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Dodd-Frank and Credit Rating Agencies

Addressing Credit Rating Agencies Through Enactment of Dodd-Frank

The Dodd-Frank Wall Street Reform and Consumer Protection Act (“Dodd-Frank Act”) was passed and signed into on July 21, 2010. A small part of this act addressed credit rating agencies and their past practices. The act intends to (1) remove references in statutes and regulations to Nationally Recognized Statistical Rating Organizations (“NRSROs”), (2) create a new office of credit ratings, (3) to expand conditions that deal with conflicts of interest that may exist both inside the credit rating agencies and with the issuers and underwriters that they deal with, (4) promote rules for better internal governance and control, (5) define new requirements for the board of directors, and (6) institute harsher consequences for non-compliance with the law. [1]

Impact of the Dodd-Frank on the Credit Rating Agencies

With the obvious lack of regulation and oversight over credit rating agencies, it was inevitable that problems regarding transparency, accountability, and conflicts of interest would eventually surface. Title IX, Subtitle C of the Dodd-Frank Act tries to address these problems in several ways. First, the act mandated the removal of references in statutes and regulations to Nationally Recognized Statistical Rating Organizations (“NRSROs”). NRSROs are credit rating agencies that the Security and Exchange Commission (“SEC”) allows other firms to use for certain regulatory purposes. Removal of statutory reference to these organizations forces regulatory organizations to come up with alternate standards for determining credit-worthiness.[2]

In addition, the Act creates a new office of credit ratings in order to oversee and enforce rule as well as ensure accuracy within the ratings. The main task of Office of Credit Ratings (OCR) within the SEC, as stated in the Dodd-Frank Act, is to administer the rules involved in determining ratings and enforcing fines and punishments to NRSROs that fail to comply with those rules. It states that the OCR will "administer its rules with respect to NRSRO practices in determining ratings, for the protection of users of credit ratings and in the public interest".[3]

The ultimate purpose of this is to provide an additional level of consistency among the various rating bodies and to ensure uniformity in the enforcement of various provisions of the Act. This greatly impacts the way NRSROs operate, since it creates a specific governing body to oversee and directly regulate their operations. In addition, the OCR is required to conduct annual reviews of NRSROs and disclose the report's information to the public. In addition, this organization publishes annual reports of their inspection findings as well as any comments received by the rating agencies and has the authority to issue penalties if it discovers non-compliance with the law. This serves to promote greater transparency and to promote a stronger flow of information about the government’s findings to investors and the public. Failure of NRSROs to comply with regulations allows the SEC to "suspend temporarily, or to revoke permanently the registration of a NRSRO with respect to a particular class or subclass of securities, if it finds that the NRSRO does not have adequate financial and managerial resources consistently to produce credit ratings with integrity".[4]

Furthermore, the bill requires "each NRSRO to disclose publicly information on the initial credit ratings it has determined for each type of obligor, security, and money market instrument, and any subsequent changes to such ratings, in order to allow users of credit ratings to evaluate their accuracy and compare the performance of ratings by different NRSROs".[5] This requirement provides more transparency within NRSROs and aims at creating more competition among NRSROs by making it easier for users to compare ratings.

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[1] "BRIEF SUMMARY OF THE DODD-FRANK WALL STREET REFORM AND CONSUMER PROTECTION ACT". US Senate, 01 Jul 2010. Web. 16 Nov 2011. http://banking.senate.gov/public/_files/070110_Dodd_Frank_Wall_Street_Reform_comprehensive_summary_Final.pdf. Last Accessed November 17, 2011

[2] “Dodd-Frank Wall Street Reform and Consumer Protection Act: Credit Rating Agency Provisions.” http://www.orrick.com/fileupload/2822.htm. Last Accessed November 15, 2011

[3] The Library of Congress. http://www.loc.gov/index.html. Last accessed November 16, 2011.

[4] Id.

[5] Id.

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