SEC proposes requirements for disclosures related to credit ratings

The disclosure is intended to help investors better understand the credit rating and its limitations, including potential conflicts of interest that could affect the credit rating. To address concerns regarding ratings shopping, the proposal would also require disclosure of preliminary credit ratings in certain circumstances to provide investors with more information about the credit ratings process that may bear on the quality or reliability of the rating. The SEC acknowledges the risk that requiring disclosure of credit ratings could emphasize their significance, but believes that questions raised as a result of the recent market crisis suggest that investors may not have sufficient information to understand credit ratings fully.

As a threshold matter, the SEC is proposing to require disclosure by registrants regarding credit ratings in their registration statements under the Securities Act and the Exchange Act if the registrant, underwriter or a selling shareholder uses the rating in connection with a registered offering. The proposal would add new paragraph Item 202(g) to Reg S-K, which would require much of the specific disclosure currently just permitted under Item 10(c ). Under the proposed amendments, a registrant would be required to disclose the information for each credit rating that triggers disclosure, including a specific description of the ratings, such as relative rank, and information regarding:

• The elements of the securities that the credit rating addresses;
• The material limitations or qualifications on the credit rating; and
• Any related published designation, such as non-credit payment risks, assigned by the credit rating agency with respect to the security.

The proposal would also require that registrants include a statement informing investors "that a credit rating is not a recommendation to buy, sell, or hold securities; that it may be subject to revision or withdrawal at any time by the assigning credit rating agency; that each credit rating is applicable only to the specific class of securities to which it applies; and that investors should perform their own evaluation as to whether an investment in the security is appropriate."

In addition, to highlight potential conflicts of interest, the proposed rule would require disclosure of the source of payment for the credit rating, and, if any additional non-rating services have been provided by the credit rating agency or its affiliates to the registrant or its affiliates over a specified period of time, disclosure of the services and the fees paid for those services would be required.

The SEC is also proposing to require, in certain circumstances, disclosure of preliminary ratings (read broadly), as well as final ratings not used by a registrant, so that investors will be informed when a registrant may have engaged in ratings shopping. A registrant can solicit preliminary credit ratings from a rating agency and, if it believes the preliminary ratings are too low, seek a different credit rating from another agency. If the registrant were to disclose only the most favorable rating, investors may not be able to find out that ratings shopping occurred and that the rating may be inflated or that the credit rating agency may have an incentive to inflate ratings to keep the registrant's business. The SEC is proposing that, if a registrant has obtained a credit rating and is required to disclose that credit rating, then all preliminary ratings of the same class of securities as the final rating that are obtained from credit rating agencies, other than the agency providing the final rating, must also be disclosed. In addition, if a rating is disclosed pursuant to the trigger described above, then any credit rating obtained by the registrant but not used must also be disclosed.

Finally, to keep investors apprised of developments relating to credit ratings for their investments, the SEC is also proposing amendments to Exchange Act reports to require registrants to disclose changes to credit ratings. If a credit rating that was previously disclosed has been changed, including when a rating has been withdrawn or is no longer being updated, that change would be required to be disclosed in a new item on Form 8-K within four business days of receipt of a notice or other communication that the credit rating agency has decided to change or withdraw a credit rating.

Interestingly, in a companion concept release, the SEC is also seeking comment on whether to propose to repeal the exemption for NRSRO credit ratings from being considered "expertized" and requiring a consent under Rule 436(g) (i.e., providing for expertizing liability under Section 11).

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