68018 Federal Register / Vol. 62, No. 249 / Tuesday, December 30, 1997 / Proposed Rules

1Securities Exchange Act Release No. 34616

(August 31 1994), 59 FR 46314 (September 7, 1994)

(‘‘Concept Release’’).

How can this problem of integration be

adequately addressed?

e. OTC Derivatives Dealer.

Question 41: Should the Commission

amend the Rule so that all broker-dealers are

eligible to use the methodology for

calculating market and credit risk as in

proposed Appendix F to the Rule?

Question 42: What minimum capital

requirements should the Commission require

a broker-dealer to meet to be eligible to use

proposed Appendix F? Should the criteria be

based on tentative net capital, net capital, or

both? Are the $100 million tentative net

capital and $20 million net capital

requirements appropriate?

Question 43: Assuming that the

Commission were to allow all broker-dealers

to utilize Proposed Appendix F, what

sections in Proposed Appendix F need to be

modified for all broker-dealers? Are the

market risk and credit risk sections in

Proposed Appendix F appropriate for all

broker-dealers? Are the qualitative and

quantitative requirements for VAR models in

Proposed Appendix F appropriate to VAR

models used by non-OTC derivatives dealers?

f. Two Tiered Approach.

Question 44: Is a Two Tiered Approach a

viable alternative to the current net capital

rule? If so, what standards should the

Commission utilize to determine which

broker-dealers are required to utilize

statistical models? Should the tier limits be

based on capital, amount of customer

business, level of proprietary trading, or

some other factor(s)? Should these minimum

net capital amounts be fixed dollar amounts

or be based on financial ratios such as

aggregate indebtedness or aggregate debit

items as in the current rule? Please provide

relevant data to support your response.

Question 45: Should the current haircut

percentages be maintained? If not, what

modifications should be made to the current

haircut percentages? Please provide relevant

data to support your response.

Question 46: What will be the impact on

competition among firms in different tiers? In

this regard, the Commission seeks comment

on the effects of creating a two-tiered system

from broker-dealers that do not currently use

models in their risk management system and

from broker-dealers that currently use models

for risk management purposes but either lack

sufficient capital or sufficiently diverse

securities portfolios to use models for net

capital purposes.

g. Base Approach with PreCommitment Feature.

Question 47: Is the Base Approach a viable

alternative to the current net capital rule?

Question 48: Should the Base Approach

only apply to firms that meet certain

standards? If so, what are the appropriate

standards?

Question 49: What minimum capital

requirements should the Commission

establish for certain broker-dealer activities?

Should these minimum net capital amounts

be fixed dollar amounts or based on financial

ratios such as aggregate indebtedness or

aggregate debit items as in the current rule?

Should the current minimum levels be

retained?

Question 50: What modifications should

the Commission make to the current haircut

percentages? Please provide relevant data to

support your response.

Question 51: What should be the

parameters for the pre-commitment feature?

Should firms be penalized for differences

between actual results and the results as

projected by VAR models? If so, what criteria

should be used to determine the additional

capital requirements for these differences?

III. Summary of Requests for Comment

Following receipt and review of

comments, the Commission will

determine whether rulemaking or other

action is appropriate. Commenters are

invited to discuss the broad range of

concepts and approaches described in

this release concerning the

Commission’s regulation of brokerdealers’ net capital requirements. In

addition to responding to the specific

questions presented in this release, the

Commission encourages commenters to

provide any information to supplement

the information and assumptions

contained herein regarding the current

net capital rule, VAR models, and the

other suggested alternatives. The

Commission also invites commenters to

provide views and data as to the costs

and benefits associated with the

possible changes discussed above in

comparison to the costs and benefits of

the current net capital rule. In order for

the Commission to assess the impact of

changes to the Rule, comment is

solicited, without limitation, from

investors, broker-dealers, SROs, and

other persons involved in the securities

markets.

Dated: December 17, 1997.

By the Commission.

Margaret H. McFarland,

Deputy Secretary.

[FR Doc. 97–33400 Filed 12–29–97; 8:45 am]

BILLING CODE 8010–01–P

SECURITIES AND EXCHANGE

COMMISSION

17 CFR Part 240

[Release No. 34–39457; File No. S7–33–97]

RIN 3235–AH28

Capital Requirements for Brokers or

Dealers Under the Securities Exchange

Act of 1934

AGENCY: Securities and Exchange

Commission.

ACTION: Proposed rule.

SUMMARY: The Securities and Exchange

Commission (‘‘Commission’’) is

proposing for comment amendments to

Rule 15c3–1 under the Securities

Exchange Act of 1934. The proposed

amendments would define the term

‘‘nationally recognized statistical rating

organization’’ (‘‘NRSRO’’). The

proposed definition sets forth a list of

attributes to be considered by the

Commission in designating rating

organizations as NRSROs and the

process for applying for NRSRO

designation.

DATES: Comments must be received on

or before March 2, 1998.

