillance practices;
- The impact of COVID-19 on commercial real estate credit ratings;
- Whether business communications are conducted through unauthorized means;
- Securities ownership by NRSRO employees;
- The effect on credit ratings from the marketing and development of stand-alone ESG products; and
- Ratings of firms based in China.
Prior years’ reports from the Office of Credit Ratings are available here.
Items of Note:
As of December 31, 2022, there were ten credit rating agencies registered as NRSROs.
Solely for purposes of this Report: Fitch, Moody’s, and S&P are categorized as “large NRSROs;” AMB, DBRS, and KBRA are categorized as “medium NRSROs;” and EJR, HR, and JCR are categorized as “small NRSROs.” These categorizations are based on revenue.
The SEC oversees and, as discussed below, examines NRSROs. The Commission is prohibited by statute, however, from regulating the substance of credit ratings or the procedures and methodologies the NRSROs use to determine credit ratings. Methodologies include, among other things, the quantitative and qualitative models used to determine credit ratings.
Summary of Essential Findings and Responses to Material Regulatory Deficiencies
- Large NRSRO #1 The NRSRO did not appear to comply with the Section 15E(g)(1) requirement to enforce policies and procedures reasonably designed to prevent the misuse of material, non-public information.
- Large NRSRO #2 The NRSRO did not promptly provide complete records subject to a retention requirement and therefore did not appear to comply with Rule 17g-2(f). The NRSRO did not provide two records requested by the Staff in a timely manner, because the NRSRO did not conduct an adequate review for completeness prior to providing its response.
- Large NRSRO #3 The NRSRO did not appear to establish, maintain, enforce, and document an effective internal control structure governing adherence to policies, procedures, and methodologies for determining credit ratings, as required by Section 15E(c)(3)(A).
Medium NRSRO #1:
- The NRSRO did not appear to establish, maintain, enforce, and document policies and procedures reasonably designed to assess the probability that an issuer of a security will default, fail to make timely payment, or otherwise not make payments to investors in accordance with the terms of the security, as required by Rule 17g-8(b)(1).
- The NRSRO did not appear to comply with the Section 15E(g)(1) requirement to enforce policies and procedures reasonably designed to prevent the misuse of material, non-public information.
- The NRSRO’s policies and procedures did not appear to be reasonably designed to address a conflict of interest that could arise from its business, as required by Section 15E(h) (1). Specifically, the NRSRO did not appear to have reasonably designed policies and procedures to prevent it from issuing or maintaining credit ratings solicited by a person that provides it with net revenue equaling or exceeding 10% of its net revenue in a fiscal year, a prohibited conflict of interest set forth in Rule 17g-5(c)(1).
- The NRSRO’s policies and procedures did not appear to be reasonably designed to address a conflict of interest that could arise from its business, as required by Section 15E(h) (1). Specifically, the NRSRO did not appear to have reasonably designed policies and procedures to prevent it from issuing or maintaining credit ratings solicited by a person that provides it with net revenue equaling or exceeding 10% of its net revenue in a fiscal year, a prohibited conflict of interest set forth in Rule 17g-5(c)(1).
- The NRSRO’s policies and procedures did not appear to be reasonably designed to address a conflict of interest that could arise from its business, as required by Section 15E(h) (1). Specifically, the NRSRO did not appear to have reasonably designed policies and procedures to prevent it from issuing or maintaining credit ratings solicited by a person that provides it with net revenue equaling or exceeding 10% of its net revenue in a fiscal year, a prohibited conflict of interest set forth in Rule 17g-5(c)(1).
Medium NRSRO #2:
- The NRSRO did not appear to enforce an internal control governing the implementation of and adherence to policies, procedures, and methodologies for determining credit ratings, as required by Section 15E(c)(3)(A).
- The NRSRO did not appear to comply with the requirement of Rule 17g-7(a)(2) to disclose Forms ABS Due Diligence-15E received by the NRSRO.
- The NRSRO did not appear to disclose the versions of procedures and methodologies used to determine a credit rating, as required by Rule 17g-7(a)(1)(ii)(B).
Medium NRSRO #3
- The NRSRO did not appear to establish, maintain, and enforce written policies and procedures reasonable designed to address and manage conflicts of interest that can arise from its business, as required by Section 15E(h) (1)
- Under the NRSRO’s policies, an analyst exposed to fee information may need to be recused from voting on credit rating actions for that entity for a period of time.
- In certain circumstances, the NRSRO did not appear to provide information disclosure forms to the same persons that it provided credit ratings, as required by Rule 17g-7(a). I
Small NRSRO Findings
Small NRSRO #1
- The NRSRO published information disclosure forms that did not appear to include all the information required to be disclosed under Rule 17g-7(a).
- The NRSRO did not appear to comply with Rule 17g-3(a)(5) when filing a non-public financial report with the Commission under the rule.
- The NRSRO did not appear to follow Form NRSRO instructions when filing certain information with the Commission, resulting in incomplete information being filed.
Small NRSRO #2
- The NRSRO did not appear to establish, maintain, and enforce an effective internal control structure governing adherence to policies, procedures, and methodologies for determining credit ratings, as required by Section 15E(c)(3)(A). Specifically, the NRSRO did not appear to have effective controls for determining a metric specified in the NRSRO’s methodology that can impact the rating outcome.
- The NRSRO did not appear to establish, maintain, and enforce an effective internal control structure governing implementation of and adherence to policies, procedures, and methodologies for determining credit ratings, as required by Section 15E(c)(3)(A). This finding specifically relates to controls regarding data quality, vetting process, and the acquisition of information that appeared to be ineffective
- The NRSRO produced information disclosure forms that did not appear to include all the information required to be disclosed under Rule 17g-7(a). Specifically, the Staff observed some information disclosure forms containing a link purporting to provide the historical performance disclosure required by the rule. Clicking on the link displayed an error message rather than the required information.
- The NRSRO did not appear to establish, maintain, enforce, and document an effective internal control structure governing adherence to policies, procedures, and methodologies for determining credit ratings, as required by Section 15E(c)(3)(A). More specifically, the NRSRO did not appear to have effective internal controls to ensure that audits of its rating files identify whether analysts have adhered to the NRSRO’s procedures and methodologies for determining credit ratings.
- The NRSRO’s policies and procedures did not appear to be reasonably designed to address and manage conflicts of interest that could arise from its business and to prevent the misuse of material, non-public information as required by Section 15(h)(1) and Section 15E(g)(1), respectively.
Small NRSRO #3
- The NRSRO’s policies and procedures did not appear to be reasonably designed to address and manage conflicts of interest that could arise from its business as required by Section 15E(h) (1). The policies and procedures in question relate to securities holdings of employees, and such policies and procedures appeared not to prevent the issuance and maintenance of a credit rating subject to the prohibited conflict of interest set forth in Rule 17g-5(c)(2).
In total the Staff communicated 23 essential findings to the NRSROs at the conclusion of the 2022 Section 15E examinations. Of these essential findings:
- nine related to disclosure or reporting issues, implicating Rule 17g-3, Rule 17g-7(a), and Form NRSRO
- five related to internal control issues, implicating Section 15E(c)(3)(A)
- four related to issues addressing or managing conflicts of interest, implicating Section 15E(h) (1) and Rule 17g-5(c
- three related to issues regarding the prevention of misuse of material, non-public information, implicating Section 15E(g)(1)
- one related to policies and procedures with respect to credit rating symbols, numbers, or scores, implicating Rule 17g-8(b)(1)
- one related to the production of records to examiners, implicating Rule 17g-2(f)
- one related to compliance with a prior Commission order
