The Securities and Exchange Commission (SEC) is getting tough on credit rating agencies. A series of measures announced on Wednesday, December 3, would impose additional requirements on the credit reporting agencies in an effort to increase transparency and accountability. Consumers, investors and lenders may even end up getting more meaningful ratings.
These comprehensive rules touch every aspect of the credit rating process - from conflicts of interest, to publication of ratings methodologies to disclosure of ratings track records,” explains SEC Chariman Christopher Cox.
The proposed rules are the result of an extensive examination of the three major credit ratings agencies recently concluded by the SEC. The examination, which lasted 10 months, revealed significant weaknesses in ratings practices.
“One of the significant weaknesses in the credit rating process has been that while the credit rating agencies often relied on other to verify the quality of assets underlying structured products - and thus their ratings were vulnerable to reliance on incorrect information - there was frequently inadequate explanation of the limitations of the ratings of these products,” Chairman Cox said. “Just as significantly, conflicts of interest ingrained into the business models of credit rating agencies were amplified as structured products were specifically designed to achieve high ratings for certain tranches and as credit rating agencies sought to gain business and market share by assisting in this process.”
This is the second set of reforms proposed by the SEC since June 2007 when Congress granted the Commision the authority to Register and oversee credit rating agencies. The Credit Rating Reform Act ended nearly a century of self-policing by the credit rating agencies who act as financial gatekeepers determining who can borrow funds and at what cost (interest rate). Some would also say that credit ratings have become a means of assessing a person’s or an organization’s trustworthiness and moral character.
Credit scoring cannot help but provide a moral context for making credit decisions. To be creditworthy is to be trusworthy,” says credit evaluation and financial identity researcher Josh Lauer, assistant professor of communication at the University of New Hampshire. “At a fundamental level, credit evaluation is an effort to determine whether a given person can be trusted.”
According to Chairman Cox, ten credit rating agencies have registered with the SEC since the Act passed in 2007. This represents an increase of 43 percent in the number of nationally recognized statistical rating organizations. Despite the increase in competition, three firms - Fitch Ratings, Standard & Poor’s and Moody’s - continue to dominate the 45 billion-a-year credit rating industry, according to the Associated Press (AP).
The public has 45 days from the date the proposed amendments are published in the Federal Register to submit comments to the SEC. The AP reports that some critics are already sayign the proposed rules do not go far enough while spokespersons for the three major credit rating agencies have already expressed their support for the measures.
A Fact Sheet containing additional details on the proposed rules can be found on the SEC website at www.sec.gov.
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