Transparency, Integrity Improvements on Credit Ratings Proposed

Jack Humphrey, Regulatory journalist
May 20, 2011 /

The Securities and Exchange Commission has proposed new rules and amendments to increase transparency and improve the integrity of credit ratings.

Earlier in September last year, the SEC spotted a possible fraud at the Moody’s Investors Service (MIS) for maintaining dubious ratings conduct.

An investigation found that an error in computer coding was detected by an analyst at MIS in 2007, meaning the credit ratings issued were not correct and higher ratings were being given to debt obligation notes.

The new proposals, which require disclosures from the Nationally Recognized Statistical Rating Organizations (NRSROs) and third-party due diligence providers as well as issuers and underwriters of asset-backed securities, will implement certain provisions of the Dodd-Frank Wall Street Reform and Consumer Protection Act.

In 2006, the US Congress passed the Credit Rating Agency Reform Act authorizing the SEC to establish a registration and oversight program for credit rating agencies registered with the SEC as NRSROs.

Mary Schapiro, chairperson of the SEC, said that when the Dodd-Frank Act was being passed, the “Congress noted that credit ratings applied to structured financial products proved inaccurate and contributed significantly to the mismanagement of risks by financial institutions and investors.”

Credit rating agencies are organizations that rate the creditworthiness of a company or a financial product such as a debt security or money market instrument. Credit ratings help investors to evaluate whether to purchase or sell securities.

The proposals require the NRSRO to file a report with the SEC containing a description of management’s responsibility in establishing the internal control structure and an assessment of the effectiveness of those internal controls.

The proposals also prohibit an NRSRO from issuing or maintaining a credit rating where its employee – who participates in the sales or marketing of a product or service of the NRSRO or of a person associated with the NRSRO – also participates in determining or monitoring a credit rating or developing or approving procedures used for determining a credit rating.

In addition, small NRSROs could seek an exemption from this provision.

A mechanism has also been established that can revoke the registration of an NRSRO or incur other penalties if it violates the conflict of interest rule.

Among other things, the proposals standardize how an NRSRO calculates and presents aggregate information about the changes of its ratings and the times that a rated entity or product subsequently defaulted.

The NRSROs are further required to enhance the so-called “100% Rule,” which requires them to publish information concerning its rating actions for credit ratings that the NRSRO initially determined on or after June 26, 2007.

The SEC seeks comments from the public regarding the credit ratings proposal within 60 days after its publication in the Federal Register.


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