Document ID: SEC-2008-0247-0001
Agency: sec
Document Type: Notice
Title: Securities Exchange Act of 1934 Conflict of Interest Prohibition Temporary Exemption Order; LACE Financial Corp.
Posted Date: 2008-02-14T05:00Z

[Federal Register: February 14, 2008 (Volume 73, Number 31)]
[Notices]               
[Page 8721-8722]
From the Federal Register Online via GPO Access [wais.access.gpo.gov]
[DOCID:fr14fe08-103]                         

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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-57301]

 
Order Granting Temporary Exemption of LACE Financial Corp. From 
the Conflict of Interest Prohibition in Rule 17a-5(c)(1) of the 
Securities Exchange Act of 1934

February 11, 2008.

I. Introduction

    The Credit Rating Agency Reform Act of 2006 (``Rating Agency 
Act''),\1\ enacted on September 29, 2006, defined the term ``nationally 
recognized statistical rating organization'' (``NRSRO''), added Section 
15E to the Securities Exchange Act of 1934 (``Exchange Act''), and 
provided authority for the Securities and Exchange Commission 
(``Commission'') to implement registration, recordkeeping, financial 
reporting, and oversight rules with respect to registered credit rating 
agencies. Exchange Act Rule 17g-1 (17 CFR 240.17g-1), and Form NRSRO 
(17 CFR 249b.300), prescribe the process for a credit rating agency to 
apply for registration. Rule 17g-1 and Form NRSRO were effective on 
June 18, 2007, and the other rules, Rules 17g-2 through 17g-6 (17 CFR 
240.17g-2 through 17g-6), became effective on June 26, 2007.\2\
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    \1\ Public Law 109-291 (2006).
    \2\ Release No. 34-55857 (June 5, 2007), 72 FR 33564, 33564-65 
(June 18, 2007).
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    In particular, Rule 17g-5(c)(1) prohibits an NRSRO from issuing or 
maintaining a credit rating solicited by a person that, in the most 
recently ended fiscal year, provided the NRSRO with net revenue 
equaling or exceeding 10% of the total net revenue of the NRSRO for the 
fiscal year. In adopting this rule, the Commission stated that such a 
person would be in a position to exercise substantial influence on the 
NRSRO, which in turn would make it difficult for the NRSRO to remain 
impartial.\3\
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    \3\ Id. at 33598.
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II. Application and Exemption Request of LACE Financial Corporation

    LACE Financial Corp. (``LACE''), a credit rating agency, furnished 
to the Commission an application for registration as an NRSRO under 
Section 15E of the Exchange Act for the classes of credit ratings 
described in clauses (i) through (v) of Section 3(a)(62)(B) of the 
Exchange Act. Based on the information provided in the application, 
LACE has a conflict of interest relating to the fourth class \4\ that 
would cause the firm to be in violation of Rule 17g-5(c)(1) if LACE 
became registered. Specifically, for the fiscal year ending December 
31, 2007, LACE maintained credit ratings on asset-backed securities 
solicited by a person that provided LACE with 10% or more of its total 
revenues for that year.
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    \4\ The fourth class of credit ratings is for ``issuers of 
asset-backed securities (as that term is defined in section 1101(c) 
of part 229 of title 17, Code of Federal Regulations* * *) (``asset-
backed securities''). Section 3(a)(62)(B)(iv) of the Exchange Act.
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    LACE has requested that the Commission exempt it from Rule 17g-
5(c)(1) on the grounds that the prohibition hinders its ability as a 
small entity to grow its business issuing credit ratings on asset-
backed securities. LACE indicated in its application that it expects 
the percentage of revenue attributable to the relevant client to 
decrease based on LACE's revenue trend, continued growth, and the 
problems in the asset-backed securities market.

III. Discussion

    The Commission, when adopting Rule 17g-5(c)(1), noted that it 
intended to monitor how the prohibition operates in practice, 
particularly with respect to asset-backed securities, and whether 
exemptions may be appropriate.\5\ The Commission notes that the revenue 
in question was earned by LACE before it submitted its application for 
registration and in the year before Rule 17g-5 was adopted, which 
limited the time for LACE to adjust its activities to conform to the 
requirements of the Rule. In addition, the Commission recognizes that, 
given LACE's size, it is more likely that the firm would be affected by 
Rule 17g-5(c)(1) than a larger credit rating agency with a more 
diversified client base. Further, the Commission notes that LACE has 
stated that it expects that the percentage of total revenue provided by 
the client will decrease. Finally, the Commission notes that the 
threshold in Rule 17g-5(c)(1) is, of necessity, a bright line, but 
activities that exceed that threshold may or may not necessarily raise 
the concerns that are the basis for the rule. Hence, the Commission 
believes that it is important for the Commission to consider for each 
application the specific facts and circumstances of the applicant and 
whether to grant an exemption from Rule 17g-5(c)(1). Moreover, in this 
instance, the Commission recognizes that granting this exemption 
furthers the primary purpose of the Rating Agency Act, which is to 
enhance competition in the highly concentrated ratings industry. 
Granting LACE registration in the asset-backed security class will 
increase the number of NRSROs registered in this class, which could 
increase competition.
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    \5\ Release No. 34-55857 (June 5, 2007), 72 FR 33564, 33598 
(June 18, 2007).
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    For these reasons, the Commission finds that granting LACE an 
exemption from Rule 17g-5(c)(1) for calendar year 2008 is necessary and 
appropriate in the public interest and is consistent with the 
protection of investors.\6\ The

[[Page 8722]]

exemption will expire on January 1, 2009 (LACE's fiscal year ends on 
December 31, 2008). The Commission believes that providing LACE with 
the opportunity to be registered in the asset-backed security class 
during this time frame is an appropriate approach to addressing the 
unique circumstances of a small credit rating agency, while balancing 
this against the goal of Rule 17g-5(c)(1)--to prohibit a conflict that 
has the potential to influence a credit rating agency's impartiality. 
Consequently, this exemption is conditioned on LACE disclosing in 
Exhibit 6 to Form NRSRO that the firm received more than 10% of its net 
revenue in fiscal year 2007 from a client that paid it to rate asset-
backed securities. This disclosure is designed to alert users of credit 
ratings to the existence of this specific conflict.
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    \6\ Section 36 of the Exchange Act authorizes the Commission, by 
rule, regulation, or order, to conditionally or unconditionally 
exempt any person from any rule under the Exchange Act, to the 
extent that the exemption is necessary or appropriate in the public 
interest and is consistent with the protection of investors. 15 
U.S.C. 78mm.
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    Simultaneously with this Order, the Commission is issuing an Order 
granting the registration of LACE with the Commission as an NRSRO under 
Section 15E of the Exchange Act.\7\
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    \7\ Release No. 34-57300 (February 11, 2008).
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IV. Conclusion

    Accordingly, pursuant to Section 36 of the Exchange Act,
    It is hereby ordered that LACE Financial Corp. is exempt from the 
conflict of interest prohibition in Exchange Act Rule 17g-5(c)(1) until 
January 1, 2009, provided that LACE Financial Corp. discloses in 
Exhibit 6 to Form NRSRO that the firm received more than 10% of its net 
revenue in fiscal year 2007 from a client that paid it to rate asset-
backed securities.

    By the Commission.
Nancy M. Morris,
Secretary.
 [FR Doc. E8-2771 Filed 2-13-08; 8:45 am]

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