Speech by SEC Staff:
Proposed Amendments Relating to References to Ratings of Nationally Recognized Statistical Rating Organizations

by

Erik R. Sirri

Director, Division of Trading and Markets
U.S. Securities and Exchange Commission

Commission Open Meeting
Washington, D.C.
June 25, 2008

Thank you Chairman Cox.

Two weeks ago the Commission voted to propose the first two of three proposed rulemaking initiatives with respect to Nationally Recognized Statistical Rating Organizations ("NRSROs"). Those proposals are designed to address concerns about the role that NRSROs played in the market turmoil related to subprime loans and to strengthen to robustness and transparency of the ratings process generally. The third set of proposed rulemaking initiatives is before you today. Our proposal would remove references to NRSRO ratings in the rules and forms under the Securities Exchange Act of 1934 and is designed to address concerns that the use of NRSRO ratings in Commission rules and forms may have contributed to an undue reliance on NRSRO ratings. The Divisions of Corporation Finance and Investment Management have drafted similar proposals that are also before you today.

The Commission first used the term NRSRO in 1975 in the net capital rule for broker-dealers. Since then, we have included the term in rules relating to alternative trading systems, transaction confirmations, and the anti-manipulation rules concerning securities offerings, as well as in several forms. We propose today to remove references to NRSRO ratings in a number of different provisions of our rules and forms.

I believe the amendments to our rules and forms accomplish the Commission's goal of reducing any undue or over reliance placed on NRSRO ratings by market participants. In the interest of time, I provide descriptions of only the proposed amendments to the Securities Haircut provisions of the Net Capital Rule, which I believe are the most likely of our proposed amendments to be of interest to market participants.

Rule 15c3-1 includes references to NRSRO ratings in Rule 15c3-1(c)(vi), which prescribes specific percentage deductions (known as haircuts) for various classes of securities. The paragraphs of the rule relating to commercial paper, nonconvertible debt securities, and cumulative, non-convertible preferred stock, refer to NRSRO ratings for determining the haircuts allowed for those classes of securities. We propose to remove references to NRSRO ratings in each of these paragraphs and to replace them with new standards. For commercial paper, the standard would be that the securities have no greater than minimal credit risk and liquidity sufficient to allow a sale at carrying value almost immediately. This would replace the previous standard that the securities be rated in one of the three highest categories by at least two NRSROs. For nonconvertible debt securities and cumulative nonconvertible preferred stock, the standard would be that the securities have no greater than moderate credit risk and liquidity sufficient to allow a sale at carrying value within a reasonably short period of time. This would replace the previous standard that these securities be rated in one of the four highest rating categories by at least two NRSROs.

The new standards should continue to advance the purpose the NRSRO ratings standards were designed to advance, which is to enable broker-dealers to make net capital computations that reflect the market risk inherent in the positioning of those particular types of securities. The Division believes that broker-dealers have the financial sophistication and the resources necessary to make the basic determinations of whether or not a security meets the requirements in the proposed amendments and to distinguish between securities subject to minimal credit risk and those subject to moderate credit risk.

Notwithstanding this, we believe it would be appropriate, as one means of complying with the proposed amendments, for broker-dealers to refer to NRSRO ratings for the purposes of determining haircuts under the rule. As such, if we adopt the proposed amendments, after considering comments, we expect to take the view in the adopting release that securities rated in one of the three highest categories by at least two NRSROs would satisfy the requirements of the proposed new standard for commercial paper and the securities rated in one of the four highest rating categories by at least two NRSROs would satisfy the requirements of the proposed new standards for nonconvertible debt securities and cumulative, nonconvertible preferred stock. It is important to emphasize, however, that references to such NRSRO ratings would be just one of the means of satisfying the requirements of the proposed amendments but would not the only means of doing so.

As I mentioned earlier, we are amending several rules and forms in addition to the securities haircut provisions of the Net Capital Rule. These include Rule 3a1-1, Rule 10b-10, Regulation M, Regulation ATS, and the related forms. I would be happy to answer any questions you may have regarding any of the rules and forms we are proposing today.

I would like to thank the many staff who contributed to this project. They include: Deputy Director Bob Colby, Mike Macchiaroli, Tom McGowan, Randall Roy, Joe Levinson, Denise Landers, Michael Gaw, Brian Trackman, Sarah Albertson, Paula Jenson, Josh Kans, Linda Sundburg, Josephine Tao, Elizabeth Sandoe, Bradley Gude, and Catherine Moore. I would also like to thank our colleagues in the Divisions of Corporation Finance and Investment Management. We are happy to answer any questions.

http://www.sec.gov/news/speech/2008/spch062508-2.htm