ADDRESSES: Persons wishing to submit

written comments should file three

copies with Jonathan G. Katz, Secretary,

Securities and Exchange Commission,

450 Fifth Street, N.W., Stop 6–9,

Washington, D.C. 20549. Comments also

may be submitted electronically at the

following E-mail address: rulecomments@sec.gov. All comment letters

should refer to File No. S7–33–97. This

file number should be included on the

subject line if E-mail is used. All

comments received will be available for

public inspection and copying in the

Commission’s Public Reference Room,

450 Fifth Street, N.W., Washington,

D.C., 20549. Electronically submitted

comment letters will be posted on the

Commission’s Internet web site (http://

www.sec.gov).

FOR FURTHER INFORMATION CONTACT:

Michael A. Macchiaroli, Associate

Director, 202/942–0131, Peter R.

Geraghty, Assistant Director, 202/942–

0177, Louis A. Randazzo, Special

Counsel, 202/942–0191, or Michael E.

Greene, Staff Attorney, 202/942–4169,

Division of Market Regulation,

Securities and Exchange Commission,

450 Fifth Street, N.W., Washington, D.C.

20549.

SUPPLEMENTARY INFORMATION:

I. Introduction

A. The Commission’s Concept Release

In August 1994, the Commission

issued a concept release soliciting

public comment on the Commission’s

role in using the ratings of NRSROs.1 In

the Concept Release, the Commission

specifically solicited comments on: (1)

Whether it should continue to use the

NRSRO concept, and, if so, whether it

should define the term ‘‘NRSRO’’; and

(2) whether the current no-action letter

process for designating a rating

organization an NRSRO is satisfactory,

and, if not, whether the Commission

should establish an alternative

procedure. The Commission is now
Federal Register / Vol. 62, No. 249 / Tuesday, December 30, 1997 / Proposed Rules 68019

2 17 CFR 240.15c3–1.

3See 17 CFR 240.15c3–1(c)(2)(vi)(E) (haircuts

applicable to commercial paper that has been rated

in one of the three highest categories by at least two

NRSROs); 17 CFR 240.15c3–1(c)(2)(vi)(F) (haircuts

applicable to nonconvertible debt securities that are

rated in one of the four highest rating categories by

at least two NRSROs); 17 CFR 240.15c3–

1(c)(2)(vi)(H) (haircuts applicable to cumulative,

nonconvertible preferred stock rated in one of the

four highest rating categories by at least two

NRSROs).

4Pub. L. 98–440, Section 101, 98 Stat. 1689

(1984). See 15 U.S.C. 78c(a)(41).

5See, e.g., Regulation S–K (17 CFR 229.10) (a

registrant may include NRSRO ratings in its

registration statements and periodic reports); Rule

436 (17 CFR 230.436) (rating assigned to a security

by an NRSRO shall not be considered part of the

registration statement prepared or certified by a

person within the meaning of sections 7 and 11 of

the Securities Act of 1933); Form S–3 (17 CFR

239.13) (Form S–3 may be used in primary offerings

of non-convertible securities and asset-backed

securities which are rated investment grade by at

least one NRSRO); Forms F–2 and F–3 (17 CFR

239.32, 239.33) (non-convertible securities for

purposes of Forms F–2 and F–3 are investment

grade securities if, at the time of sale, at least one

NRSRO has rated the security in one of its generic

rating categories that signifies investment grade).

6See, e.g., Rule 101 (17 CFR 242.101) and Rule

102 (17 CFR 242.102) (non-convertible debt

securities, nonconvertible preferred securities and

asset-backed securities which are rated investment

grade by at least one NRSRO are exempt from the

provisions of Rule 101 and Rule 102). See also Form

17–H (17 CFR 249.328T) (for each Material

Associated Person of a broker-dealer, the brokerdealer must include the name of the NRSRO which

has rated a Material Associated Person’s

commercial paper).

7See, e.g., Rule 2a–7(a)(9) (17 CFR 270.2a–7(a)(9))

(an ‘‘eligible security’’ is, among other things, a

security that has received a short-term rating by the

requisite NRSROs in one of the two highest shortterm rating categories); Rule 10f–3 (17 CFR 270.10f–

3) (municipal securities rated investment grade by

at least one NRSRO are exempt from section 10–f

of the Investment Company Act of 1940, which

prohibits registered investment companies from

purchasing certain securities); and Rule 3a–7 (17

CFR 270.3a–7) (issuers of asset-backed securities

may not be deemed investment companies for

purposes of the Investment Company Act of 1940

if, among other things, fixed-income securities sold

by the issuer are rated in one of the four highest

categories by at least one NRSRO).

8When the net capital rule became effective in

1975, Fitch Investors Service, L.P. (‘‘Fitch’’),

Standard & Poor’s and Moody’s were designated as

NRSROs by the Division for purposes of the net

capital rule. Subsequently, based on requests from

rating organizations, the Division provided noaction assurances to Duff & Phelps, BankWatch,

IBCA Limited and IBCA Inc. (IBCA Limited and

IBCA Inc. are collectively referred to as ‘‘IBCA’’).

IBCA was designated as an NRSRO for limited

purposes. In November 1997, Fitch and IBCA

combined to create Fitch IBCA, a successor rating

organization. By letter dated November 4, 1997, the

Division stated that it would not recommend

enforcement action to the Commission if Fitch

IBCA succeeded to the NRSRO designation of Fitch

for the purposes of applying paragraphs (c)(2)(vi)

Continued

proposing to amend the net capital rule

to provide a definition of the term

‘‘NRSRO’’ that sets forth the criteria that

a rating organization must satisfy to be

an NRSRO.

