Securities Law Prof Blog

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

Wednesday, June 11, 2008

SEC Proposes Credit Rating Agency Reforms

The SEC voted to formally propose a comprehensive series of credit rating agency reforms to bring increased transparency to the ratings process and curb practices that contributed to recent turmoil in the credit markets.  The proposed rulemaking continues the implementation of new regulatory authority that the SEC recently received from Congress to register and oversee nationally recognized statistical rating organizations (NRSROs).  The proposed rules are designed to regulate the conflicts of interests, disclosures, internal policies, and business practices of credit rating agencies.

The SEC is proposing the rulemaking in three parts, with the first two portions being proposed today and the third portion to be considered on June 25.

The first part of the Commission's rule proposal would:

Prohibit a credit rating agency from issuing a rating on a structured product unless information on assets underlying the product was available.

Prohibit credit rating agencies from structuring the same products that they rate.

Require credit rating agencies to make all of their ratings and subsequent rating actions publicly available. This data would be required to be provided in a way that will facilitate comparisons of each credit rating agency's performance. Doing this would provide a powerful check against providing ratings that are persistently overly optimistic, and further strengthen competition in the ratings industry.

Attack the practice of buying favorable ratings by prohibiting anyone who participates in determining a credit rating from negotiating the fee that the issuer pays for it.

Prohibit gifts from those who receive ratings to those who rate them, in any amount over $25.

Require credit rating agencies to publish performance statistics for 1, 3, and 10 years within each rating category, in a way that facilitates comparison with their competitors in the industry.

Require disclosure by the rating agencies of the way they rely on the due diligence of others to verify the assets underlying a structured product.

Require disclosure of how frequently credit ratings are reviewed; whether different models are used for ratings surveillance than for initial ratings; and whether changes made to models are applied retroactively to existing ratings.

Require credit rating agencies to make an annual report of the number of ratings actions they took in each ratings class, and require the maintenance of an XBRL database of all rating actions on the rating agency's Web site. That would permit easy analysis of both initial ratings and ratings change data.

Require the public disclosure of the information a credit rating agency uses to determine a rating on a structured product, including information on the underlying assets. That would permit broad market scrutiny, as well as competitive analysis by other rating agencies that are not paid by the issuer to rate the product.

Require documentation of the rationale for any significant out-of-model adjustments.

The second part of the SEC's proposal would require credit rating agencies to differentiate the ratings they issue on structured products from those they issue on bonds, either through the use of different symbols, such as attaching an identifier to the rating, or by issuing a report disclosing the differences between ratings of structured products and other securities.

The SEC states that the third set of recommendations "are being designed to ensure that the role the SEC has assigned to ratings in its rules is consistent with the objective of having investors make an independent judgment of risks and of making it clear to investors the limits and purposes of credit ratings for structured products."

Public comments on today's proposed amendments and rule must be received by the SEC within 30 days after their publication in the Federal Register.

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