Securities Law Prof Blog

Editor: Eric C. Chaffee
Univ. of Toledo College of Law

Tuesday, April 22, 2008

Cox Testifies on Credit Rating Agencies

Chair Cox testified on Oversight of Nationally Recognized Statistical Rating Organizations before the U.S. Senate Committee on Banking, Housing and Urban Affairs on April 22, 2008.  He reported on the SEC's examination of the credit rating agencies on "the adequacy of their public disclosures, their recordkeeping, and their procedures to prevent the misuse of material nonpublic information" as well as "how the firms manage their conflicts of interest, as well as their approaches to preventing unfair, abusive, or coercive practices."

While stating that it was premature to describe the results, he went on to say:

that it appears the volume of the structured finance deals that were brought to the credit rating agencies increased substantially from 2004 to 2006. In addition, during the period of time under examination, the structured products that the rating agencies were being asked to evaluate were becoming increasingly complex, with many employing derivatives such as credit default swaps to replicate the performance of mortgage backed securities. At the same time, the loan assets underlying these securities shifted from primarily plain vanilla 30-year mortgages to a range of more difficult-to-assess products, such as adjustable rate and second lien loans.

We are evaluating whether credit rating agencies adapted their rating approaches in this environment. The staff is observing that the ratings process used to rate these products may have been less quantitatively developed, particularly as the products became more complicated and involved different types of loans, than was generally believed. ... The staff is currently working to assess whether, and if so the extent to which, these factors contributed to the volume of eventual downgrades, and whether other factors — such as the desire to maintain or increase market share — may have caused the credit rating agencies to be less conservative than their disclosed methodologies otherwise would have indicated.

We expect the results of these staff examinations will provide significant and useful new information that will help not only the SEC, but also issuers and users of credit ratings in this country and around the world, to address the problems we have seen with ratings of subprime-related products.

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