B. Summary of the Comments

The Commission received 25

comment letters in response to the

Concept Release. The comments

generally supported the continued use

of the NRSRO concept, but

recommended that the Commission

adopt a formalized process for

designating NRSROs. A few commenters

set forth criteria that the Commission

should consider to determine whether a

rating organization is an NRSRO. In

addition, commenters generally

opposed formal regulatory oversight of

NRSROs. These issues are discussed in

greater detail in Sections III and IV

below.

C. The Development and Expanded Use

of the NRSRO Concept

The term ‘‘NRSRO’’ was initially

adopted by the Commission in 1975 for

the narrow purpose of distinguishing

different grades of debt securities under

the Commission’s net capital rule, Rule

15c3–1.2 Rule 15c3–1 requires a brokerdealer to reduce the value of the

securities positions that it owns by

specified percentages (‘‘haircuts’’) when

calculating its net capital. Brokerdealers that own commercial paper,

nonconvertible debt securities, and

nonconvertible preferred stock are

allowed to reduce their haircuts for

these instruments when calculating net

capital if the instruments are rated

investment grade by at least two

NRSROs.3

Since its adoption in 1975, the

NRSRO concept has expanded beyond

its originally intended use under the net

capital rule. For example, Congress, in

certain mortgage related legislation,4

and the Commission, in its regulations

pursuant to the Securities Act of 1933,5

the Securities Exchange Act of 1934

(‘‘Exchange Act’’),6 and the Investment

Company Act of 1940,7 use the ratings

of NRSROs as proxies to distinguish

‘‘investment grade’’ from ‘‘noninvestment grade’’ debt securities. These

references are to an NRSRO as that term

is used in Rule 15c3–1; however, the

term ‘‘NRSRO’’ has not been defined for

purposes of the federal securities laws.

D. Current Process for Determining

Whether an Entity is an NRSRO

Currently, to determine whether a

rating organization is an NRSRO, the

Division of Market Regulation

(‘‘Division’’) staff first reviews the rating

organization’s operations, position in

the marketplace, and other criteria. If

the Division staff determines that a

rating organization may properly be

labelled an NRSRO, the staff issues a

letter stating that it will not recommend

enforcement action to the Commission if

the rating organization is considered by

registered broker-dealers to be an

NRSRO for purposes of applying the

relevant portions of the net capital rule.

In determining whether a rating

organization may be considered an

NRSRO for purposes of the

Commission’s rules, the staff considers

a number of criteria. The single most

important criterion is that the rating

organization is nationally recognized,

which means the rating organization is

recognized in the United States as an

issuer of credible and reliable ratings by

the predominant users of securities

ratings. The Division also examines the

operational capability and reliability of

each rating organization in conjunction

with this standard of national

recognition. Included within this

assessment are: (1) The organizational

structure of the rating organization; (2)

the rating organization’s financial

resources (to determine, among other

things, whether it is able to operate

independently of economic pressures or

control from the companies it rates); (3)

the size and quality of the rating

organization’s staff (to determine if the

entity is capable of thoroughly and

competently evaluating an issuer’s

credit); (4) the rating organization’s

independence from the companies it

rates; (5) the rating organization’s rating

procedures (to determine whether it has

systematic procedures designed to

produce credible and accurate ratings);

and (6) whether the rating organization

has internal procedures to prevent the

misuse of non-public information and

whether those procedures are followed.

The Division’s no-action position

regarding NRSRO designation is based

on representations made to the staff by

the rating organization during the noaction process. The no-action letter

directs the rating organization to advise

the Division of any material change in

the facts that serve as the basis for

granting the no-action position. For

example, material changes in an

NRSRO’s organizational structure or

modifications of its rating practices

could affect the NRSRO’s standing as a

credible evaluator in the credit market.

The Division may withdraw a no-action

letter designating a particular rating

organization as an NRSRO under certain

circumstances.

To date, the Commission regards five

rating organizations as NRSROs for

purposes of the net capital rule: (1)

Standard & Poor’s Corporation

(‘‘Standard & Poor’s’’); (2) Moody’s

Investors Service, Inc. (‘‘Moody’s’’); (3)

Fitch IBCA, Inc. (‘‘Fitch IBCA’’); 8 (4)
68020 Federal Register / Vol. 62, No. 249 / Tuesday, December 30, 1997 / Proposed Rules

(E), (F), and (H) of the net capital rule to all debt.

Subsequent to the transfer of the ownership of IBCA

to Fitch IBCA, IBCA was no longer considered to

be an NRSRO. See Letter regarding Fitch IBCA Inc.

(November 4, 1997).

9See Letter regarding Duff & Phelps, Inc.

(February 24, 1982).

10See Letter regarding Thomson BankWatch, Inc.

(August 6, 1991). BankWatch is recognized as an

NRSRO only for the purposes of rating debt issued

by banks, bank holding companies, non-bank banks,

thrifts, broker-dealers, and broker-dealers’ parent

companies.

