The SEC Proposes Tougher Regulations For Credit Rating Agencies

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Since 2008, the big three credit rating agencies, Moody’s Corporation, Standard & Poor’s and Fitch Ratings have been under intense scrutiny by Congress, the Securities and Exchange Commission and the general investing public for their role in the global financial crisis. Credit rating agencies are responsible for providing investors with information about the creditworthiness of different financial products.  Prior to the bursting of the housing bubble, Moody’s, S&P and Fitch each consistently provided positive credit grades on mortgage-backed securities despite the fact that they were extremely risky products.  Much of the criticism of the credit rating agencies relates to the fact that these firms are paid by the issuers they rate and therefore have a conflict of interest.

On May 18, the SEC’s five commissioners voted unanimously to propose new, tougher regulations for credit rating agencies.  This was the culmination of an initiative that was approved by the commissioners three years ago, in June 2008. The new proposed rules, which are over 500 pages and are now open for public comment, would implement certain provisions of the Dodd-Frank Wall Street Reform and Consumer Protection Act and enhance the SEC’s existing rules governing credit ratings that are registered with the SEC as Nationally Recognized Statistical Rating Organizations (“NRSROs”). Among other things, under the SEC’s proposals, NRSROs would be required to:

  •  Report on internal controls;
  • Protect against conflicts of interest;
  • Establish professional standards for credit analysts;
  • Publicly provide – along with the publication of the credit rating – disclosure about the credit rating and the methodology used to determine it;
  • Enhance their public disclosures about the performance of their credit ratings; and
  • Require disclosure concerning third-party due diligence reports for asset-backed securities.

 You can find the SEC’s press release here, which also contains a link to the proposed rules. Public comments on the SEC’s proposal are required to be submitted within 60 days after it is published in the Federal Register. The major rating agencies immediately issued press releases expressing general approval of the proposed rules, which rely primarily on internal self-assessment.  So far one comment received by the SEC suggests that the new proposals are not enough and that periodic external audit of some rating agency decisions should also be imposed.

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