Risk & Compliance

Pressure Tightens on Rating Agencies

As Congress and President Bush take interest in credit rating agencies following the subprime-mortgage meltdown, the SEC steps up its oversight of ...
Sarah JohnsonSeptember 5, 2007

Nearly a year after passing a law intended to address a lack of oversight over credit rating agencies and conflicts of interest, congressmen are wondering if they should have tucked more language into their legislation. Their regret comes as they consider whether to make changes to ensure this summer’s subprime-loan mess doesn’t repeat itself.

At a House Financial Services Committee hearing on Wednesday, Rep. Paul Kanjorski (D-Pa.) said he intends to address the responsibilities and independence issues of credit rating agencies at an upcoming meeting. “We took action last year, but we may still need to do more,” he said. He’s not alone; President Bush has asked Treasury secretary Henry Paulson to look into the agencies’ role in the mortgage industry, and the Securities and Exchange Commission is taking a closer look into the agencies’ practices.

To be sure, the Credit Rating Agency Reform Act, signed last September by President Bush, made several changes to foster competition in the credit rating industry and keep the agencies in line. Under the law, the SEC has the authority to inspect them and use enforcement tools if their practices prove abusive to investors.

Since the law passed, the SEC adopted rules in June to ensure its broader oversight and is in the process of accepting the registrations of the agencies previously called NRSROs (nationally recognized statistical rating organizations). These include Moody’s Investor Service, Standard and Poor’s Ratings Service, and Fitch Inc.

Besides these administrative undertakings, the SEC initially didn’t show much enthusiasm for its new authority over NRSROs. But the subprime market problems and subsequent credit crunch appear to have changed the regulator’s attitude. Because of the problems in the mortgage industry, the SEC is doing more, according to testimony Wednesday by Erik Sirri, director of the SEC’s Division of Market Regulation. The commission has begun to look at the agencies’ policies and procedures for their ratings of residential mortgage-backed securities and CDOs. The SEC’s review will include “the advisory services they may have provided to underwriters and mortgage originators, their conflicts of interest, disclosures of their ratings processes, the agencies’ rating performance after issuance, and the meanings of assigned ratings,” he said.

The heat that credit rating agencies have faced lately is reminiscent of the criticism lobbed at them soon after Enron’s collapse in 2001. Critics say their risk assessments of the mortgage-backed securities over the past several months missed the mark. “There is a loss of confidence in rating agencies, and they deserve it,” said Rep. Carolyn Mahoney (D-N.Y.). “As with Enron, the rating agencies have been dead wrong.” Just days before the energy giant filed for bankruptcy, the NRSROs had given the company a good credit risk rating. The Sarbanes-Oxley Act mandated that the SEC look into the agencies’ role in the securities market, and its 2003 report laid the groundwork for the law passed last year.

On Wednesday, Sirri acknowledged that the agencies still can be perceived as having conflicts of interest, particularly because a portion of their revenue comes from the companies that pay them for their ratings. He said the SEC is looking into the agencies’ policies in this area. It is also looking into whether the agencies give proper disclosures for their methodologies. “Firms should be clear about this and adhere to those practices,” he said. “If we see conflicts, if we see they are not following their procedures . . . we would be impelled to follow up.”

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