11The Commission understands that a rating

organization’s application may contain commercial

or financial information that is confidential. It is the

responsibility of the rating organization to request

confidentiality under the appropriate Commission

rules. See 17 CFR 200.83. The Commission believes,

however, that the cover letter from the rating

organization requesting NRSRO designation and

any response by the Commission would be publicly

available.

12The Commission believes that a systematic

rating procedure should help to ensure that the

same or similar analysis is conducted for all issues

rated. In addition, the ratings should be structured

in such a way that the different rating categories are

easily identifiable.

13The Commission believes that rating

organizations that have access to senior

management are better able to make subjective

opinions regarding the risks associated with the

issue.

14The Commission believes that maintaining

these procedures should help ensure that the

issuer’s management is comfortable with providing

the rating organization all information necessary for

the rating organization to make reliable subjective

opinions about the risks associated with the issue.

Duff & Phelps Credit Rating Co. (‘‘Duff

& Phelps’’);9 and (5) Thomson

BankWatch, Inc. (‘‘Bankwatch’’).10

II. The NRSRO Concept Release

The Concept Release requested

comment on whether the Commission

should continue to employ an NRSRO

concept to distinguish various types of

debt and other securities for purposes of

its rules. Thirteen commenters

discussed the NRSRO concept. Overall,

the commenters generally supported the

continued use of the NRSRO concept in

the net capital and other Commission

rules. For example, the Securities

Industry Association Capital Committee

(‘‘SIA’’) believes that the continued use

of the NRSRO concept is an integral part

of the net capital rule. Additionally, the

SIA commented that the use of NRSRO

ratings is a vital ingredient of the

Commission’s efforts to safeguard the

capital markets against risks arising

from fluctuations in the proprietary

positions of securities firms.

Some commenters suggested that the

Commission discontinue the use of the

NRSRO concept and instead employ

statistical models or historical spreads

to determine the level of risk associated

with a particular instrument. As the SIA

commented, however, continued use of

the NRSRO concept in the net capital

rule would give broker-dealers an

objective, simple standard for

determining the capital value of a debt

instrument under the rule. In contrast,

a modelling approach involves a

possibly intricate statistical

configuration. It is also likely that

modelling will work only where there is

a deep and liquid market for the

instrument because of the difficulty in

obtaining prices. It would not be

adequate for debt issuers with no

previously issued or very old public

debt. In order to assist the Commission

in determining whether statistical

modelling may be appropriate in the

future for purposes of the NRSRO

concept, the Commission invites

comments on practical approaches to

the use of statistical models in the

context of determining the credit risk of

individual financial instruments.

III. Description of the Proposed

Amendments

As discussed in more detail below,

the proposal would amend Rule 15c3–

1 by adopting a new subparagraph

(c)(13), which would define the term

‘‘NRSRO.’’ As proposed, the definition

of NRSRO will include rating

organizations designated as NRSROs by

the Commission. Designation of such

rating organizations as NRSROs would

be based upon written application filed

with the Director of the Commission’s

Division of Market Regulation in

Washington, D.C.11 The Commission

would consider the attributes currently

assessed by the Division in the noaction letter process in determining

whether a rating organization is an

NRSRO.

IV. Discussion of the Proposed

Amendments

A. Proposed Definition of NRSRO in the

Net Capital Rule

Having considered the comments

received, the Commission proposes to

define NRSRO in the net capital rule to

include a list of attributes that will be

considered by the Commission in

designating rating organizations as

NRSROs. These attributes are described

in more detail below. Under the

proposal, rating organizations that have

received no-action assurances from the

Division will retain whatever NRSRO

designation status that they currently

possess and will not be required to

reapply for NRSRO designation;

however, the Commission will conduct

reviews of the current NRSROs to assure

that they meet the requirements in the

proposed definition. In the event the

Commission determines that any such

rating organization does not satisfy the

requirements set forth in the proposed

rule, the Commission will act to revoke

the NRSRO designation.

The Commission believes that

defining the term ‘‘NRSRO’’ in the net

capital rule should provide clarity and

limit concerns regarding any perceived

arbitrariness in the current process of

designating NRSRO status.

B. Criteria in the Definition of NRSRO

Commenters generally recommended

that the Commission adopt procedures

for designating NRSRO status that

clearly identify the criteria a rating

organization must possess. Specifically,

commenters recommended that the

Commission formalize the current noaction letter criteria for designating

NRSROs in a Commission rule. For

example, various rating organizations

recommended including the

requirement of national recognition and

market acceptance of the organizations’

ratings.

Consistent with the comment letters

received, an NRSRO would include any

rating organization designated by the

Commission after considering a list of

attributes similar to the criteria

currently considered by the Division in

the no-action letter process. The rating

organization would have to meet each

criterion in order to be designated as an

NRSRO. The Commission’s designation

would apply only to a rating

organization’s opinion concerning the

creditworthiness of debt instruments.

The Commission notes that other

opinions and views of the rating

organization would be outside the scope

of the NRSRO designation.

