Risk Management

SEC Spells Out How Rating Agencies Must Reveal Conflicts of Interest

New rule requires rating agencies to promptly gauge whether a company's current rating must be revised to eliminate a conflict of interest.
David KatzAugust 28, 2014
SEC Spells Out How Rating Agencies Must Reveal Conflicts of Interest

The Securities and Exchange Commission yesterday issued new rules spelling out what credit rating agencies must do if a conflict of interest has influenced a rating given to a company.

SEC Mary Jo White

Mary Jo White

One of the new rules, for instance, requires that if the rating agency finds out, via an internal review mandated by the Dodd-Frank Wall Street Reform and Consumer Protection Act, that a conflict of interest influenced a credit rating, it must have procedures in place to:

  • Promptly decide whether the company’s current rating must be revised  to eliminate the conflict of interest.
  • Promptly publish, based on the agency’s decision about whether a conflict influenced a rating, a revised credit rating or an affirmation of the rating. The publication must include disclosures “about the existence and impact of the conflict of interest.”
  • If the rating isn’t revised or affirmed within 15 calendar days of the date the influence of a conflict is discovered, the agency must issue a publication reporting that the rating is up for review. The publication must include an explanation “that the reason for the action is the discovery that the credit rating was influenced by a conflict of interest.”

Under Dodd-Frank, nationally recognized statistical rating organizations (NRSROs), including Moody’s, Standard & Poor’s and Fitch Group, must have policies and procedures in place to conduct “look-back” reviews. The review’s purpose is to gauge whether the prospect of future employment by a public issuer influenced a credit analyst in determining a credit rating. If such an influence is unearthed, the agency must revise the credit rating. The SEC’s rulemaking on Wednesday detailed how that should be done.

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Overall, the SEC’s stated goal in issuing the rules is to boost ratings quality and increase credit-agency accountability in the wake of the NSROs’ alleged role in triggering the financial crisis.  In particular, the agencies have been accused of failing to alarm investors about problems with debt instruments because of their business interests in them.

The rules “will help protect investors and markets against a repeat of the conduct and practices that were central to the financial crisis,” SEC chairwoman Mary Jo White predicted yesterday in a press release.

An NRSRO can be registered in one or more of five classes of credit ratings: corporate issuers; financial institutions, brokers or dealers; insurance companies;  issuers of asset-backed securities; and issuers of government securities, municipal securities or securities issued by a foreign government. Currently, 10 credit rating agencies are registered as NRSROs.

The new requirements call for yearly certification by rating agency chief executives of  the effectiveness of internal controls. CEO certifications attesting that the rating wasn’t influenced by other business activities must also accompany the ratings.

Certain requirements will become effective 60 days after they’re published in the Federal Register. The amendments concerning the annual report on internal controls and one mandating disclosure of credit rating performance statistics will be effective on Jan. 1, 2015. That means the first internal-controls report to be submitted by an NRSRO would cover the fiscal year that ends on or after Jan. 1, 2015.