The U.S. Securities and Exchange Commission’s (SEC’s) proposed regulations relating to asset-backed securities, which would have diminished the role of rating agencies in the context of asset-backed securities and limited the sale of such securities to sophisticated investors, are discussed in a McDermott Will & Emery On the Subject dated July 7, 2008. The SEC recently released its final rule amending the rules applicable to nationally recognized statistical rating organizations as part of its effort to address concerns about the integrity of the process by which rating agencies rate structured finance products. However, the SEC has not taken action with respect to the remainder of its proposals, leaving investment grade asset-backed securities eligible for purchase in a public offering by all types of investors, subject to the usual suitability rules.
In the summer of 2008, the SEC proposed a series of regulations that would have significantly diminished the role of nationally recognized statistical rating organizations (NRSROs) in the asset-backed securities market. On June 16, 2008, the SEC, in the first of three related actions, proposed a series of amendments designed to address concerns about the integrity of the process by which rating agencies rate structured finance products, particularly asset-backed securities. This set of amendments was designed to enhance the disclosure and comparability of credit ratings performance statistics, increase the disclosure of information about structured products, require more information about the methodologies used to determine credit ratings for structured products, strengthen internal controls through reporting requirements, and address conflicts of interest arising from the rating process.
The second action taken by the SEC was to propose a new rule that would require rating agencies to distinguish their ratings for structured finance products from other classes of credit ratings by publishing a report along with the rating or using a different rating symbol. Finally, the third action taken by the SEC was to propose a series of amendments to the Securities Act of 1933, the Securities Exchange Act of 1934 and the Investment Company Act of 1940. These amendments would have removed the ratings requirements for Form S-3 shelf registrations of asset-backed and mortgage-backed securities, limited the offering of such securities to “qualified institutional buyers” as defined in Rule 144(a)(1) under the Securities Act of 1933 and removed the ratings requirement for the exemption from the Investment Company Act provided by Rule 3a-7 thereunder. These proposals were far-reaching changes aimed at combating the perception that the SEC’s ratings requirements placed an “official seal of approval” on securities once they received an investment grade rating. In particular, the SEC crafted these proposals to address concerns that certain investors assume the risk characteristics of structured finance products, particularly highly rated instruments, are the same as for other types of similarly rated instruments, such as corporate and municipal debt.
In a final rule released on February 9, 2009, the SEC adopted, with revisions, a majority of the rule amendments proposed in the first action, designed to increase the transparency of the NRSROs’ rating methodologies, strengthen their disclosure of ratings performance, prohibit NRSROs from engaging in certain practices that create conflicts of interest, and enhance the NRSROs’ recordkeeping and reporting obligations. In conjunction with the final rule, the SEC resubmitted for public comment revised amendments that would require disclosure of credit rating histories for all outstanding credit ratings paid for by the obligor being rated or by the issuer, underwriter or sponsor of the security being rated. Another revised amendment would prohibit an NRSRO from issuing a rating for a structured finance product paid for by the product’s issuer, sponsor or underwriter, unless the information about the product provided to the NRSRO to determine the rating and, thereafter, to monitor the rating, is made available to other persons.
However, the SEC took no further steps with respect to the second and third proposals, stating simply, without further elaboration, that “[t]he second and third actions are not being finalized in this release.” It appears that, at least in the short-term, these proposals will not be adopted. Therefore, asset-backed securities remain eligible for registration on Form S-3 and to be publicly offered to all types of investors under a shelf registration statement provided they are “investment grade securities.” Such securities are investment grade securities if, “at the time of sale, at least one [NRSRO] has rated the security in on its generic rating categories which signifies investment grade.” Similarly, the ratings requirements of Investment Company Act Rule 3a-7 remain in effect. These final rules actually adopted indicate that the SEC’s priority lies in reforming NRSROs’ methodologies and disclosure such that a particular structured product’s rating more accurately informs an investment decision.
The final rules released this month will take effect on April 10, 2009. The SEC will accept comments on the revised amendments until March 26, 2009.