Risk & Compliance

SEC: Credit Ratings Are a Crutch

The regulator moves to eliminate or revise most references to ratings in its rules, saying investors over-relied on them.
Kate PlourdJune 26, 2008

The Securities and Exchange Commission on Wednesday continued its assault on the central role credit-rating agencies have played in the evaluation of securities. Two weeks after floating new rules to mitigate the agencies’ conflicts of interest and require them to distinguish among different types of asset-backed securities, the SEC proposed to also severely limit the influence of credit ratings on its own rules.

Specifically, the SEC recommended that of its 44 rules that contain references to credit ratings, 11 should be eliminated and 27 others rewritten with more clearly stated regulatory purposes.

In an open meeting, chairman Christopher Cox admitted that the SEC has been using rating agencies as a crutch — and one that can lead to unrealistic securities appraisals. “Our own rules may be contributing to an uncritical reliance on rating agencies as a substitute for independent evaluation,” he said.

The agency’s current rules do not “properly reflect the different risk characteristics of structured products, and the different kinds of information and ratings methodologies that go into ratings,” Cox said. And he acknowledged criticism that the commission’s official recognition of ratings for various regulatory purposes may have in turn encouraged investors to rely on them too much.

Cox strongly implied that this over-reliance helped generate the heavy trading in highly rated securities that, as it turned out, were backed by bad mortgage loans. “Events of recent months have had a profound effect on our economy and our markets, and they have galvanized regulators and policy makers not only in this country but around the world to re-examine every aspect of the regulatory framework governing credit rating agencies,” Cox said.

On June 11 the SEC proposed to prohibit ratings agencies from issuing ratings on structured products unless they have sufficient information about the underlying assets. The rule also would prevent agencies from structuring the same products they rate. And they would be subject to a host of new disclosure requirements: make all their ratings publicly available, disclose the information used to make ratings, publish regular performance statistics, publish an annual report of all ratings action they took, and maintain that information in an interactive database.

The second proposed rule would require ratings agencies to label complex asset-backed securities differently than traditional corporate bonds.