The attributes the Commission would

consider are: (1) National recognition,

which means that the rating

organization is recognized as an issuer

of credible and reliable ratings by the

predominant users of securities ratings

in the United States; (2) adequate

staffing, financial resources, and

organizational structure to ensure that it

can issue credible and reliable ratings of

the debt of issuers, including the ability

to operate independently of economic

pressures or control by companies it

rates and a sufficient number of staff

members qualified in terms of education

and experience to thoroughly and

competently evaluate an issuer’s credit;

(3) use of systematic rating procedures

that are designed to ensure credible and

accurate ratings; 12 (4) extent of contacts

with the management of issuers,

including access to senior level

management of the issuers; 13 and (5)

internal procedures to prevent misuse of

non-public information and compliance

with these procedures.14 In addition to
Federal Register / Vol. 62, No. 249 / Tuesday, December 30, 1997 / Proposed Rules 68021

15All currently designated NRSROs are registered

with the Commission under the Advisers Act.

Although section 203A of the Advisers Act

prohibits investment advisers that have less than

$25 million of assets under management to register

with the Commission, the Commission has

exempted investment advisers that are designated

as NRSROs from this prohibition. See rule 203A–

2 [17 CFR 275.203A–2].

As proposed, a rating organization must be

registered as an investment adviser under the

Advisers Act and maintain such registration as a

condition of receiving and retaining its NRSRO

designation. A rating organization applying for

designation as an NRSRO that is not registered as

an investment adviser, because, for example, it does

not have $25 million of assets under management,

would have to register under rule 203A–2(d) under

the Advisers Act, which permits an investment

adviser that reasonably expects to be eligible for

Commission registration within 120 days of

registering with the Commission to register with the

Commission even though it may not otherwise meet

the criteria for Commission registration under

section 203A of the Advisers Act. Once a rating

organization is registered as an investment adviser,

it must maintain its registration. Otherwise, its

NRSRO designation will void automatically.

16The Commission proposes to amend Rule

200.30–3, which provides for delegation of

authority to the Director of the Division of Market

Regulation, to include the designation of NRSROs.

See 17 CFR 200.30–3.

17See 17 CFR 201.430.

18See 17 CFR 201.110.

the attributes noted above, the proposal

would require a rating organization to

be registered with the Commission as an

investment adviser under the

Investment Advisers Act of 1940

(‘‘Advisers Act’’) in order to be

designated as an NRSRO.15

By specifying required criteria in the

definition of NRSRO, the Commission

will be able to promulgate the

characteristics that are necessary for

NRSRO designation, thereby assuring

rating organizations that if they possess

such characteristics, they will likely be

designated, and will remain, NRSROs.

Similar to the no-action letter process,

however, the Commission is reserving

the ability to withdraw designation if a

rating organization fails to maintain the

requisite criteria. Accordingly, a rating

organization designated as an NRSRO

would be required to notify the

Commission when it experiences

material changes that may affect its

ability to continue to meet any of the

requisite criteria. For example, material

changes in an NRSRO’s organizational

structure or modifications of its rating

practices could affect the NRSRO’s

standing in the credit market that could

warrant withdrawing NRSRO

designation. Codifying the current

NRSRO designation would ensure that

the process is transparent and applied

consistently.

C. Application Process

A rating organization seeking NRSRO

designation would be required to file an

application with the Director of the

Commission’s Division of Market

Regulation in Washington, D.C. The

rating organization would be required to

include in the application detailed

information explaining how the rating

organization satisfies the attributes

necessary for NRSRO designation. The

rating organization also would be

required to file any additional

information subsequently requested by

the Division.

D. Delegation of Authority to the

Division

The Commission proposes to delegate

authority to the Division to examine

rating organizations’ applications and to

designate a rating organization as an

NRSRO or to deny such designation.16

Under the proposed amendments, the

Division would not have delegated

authority to revoke or withdraw any

previously granted designation.

Delegating authority to the Division will

allow rating organizations that receive

an adverse decision from the Division to

seek Commission review. Pursuant to

the Commission’s Rules of Practice, any

person aggrieved by an action made by

delegated authority may seek

Commission review of the action by

filing a petition for review with the

Commission.17 The Commission may

preside over or, if it so orders, designate

a hearing officer to preside over any

proceeding instituted to review a

determination made pursuant to

delegated authority. The Commission

may, at its discretion, designate an

administrative law judge as the hearing

officer presiding over such

proceedings.18

E. Charging Fees Based on the Size of

the Transaction

In the Concept Release, the

Commission requested comments on the

practice of NRSROs charging issuers for

ratings and whether it is appropriate for

an NRSRO to charge an issuer fees based

on the size of the transaction being

rated.

Fourteen commenters offered views

on this practice. As a general matter,

they did not oppose NRSROs charging

issuers for ratings. Various commenters

expressed concern, however, regarding

charging fees based upon the size of the

transaction. For example, one rating

organization commented that it is not

appropriate for rating organizations to

charge issuers based upon the size of the

transaction because the large fees

received may cause the rating

organization to have an interest in

whether the issue is successful or

unsuccessful. In addition, the rating

organization commented that basing

fees on the size of an issue may

compromise the rating organization’s

objectivity in rating the issue.

