SEC's New Rules on Credit Rating Agencies

Sources:
WSJ: SEC Aims to Tighten the Rules on Raters
Bloomberg: SEC Credit-Rating Rules, 401(k) Bill, WTO’s Airbus Aid Ruling: Compliance
SEC: SEC Proposes Rules to Increase Transparency and Improve Integrity of Credit Ratings

On Wednesday, the Securities and Exchange Commission (SEC) proposed more restrictive rules on credit rating agencies (CRAs). CRAs rate the “creditworthiness” of debts as well as financial institutions holding debts. During the financial crisis, CRAs were criticized for contributing to the housing bubble by providing inaccurate and inflated ratings for mortgage-backed securities. Congress, in passing the Dodd-Frank Wall Street Reform and Consumer Protection Act, intended to correct such problems, and the SEC’s new rules would implement relevant provisions of the Act. The SEC’s proposed rules aim to “strengthen the integrity and improve the transparency of credit ratings,” said SEC Chairman Mary L. Schapiro.

Specifically, new rules would require CRAs to disclose more background information explaining their ratings. In the case of ratings on asset-backed securities, CRAs would have to submit any information provided by a third-party firms which conduct a review of the underlying assets. Also, the new rules require CRAs to file an internal control report with the SEC every year. Additionally, the new rules propose measures to prevent conflicts of interest problems. CRAs and issuers of debts have close relationships as most CRAs get fees from issuers and CRAs provide advice for issuers regarding how to receive high ratings. Under the new rules, for example, CRAs are not allowed to issue a rating if their employee who is involved in the sales of a debt also plays a part in assigning a credit rating for the debt. If a CRA violates such rules, the SEC can suspend or revoke the CRA’s registration with the SEC.

Critics say that the new rules still do not require CRAs to provide sufficient information about the ratings. In addition, some point out that the rules would not solve the fundamental problems of an “inherent conflict” that arise from close relationships between CRAs and issuers. As for the internal control report requirement, Kathleen Casey, one of the SEC commissioners, said that small-sized CRAs might find the requirement onerous and the requirement could discourage such CRAs from registering with the SEC, reducing competition.

The new rules will be finalized after the 60-day comment period. Upon a final approval by the SEC commissioners, the rules will apply to the CRAs registered with the SEC. Currently, 10 CRAs including Moody’s Corp. and Standard & Poor’s are registered with the SEC.