Corporate Governance

Credit Rating Agencies Under Intense Scrutiny

By Jim Hodgson

The SEC has launched a two-pronged attack on the credit rating agencies believed to be partially responsible for the subprime mortgage debacle.  The agencies -- namely, Moody?s Investors Service, Standard & Poor?s, and Fitch Ratings -- have recently come under fire for issuing unjustifiably high ratings on mortgage-backed securities and for failing to lower those ratings once the securities started to perform poorly in the marketplace.  The SEC has commenced an investigation of all three agencies and has promised that new rules regulating how the agencies do business are forthcoming.

The investigation, which should be wrapped up sometime this summer, is focused on ?whether credit rating agencies departed from their standard procedures for determining credit ratings in order to give securities a higher rating than they truly deserved and whether they effectively managed potential conflicts of interest?? according to a recent Securities Law 360 article (subscription required).

The new rules, then, are set to build upon the results of this SEC investigation.  That is, the rules should require ?better disclosure of past ratings and limiting conflicts of interest,? according to SEC Chairman Christopher Cox in recent testimony before Congress.  He also said that ?the coming rule proposals will be aimed at fostering greater accountability, transparency and competition in the industry.?

Well, we can hope.  But, unless these new rules specifically address the disclosure of the role of third-party due diligence in the rating assignment process, little will have been accomplished to break up the cozy world of bond ratings.  For, as we have reported before, the rating agencies, themselves, work closely with issuers and underwriters in structuring transactions; and, in turn, issuers routinely pay the ratings agencies for their highest credit ratings.

Who, then, keeps a disinterested check on the ratings process?  With this question in mind, Senator Charles Schumer has suggested to Chairman Cox that the new rules should require ??some really tough disclosures? that would tell investors how ratings were reached,? according to a recent article in Dow Jones Financial News Online.

Chairman Cox has stated that his goal is to have new rules enacted by the end of 2008.  This means that we can expect the rule proposals sometime in the next couple of months.

Full post as published by PomTalk on April 24, 2008 (boomark / email).