Credit rating agencies
See also Equivalent disclosure.
Credit rating regulation under the Dodd-Frank Act
- Rulewiting specifics under the Dodd-Frank Act Securities and Exchange Commission
On July 21, 2010, U.S. President Barack Obama signed into law the Dodd-Frank Wall Street Reform and Consumer Protection Act ("Dodd-Frank") following earlier passage of the legislation by a 237 to 192 vote in the U.S. House of Representatives and a 60 to 39 vote in the U.S. Senate. Dodd-Frank represents Congress's response to what the House Committee on Financial Services calls "years without accountability for Wall Street [and] the worst financial crisis since the Great Depression."
Subtitle C of Title IX of Dodd-Frank – "Improvements to the Regulation of Credit Rating Agencies" ("Subtitle C") – establishes an almost wholly new framework for governing and regulating credit rating agencies, including nationally recognized statistical rating organizations ("NRSROs"). The overhaul stands to dramatically change the role NRSROs play in the markets, and is based on Congressional findings that "the systemic importance of credit ratings and the reliance placed on credit ratings by individual and institutional investors and financial regulators" makes the activities and performance of NRSROs "matters of national public interest, as credit rating agencies are central to capital formation, investor confidence, and the efficient performance of the United States economy."
Dodd-Frank imposes new requirements covering key areas of NRSRO function and oversight, including:
- Increased Authority of the Securities and Exchange Commission (the "SEC"): Subtitle C gives the SEC substantial rulemaking authority and establishes an Office of Credit Ratings (the "OCR") within the SEC.
- Liability Provisions: By lowering pleading requirements, removing safe-harbor protections, and imposing filing and other requirements, Subtitle C heightens the liability that NRSROs face.
- NRSRO Governance: Subtitle C contains many provisions aimed at minimizing the impact of conflicts of interest on the integrity of NRSROs' issuance of credit ratings.
- Public Disclosure: Under the terms of Subtitle C, NRSROs are required to disclose an array of new information, such as the performance record of their credit ratings and the procedures and methodologies used in the credit ratings process.
Impact on Existing Federal Securities Laws: Subtitle C removes a wide range of statutory references to NRSROs and, among other matters, calls for the SEC and other federal agencies to develop new standards of creditworthiness.
Asset-Backed Securities ("ABS"): Dodd-Frank includes many provisions designed to improve the asset-backed securitization process, including new disclosure requirements and an SEC study to identify the appropriate way to reconstruct the current issuer-pays business model of obtaining credit ratings for ABS (also referred to as structured finance products).
Looking Forward: In addition to the SEC study on the issuer-pays model, Dodd-Frank, and Subtitle C in particular, requires that the SEC, the Government Accountability Office (the "GAO") and others conduct studies that may result in additional rules and regulations affecting the role and import of NRSROs and credit ratings in the markets.
- Evolving Disclosure Practices in Response to the Repeal of Rule 436(g) Dewey & LeBoeuf LLP, February 18, 2011
- Registered Public Offerings Of Debt Securities And The Use Of Credit Ratings Information Sheppard Mullin Richter & Hampton, August 18, 2010
- Alternatives to the Use of External Credit Ratings in the Regulations of the OCC Office of the Comptroller of the Currency, August 13, 2010
OCC seeks alternatives to use of credit ratings
- Alternatives to the Use of Credit Ratings in OCC Regulations Credit Risk Chronicles, September 8, 2010
The Office of the Comptroller of the Currency (OCC) is seeking comment on two advance notices of proposed rulemaking regarding alternatives to the use of credit ratings in the OCC’s regulations. These advance notices are issued in response to section 939A of the Dodd–Frank Wall Street Reform and Consumer Protection Act, enacted on July 21, 2010.1 Section 939A requires the OCC and other federal banking agencies to review regulations that
- require an assessment of the credit-worthiness of a security or money market instrument and
- contain references to or requirements regarding credit ratings.
In addition, the agencies are required to remove such references and requirements and replace them with substitute standards of credit-worthiness. In developing substitute standards of credit-worthiness, each agency is required to take into account the entities it regulates and, to the extent feasible, seek to establish uniform standards.
Use of Credit Ratings in Regulatory Capital Standards
The federal banking agencies (the OCC, Board of Governors of the Federal Reserve System, the Federal Deposit Insurance Corporation, and the Office of Thrift Supervision) currently use credit ratings issued by nationally recognized statistical rating organizations (NRSROs) in their risk-based capital standards. These standards reference credit ratings in four general areas:
- the assignment of risk weights to securitization exposures under the general risk-based capital rules and advanced approaches rules;
- the assignment of risk weights to claims on, or guaranteed by, qualifying securities firms under the general risk-based capital rules;
- the assignment of certain standardized specific risk add-ons under the agencies’ market risk rule; and
- the determination of eligibility of certain guarantors and collateral for purposes of the credit risk mitigation framework under the advanced approaches rules.