In particular, the Commission is

concerned that a rating organization

may be tempted to give a more favorable

rating to a large issue because of the

large fee and to encourage the issuer to

submit future large issues to the rating

organization. The Commission invites

further comment on whether the use of

this practice should be added as a

criterion in the definition of an NRSRO.

V. Request for Comments

In response to the Concept Release,

some commenters suggested using

objective criteria in the definition of

NRSRO. The Commission’s concerns

about using objective criteria is that it

could lead to unintended results and

possible manipulation of the NRSRO

designation process. A rating

organization may meet the basic

objective criteria standard, but have no

credibility in the marketplace. For

example, using the number of persons

employed by a rating organization as

one of the criteria would not take into

consideration qualifications of the

employees with respect to rating issuer’s

securities. On the other hand, a rating

organization may have a solid

reputation for publishing reliable

ratings, but may not meet an objective

criteria, such as a minimum number of

employees. The Commission, however,

invites comment on whether objective

criteria should be used to determine

NRSRO designation and the types of

objective criteria that should be

considered.

The Commission also invites

comment on whether a specific time

period should be established for the

Commission to act on an application. If

such a period is considered appropriate,

the Commission also seeks comment on

whether a time period in the range of

180 to 365 calendar days would be

appropriate.

In addition, concerns have been

raised to the Commission about the fact

that some ratings may not be generally

available to the public and may be

restricted only to subscribers. Because

the Commission is proposing to provide

rating organizations with the NRSRO

designation, the Commission invites

comment on whether NRSROs should

be required to provide their ratings to

the public. The Commission also invites

interested persons to submit written

data, views, arguments and/or

comments on the other aspects of the

proposed amendments.
68022 Federal Register / Vol. 62, No. 249 / Tuesday, December 30, 1997 / Proposed Rules

19The average time to complete an application is

estimated to be 100 hours. See infra section VIII D.

20 5 U.S.C. 601 et seq. The Regulatory Flexibility

Act states that the term ‘‘small entity’’ shall have

the same meaning as the term ‘‘small business’’

under the Regulatory Flexibility Act. According to

section 601(3) under the Regulatory Flexibility Act,

‘‘the term ‘small business’ has the same meaning as

the term ‘small business concern’’ under section 3

of the Small Business Act (15 U.S.C. 632), unless

an agency, after consultation with the Small

Business Administration and after opportunity for

public comment, establishes one or more

definitions of such term which are appropriate to

the activities of the agency and publishes such

definition(s) in the Federal Register’’. If the agency

has not defined the term for a particular purpose,

the Small Business Act states that ‘‘a small business

concern, * * *, shall be deemed to be one which

is independently owned and operated and which is

not dominant in its field of operation.’’ Because the

Commission has not defined the term ‘‘small

entity’’ in the context of NRSROs for purposes of

the Regulatory Flexibility Act, for purposes of this

rulemaking, the Commission is using the broader

definition of ‘‘small business concern’’ as defined

in the Small Business Act. Furthermore, based on

this broader definition, it appears that none of the

current NRSROs would be considered small entities

for purposes of the Regulatory Flexibility Act. 21 44 U.S.C. 3501 et seq.

VI. Costs and Benefits of the Proposed

Amendments and Their Effects on

Competition

To assist the Commission in its

evaluation of the costs and benefits that

may result from the proposed rule

amendments, commenters are requested

to provide analyses and data relating to

the costs and benefits associated with

any of the proposals herein. The

Commission believes the benefit of the

proposed definition will be to make its

current practice of designating NRSROs

more transparent and formalized. The

Commission preliminarily believes that

the proposed amendments will benefit

all market participants by clarifying the

basis for designating NRSROs and

making the designation process more

transparent. The amendments also will

provide an appeal process for rating

organizations that have been denied

NRSRO designation. The amendments

will impose no additional compliance

burdens on broker-dealers and will not

impede efficiency, competition, and

capital formation, because they merely

codify the current criteria a credit rating

organization must meet in order to be

designated as an NRSRO. The costs

associated with the rule proposal would

not differ significantly from those

incurred under the current no-action

letter process.19 The proposed

amendments would not change the basis

by which broker-dealers determine the

deductions applicable to their

proprietary securities. Section 23(a) of

the Exchange Act, 15 U.S.C. 78w(a)(2),

requires the Commission, in adopting

rules under the Exchange Act, to

consider the anti-competitive effect of

the rule, if any. The Commission has

considered the proposed amendments

in light of this standard and believes,

preliminarily, that if adopted, they

would not likely impose any significant

burden on competition that is not

necessary or appropriate in furtherance

of the Exchange Act. The Commission

solicits comment on this preliminary

view.

VII. Summary of Initial Regulatory

Flexibility Analysis

In accordance with 5 U.S.C. 603, the

Commission has prepared an Initial

Regulatory Flexibility Analysis

(‘‘IRFA’’) concerning the proposed

amendments. The IRFA notes that the

purpose of the proposed amendments is

to make the NRSRO designation process

open and transparent by defining the

term ‘‘NRSRO’’ for purposes of the net

capital rule to provide a list of attributes

that would be considered by the

Commission in designating rating

organizations as NRSROs. The IRFA

indicates that the proposed amendments

would apply to all credit rating

organizations that request NRSRO

designation.

