Congress Reforms Process for Designating Credit Rating Agencies

A process begun in 2002 by the Sarbanes-Oxley Act has culminated in the legislative reform of the procedures for designating nationally recognized credit rating agencies. Now, four years, one SEC report, and seven congressional hearings later, the Credit Rating Agency Reform Act (P.L. No. 109-291) creates a new regulatory system for identifying and overseeing the nationally recognized agencies that issue credit ratings. The Act establishes a transparent registration process through the SEC for rating agencies wishing to become nationally recognized and a time certain in which a decision must be made. The measure balances the need to increase the number of credit rating agencies from the current five with the need to ensure quality ratings.

Under the Act, applicants seeking to become rating agencies will be required to disclose procedures used to determine ratings, policies to prevent the misuse of inside information, conflicts of interest, a code of ethics, and the type of ratings that the applicant intends to use. A preemption provision gives the SEC exclusive NRSRO registration and qualification authority. Through examinations and enforcement, the SEC will oversee the registered NRSROs. The Act also directs the SEC to issue rules regarding NRSROs’ conflicts of interest and the misuse of inside information. The centerpiece of the reformed ratings regime is new Section 15E of the Exchange Act.

The Act reforms an opaque process that provided applicants with little guidance on the substance and procedures by which they would be evaluated. Currently, only five ratings agencies are designated NRSROs by the SEC, with two of the agencies essentially constituting a duopoly with an 80% market share. Many more aspire to be so designated but languish for years without an up-or-down vote on admission to this elite club.