In 2008, the agencies issued a notice of proposed rulemaking that sought comment on implementation in the United States of certain aspects of the standardized approach in the Basel Accord. The Basel standardized approach for credit risk relies extensively on credit ratings to assign risk weights to various exposures.
The agencies have issued a joint advance notice of proposed rulemaking (ANPR) to solicit comment and information as they begin to develop alternatives to the use of credit ratings in their capital rules (Capital ANPR). The Capital ANPR solicits input on alternative standards of credit-worthiness that could be used in lieu of credit ratings in those rules and asks for comments on a range of potential approaches, including basing capital requirements on more granular supervisory risk weights or on market-based metrics. The comment period for the Capital ANPR closes on October 25.
- Use of Credit Ratings in Other OCC Regulations
The noncapital regulations of the OCC include various references to and requirements for use of credit ratings. These references include:
Investment Securities—The OCC’s investment securities regulations at 12 CFR 1 use credit ratings as a factor for determining the credit quality, liquidity/marketability, and appropriate concentration levels of investment securities purchased and held by national banks. For example, under these rules, an investment security must not be “predominantly speculative in nature.” The OCC rules provide that an obligation is not “predominantly speculative in nature” if it is rated investment grade or, if unrated, is the credit equivalent of investment grade.
“Investment grade,” in turn, is defined as a security rated in one of the four highest rating categories by two or more NRSROs (or one NRSRO if the security has been rated by only one NRSRO). Credit ratings are also used to determine marketability in the case of a security that is offered and sold pursuant to Securities and Exchange Commission Rule 144A. In addition, credit ratings are used to determine concentration limits on certain investment securities.
Securities Offerings—Securities issued by national banks are not covered by the registration provisions and SEC regulations governing other issuers’ securities under the Securities Act of 1933. However, the OCC has adopted part 16 to require disclosures related to national bank-issued securities. Part 16 includes references to “investment grade” ratings. For example, section 16.6, which provides an optional abbreviated registration system for debt securities that meet certain criteria, requires that a security receive an investment grade rating in order to qualify for the abbreviated registration system.
International Banking Activities—Pursuant to section 4(g) of the International Banking Act (IBA), foreign banks with federal branches or agencies must establish and maintain a capital equivalency deposit (CED) with a member bank located in the state where the federal branch or agency is located. The IBA authorizes the OCC to prescribe regulations describing the types and amounts of assets that qualify for inclusion in the CED, “as necessary or desirable for the maintenance of a sound financial condition, the protection of depositors, creditors, and the public interest.”
At 12 CFR 28.15, OCC regulations set forth the types of assets eligible for inclusion in a CED. Among these assets are certificates of deposit, payable in the United States, and banker’s acceptances, provided that, in either case, the issuer or the instrument is rated investment grade by an internationally recognized rating organization, and neither the issuer nor the instrument is rated lower than investment grade by any such rating organization that has rated the issuer or the instrument.
The OCC has issued an ANPR soliciting comment on alternative measures of credit-worthiness that may be used instead of credit ratings in the above regulations (Investment Securities and Other Regulations ANPR). The ANPR seeks comments on criteria that the OCC should consider when developing such measures and outlines a range of alternatives for replacing references to credit ratings in part 1. The comment period for the Investments and Other Regulations ANPR closes on October 12.
For information or questions on the Capital ANPR, contact Mark Ginsberg, Risk Expert, Capital Policy Division, (202) 874-5070, or Carl Kaminski, Senior Attorney, Legislative and Regulatory Activities Division, (202) 874-5090. For information or questions on the Investment Securities and Other Regulations ANPR, contact Michael Drennan, Senior Advisor, Credit and Market Risk Division, (202) 874-4564, or Carl Kaminski, Senior Attorney, Legislative and Regulatory Activities Division, (202) 874-5090.
/signed/ Timothy W. Long Senior Deputy Comptroller for Bank Supervision Policy and Chief National Bank Examiner
- Credit Ratings Reversals Expect[ed] Loss, September 27, 2010
SEC suspends rule for ratings in ABS offerings
- Source: What’s the SEC to do about 436(g)? Call a time out FT Alphaville, July 22, 2010
"... So what’s the SEC to do? For now, they’ve offered a 6-month reprieve to issuers and rating agencies.
On Thursday, the director of the SEC’s division of corporate finance issued the following statement (emphasis ours):
"Within the next day, the Division of Corporation Finance expects to issue a ‘no action’ letter allowing issuers for a period of 6 months to omit credit ratings from registration statements filed under Regulation AB. Although there are currently few issuers in the registered asset-backed securities market, we understand from some issuers that they cannot currently obtain credit rating agency consent to include the credit ratings in these ‘Reg AB’ filings. This action will provide issuers, rating agencies and other market participants with a transition period in order to implement changes to comply with the new statutory requirement while still conducting registered ABS offerings."
