Finance and real estate-08-10-35-dodd-frank measures affecting credit

August 2010 / Issue 35

A legal update from Dechert’s Finance and Real Estate Group

Dodd-Frank Measures Affecting Credit Rating Agencies
Subtitle C of Title IX of the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Act”) reflects Congressional findings that credit ratings are systemically important and that “inaccurate” credit ratings played a role in the mismanagement ofrisk by large financial institutions and investors, which contributed to the crisis in the financial markets. Accordingly, the Act substantially expands the scope of regulation and accountability of credit rating agencies generally and nationally recognized statistical ratings organizations (“NRSROs”) in particular. Interestingly, the goals reflected by the Act appear to be somewhat inconsistent. Onthe one hand, the Act aims to improve the overall quality and integrity of credit ratings issued by credit rating agencies through implementing internal and external control structures, increasing the potential liability of credit rating agencies and promoting a more transparent credit rating process. On the other hand, the Act seeks to reduce the deference and reliance that investors,regulators, and other users of credit ratings may give to such credit ratings.
Internal and External Controls
The Act evidences a concern that business pressures on NRSROs to generate revenue may have led NRSROs to loosen their credit rating procedures or to apply them inconsistently. In an attempt to mitigate the potential conflicts of interest associated with the issuer-pay model prevalent in the creditrating industry, the Act requires NRSROs to comply with a number of internal and external controls. Among other things, each NRSRO is required to establish and document internal policies and procedures for determining credit ratings. Each NRSRO is also required to segregate its sales and marketing personnel and efforts from its credit rating operations pursuant to rules to be issued by the SEC.Each NRSRO is required to have a compliance officer (whose compensation may not be tied to the financial performance of the company) to monitor compliance with these policies, procedures, and rules. The Act further requires each NRSRO to have a Board of Directors with independent directors comprising at least one half (and no fewer than two) of its members. The Act also requires each NRSRO tomonitor instances where certain of its employees subsequently become employees of customers of the NRSRO. If an employee who was employed at an NRSRO over the previous five

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years as a senior officer, an employee who participated in determining credit ratings, or a supervisor of an employee who participated in determining credit ratings, leaves the NRSRO to obtain employment with an obligor,issuer, underwriter, or sponsor of a security or money market instrument rated by that NRSRO during the one-year period prior to the employee’s departure, the NRSRO must report this transition to the SEC. Additionally, if any employee of an NRSRO who participated in any way in determining a credit rating subsequently becomes employed by the related issuer, underwriter, sponsor, or other entitysubject to such credit rating, the NRSRO is required to “look-back” for a one-year time period preceding the date an action was taken with respect to that credit rating to determine whether such employee was influenced by a conflict of interest and, if so, to revise the credit rating. The Act calls for a new Office of Credit Ratings to be established by the SEC, with the stated purposes ofprotecting users of credit ratings, promoting accuracy in credit ratings, and ensuring that ratings are not influenced by conflicts of interest. This Office will be required to audit each NRSRO annually and make its inspection reports publicly available. The internal and external controls required by the Act may lead to some degree of improved confidence in the integrity of credit ratings. Whether these...