The IRFA further indicates that in the

past, the Commission has only

designated seven credit rating

organizations as NRSROs. In addition,

only seven other credit rating

organizations have requested

designation as an NRSRO. Because the

Commission cannot determine the

number of entities that may request

NRSRO designation in the future, it is

difficult to estimate the number of small

entities that may be subject to the

proposed amendments. However, due to

the fact that only seven credit rating

organizations have been designated as

NRSROs and only seven other entities

have requested NRSRO designation, the

IRFA adds that it appears that very few

small entities, if any, as contemplated

by the Regulatory Flexibility Act 20, will

be subject to the proposed amendments.

In addition, the IRFA states that the

proposed amendments require the filing

of an application and notification of any

material changes in the NRSROs

business and that no federal rules

duplicate, overlap, or conflict with, the

proposed amendments. Furthermore,

the IRFA states that the Commission

does not believe that any less

burdensome alternatives are available to

accomplish the objectives of the

proposed amendments.

The Commission encourages the

submission of comments with respect to

any aspect of the IRFA. Comment

specifically is requested on the number

of small entities that would be affected

by the proposed rules. Such comments

will be considered in the preparation of

the Final Regulatory Flexibility

Analysis, if the proposed rules are

adopted, and will be placed in the same

public file as comments on the proposed

rules themselves. Comment letters

should be submitted in triplicate to

Jonathan G. Katz, Secretary, Securities

and Exchange Commission, 450 Fifth

Street, N.W., Stop 6–9, Washington,

D.C. 20549. Comments also may be

submitted electronically at the following

E-Mail address: rule-comments@sec.gov.

All comment letters should refer to File

No. S7–33–97. This file number should

be included on the subject line if E-mail

is used. All comments received will be

available for public inspection and

copying in the Commission’s Public

Reference Room, 450 Fifth Street, N.W.,

Washington, D.C., 20549. Electronically

submitted comment letters will be

posted on the Commission’s Internet

web site (http://www.sec.gov). A copy

of the IRFA may be obtained by

contacting Michael E. Greene, Securities

and Exchange Commission, 450 Fifth

Street, N.W., Mail Stop 2–2,

Washington, D.C. 20549.

For purposes of the Small Business

Regulatory Enforcement Fairness Act of

1996 (‘‘SBREFA’’), the Commission is

also requesting information regarding

the potential impact of the proposed

rule on the economy on an annual basis.

The Commission preliminarily believes

that the proposed amendments do not

constitute a ‘‘major rule’’ for purposes of

SBREFA based on the criteria used to

determine what constitutes a ‘‘major

rule’’ under SBREFA. Commenters

should provide empirical data to

support their views.

VIII. Paperwork Reduction Act

Certain provisions of the proposed

amendments contain ‘‘collection of

information’’ requirements within the

meaning of the Paperwork Reduction

Act of 1995 (‘‘PRA’’),21 and the

Commission has submitted them to the

Office of Management and Budget for

review in accordance with 44 U.S.C.

3507(d) and 5 CFR 1320.11. The title for

the collection of information is: ‘‘Net

Capital Requirements for Brokers or

Dealers: Definitions: NRSRO.’’

A. Collection of Information Under

Proposed Amendments

The proposed amendments would

require credit rating organizations that

desire designation as NRSROs to submit

certain information to the Commission

in order to obtain such designation and

to report to the Commission in the event

of any material change in their status.
Federal Register / Vol. 62, No. 249 / Tuesday, December 30, 1997 / Proposed Rules 68023

B. Proposed Use of Information

The information collected pursuant to

the proposed amendments would be

used only by the Commission. No other

governmental agency or third party

would regularly receive any of the

information described above. The

Commission would use the information

required by the proposed amendments

in determining whether to designate a

credit rating organization as an NRSRO.

C. Respondents

The proposed amendments would

apply to those credit rating

organizations that desire designation as

an NRSRO by the Commission.

D. Total Annual Reporting and

Recordkeeping Burden

The proposed amendments require a

one-time application process, which

includes any amendments to the initial

application. Therefore, there is no

recurring reporting or recordkeeping

requirement and thus no annual

reporting or recordkeeping requirement.

However, it is estimated that on an

annual basis there will be ten

respondents to this collection of

information. It is also estimated that the

time to complete the proposed

collection of information is 100 hours.

E. General Information About the

Collection of Information

The collection of information under

the proposed amendments would be

required in order to obtain NRSRO

designation. There would be no

obligation on the NRSRO to retain the

information submitted to the

Commission to obtain NRSRO

designation. Any information received

by the Commission pursuant to the

proposed amendments would be kept

confidential (except the cover letter),

subject to the provisions of the Freedom

of Information Act, 5 U.S.C. 552 and the

Commission’s regulations thereunder

(17 CFR 200.80). The proposed

amendments do not mandate a time

period for retaining the information

submitted to the Commission by credit

rating organizations applying for

NRSRO designation. Seeking the

NRSRO designation is voluntary;

however, for rating organizations that

desire the NRSRO designation, the

obligation to respond to the collection of

information is mandatory. Persons

should be aware that the Commission

may not conduct or sponsor, and a

person is not required to respond to, a

collection of information unless it

displays a currently valid control

number.

