Prof. Jayanth R. Varma’s Financial Markets Blog

A blog on financial markets and their regulation

SEC No Action Letter on Rating Non Disclosure

Updated July 27, 2010: Added link and corrected title of the Reform Act.

The US SEC issued a “No Action Letter” last week to negate a key provision of the Dodd-Frank Wall Street Reform and Consumer Protection Act on the day that it came into force. The “No Action Letter” is self explanatory:

Items 1103(a)(9) and 1120 of Regulation AB require disclosure of whether an issuance or sale of any class of offered asset-backed securities is conditioned on the assignment of a rating by one or more rating agencies. If so conditioned, those items require disclosure about the minimum credit rating that must be assigned and the identity of each rating agency. Item 1120 also requires a description of any arrangements to have such ratings monitored while the asset-backed securities are outstanding.

Effective today, Section 939G of the Dodd-Frank Act provides that Rule 436(g) shall have no force or effect. As a result, disclosure of a rating in a registration statement requires inclusion of the consent by the rating agency to be named as an expert. We note that the NRSROs have indicated that they are not willing to provide their consent at this time. In order to facilitate a transition for asset-backed issuers, the Division will not recommend enforcement action to the Commission if an asset-backed issuer as defined in Item 1101 of Regulation AB omits the ratings disclosure required by Item 1103(a)(9) and 1120 of Regulation AB from a prospectus that is part of a registration statement relating to an offering of asset-backed securities.

This no-action position will expire with respect to any registered offerings of asset-backed securities commencing with an initial bona fide offer on or after January 24, 2011.

The relevant portion of Rule 436 is as follows:

(a) If any portion of the report or opinion of an expert or counsel is quoted or summarized as such in the registration statement or in a prospectus, the written consent of the expert or counsel shall be filed as an exhibit to the registration statement and shall expressly state that the expert or counsel consents to such quotation or summarization.

(g) Notwithstanding the provisions of paragraphs (a) and (b) of this section, the security rating assigned to a class of debt securities, a class of convertible debt securities, or a class of preferred stock by a nationally recognized statistical rating organization … shall not be considered a part of the registration statement.

I can understand a “No Action Letter” that says that as an interim measure the identity of the rating agency need not be disclosed, but I am amazed to find that the SEC is allowing the entire “ratings disclosure” to be omitted. The fact that an issue is conditioned by a minimum rating requirement is I think a material fact.

Also, I do not understand why the SEC cannot simply state that the rating agency shall not be regarded as an expert and require the registration statement to make the same statement. Rating reports should be regarded as being in the same category as press reports and editorials. Ultimately, the SEC should simply abolish the whole category of nationally recognized statistical rating organizations (NRSROs).

I have blogged about rating agency regulatory reform several times in the last three years:

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3 responses to “SEC No Action Letter on Rating Non Disclosure

  1. Richard Careaga July 27, 2010 at 1:51 am

    The upcoming no-action letter does something temporarily that the Commission is considering permanently, which is to drop the requirement for an investment grade rating as a condition for registration on Form S-3 (i.e., shelf registration). No requirement for a rating means no requirement to obtain the consent for the rating agency to be named as an expert, which they are refusing to do. The history of the rating requirement is one of those slow-mo historical accidents that came about by trying to fit ABS into the framework for debt/equity shelf registration.

  2. Accounting Directory August 2, 2010 at 7:15 am

    I’m not sure how much comfort I have in this process anymore. The SEC has a lot on it’s plate especially with the recent financial reforms.

  3. Debt Cancellation August 2, 2010 at 7:56 am

    I agree…the SEC has so much on it’s plate that I’m not sure if they are up to the task. We’ll see.

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