Within OCIE, the NRSRO  examination team within the Office of Market Oversight conducts NRSRO  examinations. NRSRO Application Review Process Limits SEC Staff’s Ability to Ensure That Applicants Meet the Act’s Requirements and NRSRO Examination Program Faces Staffing Challenges

SEC’s implementation of the Act involved developing an NRSRO  application review process and an examination program. As currently  implemented and staffed, both programs require further attention. Staff said that even if SEC had authority to examine an NRSRO applicant  prior to acting on its application, the Act’s 90-day deadline for acting on an  application would not provide enough time for a more thorough review. We identified other registration processes that have built in greater  authority and flexibility for the staff to clarify issues before registering  applicants. However, because the NRSRO registration program  requires SEC to act within 90 days of receiving the application and SEC  has limited ability to extend that deadline, staff have recommended  granting registration to credit rating agencies as NRSROs with some  concerns outstanding about their meeting the Act’s requirements. As a result, with the current  level of staffing it is unlikely that OCIE would have been able to meet its  planned routine examination schedule of examining the three largest  NRSROs every 2 years and the remaining NRSROs every 3 years depending  on staffing resources, and two examinations have taken over 18 months to  complete. SEC requested additional resources which it anticipated using  to fully staff this oversight function. The Dodd-Frank Act requires SEC to staff the office sufficiently to carry  out these requirements. SEC Has Increased the Amount of Performance-related Data NRSROs Are Required to Disclose, but These Data Have Limited Usefulness

Since the implementation of the Act, SEC has made several revisions to  the Form NRSRO that are intended to make more information publicly  available for evaluating and comparing NRSRO performance. However, because SEC did not specify how NRSROs should  calculate these statistics, the NRSROs used varied methodologies, limiting  their comparability. Further, we found that the ratings history data sets do  not contain enough information to construct comparable performance  statistics and are not representative of the population of credit ratings at  each NRSRO. Without better disclosures, the information being provided  will not serve its intended purpose of increasing transparency. Although the number of NRSROs has increased, the credit rating industry  remains highly concentrated. First, credit rating agencies may have relatively high fixed costs. Models Proposing Alternative Means of Compensating NRSROs Intend to Address Conflicts of Interests in the Issuer- Pays Model

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 has recently removed or  proposed to remove references to NRSRO ratings from several rules. 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 should:    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. 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 take the  following eight actions:  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; and    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;  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;    consider requiring NRSROs to publish a codebook to explain the  variables included in the datasets;    clarify that NRSROs should include defaults in the 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; and  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;  for the disclosures of total outstanding ratings required on Form NRSRO,    provide specific guidance to NRSROs to calculate their total  outstanding ratings. Appendix I: Objectives, Scope, and Methodology

To discuss the implementation of the Credit Rating Agency Reform Act of  2006 (Act), focusing on Securities and Exchange Commission (SEC)  rulemaking and SEC’s implementation of the registration and examination  programs for Nationally Recognized Statistical Rating Organizations  (NRSRO), we reviewed the rules SEC has adopted to implement the Act,  including the NRSRO registration program and its oversight of NRSROs. To understand additional changes to  SEC’s oversight of the NRSROs, we reviewed the recently passed Dodd- Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank  Act).
Why GAO Did This Study

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.

What GAO Found

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.