F. Request for Comment

Pursuant to 44 U.S.C. 3506(c)(2)(B),

the Commission solicits comments to:

(i) evaluate whether the proposed

collection of information is necessary

for the proposed performance of the

functions of the agency, including

whether the information shall have

practical utility;

(ii) evaluate the accuracy of the

Commission’s estimate of the burden of

the proposed collection of information;

(iii) enhance the quality, utility, and

clarity of the information to be

collected; and

(iv) minimize the burden of collection

of information on those who are to

respond, including through the use of

automated collection techniques or

other forms of information technology.

Persons desiring to submit comments

on the collection of information

requirements should direct them to the

Office of Management and Budget,

Attention: Desk Officer for the

Securities and Exchange Commission,

Office of Information and Regulatory

Affairs, Washington, D.C. 20503, and

should also send a copy of their

comments to Jonathan G. Katz,

Secretary, Securities and Exchange

Commission, 450 Fifth Street, N.W.,

Washington, D.C. 20549, and refer to

File No. S7–33–97. OMB is required to

make a decision concerning the

collections of information between 30

and 60 days after publication of this

release in the Federal Register, so a

comment to OMB is best assured of

having its full effect if OMB receives it

within 30 days of this publication.

IX. Statutory Analysis

Pursuant to the Securities Exchange

Act of 1934 and particularly Sections

3(b), 15(c)(3), 17, and 23 thereof, 15

U.S.C. 78c(b), 78o(c)(3), 78q, and 78w,

the Commission proposes to amend

240.15c3–1 of Title 17 of the Code of

Federal Regulations in the manner set

forth below.

X. List of Subjects in 17 CFR Part 240

Reporting and recordkeeping

requirements, Securities.

XI. Text of the Proposed Rule

Amendments

In accordance with the foregoing,

Title 17, Chapter II of the Code of

Federal Regulation is proposed to be

amended as follows:

PART 240—GENERAL RULES AND

REGULATIONS, SECURITIES

EXCHANGE ACT OF 1934

1. The authority citation for Part 240

continues to read in part as follows:

Authority: 15 U.S.C. 77c, 77d, 77g, 77j,

77s, 77z–2, 77eee, 77ggg, 77nnn, 77sss, 77ttt,

78c, 78d, 78i, 78j, 78k, 78k–1, 78l, 78m, 78n,

78o, 78p, 78q, 78s, 78u–5, 78w, 78x, 78ll(d),

79q, 79t, 80a–20, 80a–23, 80a–29, 80a–37,

80b–3, 80b–4 and 80b–11, unless otherwise

noted.

* * * * *

2. Section 240.15c3–1 is amended by

adding paragraph (c)(13) to read as

follows:

§ 240.15c3–1 Net capital requirements for

brokers or dealers.

* * * * *

(c) * * *

* * * * *

(13)(i) The term nationally recognized

statistical rating organization

(‘‘NRSRO’’) means any entity that:

(A) Issues ratings which are current

assessments of the creditworthiness of

obligors with respect to specific

securities or money market instruments

and that is registered under the

Investment Advisers Act of 1940 (15

U.S.C. 80b–1 et seq.) and

(B) Is designated as an NRSRO by the

Commission.

(ii) The Commission will consider the

following attributes in determining

whether to grant NRSRO status:

(A) Recognition of the rating

organization in the United States as an

issuer of credible and reliable ratings by

users of securities ratings;

(B) Adequate staffing, financial

resources, and organizational structure

to ensure that it can issue credible and

reliable ratings of the debt of issuers,

including a sufficient number of

qualified staff members and the ability

to operate independently of economic

pressures or control by companies that

it rates;

(C) Use of systematic rating

procedures that are designed to ensure

credible and accurate ratings;

(D) Extent of contacts with the

management of issuers, including access

to senior level management of issuers;

and

(E) Internal procedures to prevent

misuse of non-public information and

compliance with these procedures.

(iii) A rating organization seeking

NRSRO designation shall file an

application with the Director of the

Commission’s Division of Market

Regulation in Washington, DC. The

application should provide detailed

information explaining how the rating

organization satisfies the attributes set

forth in paragraph (c)(13)(i) of this

section. The rating organization shall

also file any additional information

subsequently requested by the

Commission relating to the attributes set

forth in paragraph (c)(13)(i) of this

section.
68024 Federal Register / Vol. 62, No. 249 / Tuesday, December 30, 1997 / Proposed Rules

(iv) An NRSRO shall notify the

Director of the Commission’s Division of

Market Regulation of any material

changes that occur in the facts and

circumstances of this application for an

NRSRO designation.

(v) In the event it is determined that

an NRSRO no longer satisfies all of the

attributes set forth in (c)(13)(i) of this

section, the Commission may revoke or

withdraw NRSRO designation.

* * * * *

Dated: December 17, 1997.

By the Commission.

Margaret H. McFarland,

Deputy Secretary.

[FR Doc. 97–33402 Filed 12–29–97; 8:45 am]

BILLING CODE 8010–01–P