- CREDIT RATINGS: HOT BOND MARKETS, AMIDST THE CHILL OF DODD-FRANK Westlaw, July 30, 2010
- SEC Provides Interpretive Guidance on Ratings Disclosure in Non-ABS Offerings Alston and Bird, July 23, 2010
Raters request issuers to remove ratings from ABS offering docs
- Source: Bond Sale? Don't Quote Us, Request Credit Firms Wall Street Journal, July 21, 2010
The nation's three dominant credit-ratings providers have made an urgent new request of their clients: Please don't use our credit ratings.
The odd plea is emerging as the first consequence of the financial overhaul that is to be signed into law by President Obama on Wednesday. And it already is creating havoc in the bond markets, parts of which are shutting down in response to the request.
Standard & Poor's, Moody's Investors Service and Fitch Ratings are all refusing to allow their ratings to be used in documentation for new bond sales, each said in statements in recent days. Each says it fears being exposed to new legal liability created by the landmark Dodd-Frank financial reform law.
The new law will make ratings firms liable for the quality of their ratings decisions, effective immediately. The companies say that, until they get a better understanding of their legal exposure, they are refusing to let bond issuers use their ratings.
That is important because some bonds, notably those that are made up of consumer loans, are required by law to include ratings in their official documentation. That means new bond sales in the $1.4 trillion market for mortgages, autos, student loans and credit cards could effectively shut down.
- U.S. Financial Reform Act’s Implications for Credit Rating Disclosure in Prospectuses and Registration Statements Tory's, August 18, 2010
- Davis-Polk Guidance on Use of Credit Ratings in Securities Offerings Following Dodd-Frank Credit Risk Chronicles, July 21, 2010
- Did The Credit Agencies Just Go Extinct? ZeroHedge, July 21, 2010
Franken amendment adopted in legislation
- Franken Amendment on Random Assignment of Credit Ratings May Yet Be Implemented Jim Hamilton's World of Securities Regulation
The legislation that passed the Senate on May 20, 2010 contained a provision, Sec. 939D, authored by Senator Al Franken that conducted a frontal attack on the conflict of interest problem by adding new Exchange Act Sec. 15E(w) to create an SRO overseen by the SEC that would assign credit rating agencies to provide initial ratings for asset-backed securities and structured financial products on a rotating basis. There was no comparable provision in the legislation the House passed on December 11, 2009. The House-Senate conference committee that produced the Dodd-Frank Act reached a compromise that directs the SEC to conduct a study on the feasibility of assigning a rating agency to issue ratings on structured products and, if no better method is found, implement the Sec. 15E(w) as authored by Senator Franken. (Sec. 939F of the Dodd-Frank Act).
The SEC study must determine the extent to which the creation of such a system would be viewed as the creation of moral hazard by the Federal Government, and examine any constitutional or other issues concerning the establishment of such a system. The study must also look at the range of metrics that could be used to determine the accuracy of credit ratings; and alternative means for compensating nation rating organizations that would create incentives for accurate credit ratings. The study must assess potential mechanisms for determining fees for the raters and appropriate methods for paying the fees. (Sec. 939F(b) of the Dodd-Frank Act).
Within two years of enactment, the SEC must report to Congress on the findings of the study. (Sec. 939F(c) of the Dodd-Frank Act). After submission of the report, the SEC must establish a system for the assignment of nationally recognized statistical rating organizations to determine the initial credit ratings of structured finance products in a manner that prevents the issuer, sponsor, or underwriter of the product from selecting the rating agency that will determine the initial credit ratings and monitor such credit ratings. In issuing rules, the Commission must give thorough consideration to the Franken-authored Exchange Act. Sec. 15W(e) and must implement the system set forth in Sec. 15W(e) unless the Commission decides that an alternative system would better serve the public interest and protect investors. (Sec. 939F(d) of the Dodd-Frank Act).
The Franken Amendment further attacks the conflict of interest problem by creating a board overseen by the SEC that will assign credit rating agencies to provide initial ratings on a rotating basis. The SEC will create a credit rating agency board, a self-regulatory organization, tasked with developing a system in which the board assigns a rating agency to provide a product’s initial rating. Requiring an initial credit rating by an agency not of the issuer’s choosing will put a check on the accuracy of ratings, in the Senator’s view. The amendment does not prohibit an issuer from then seeking a second or third or fourth rating from an agency of their choosing. The amendment leaves flexibility to the Board to determine the assignment process. Thus, the new board gets to design the assignment process it sees fit, which can be random or based on a formula, just as long as the issuer doesn’t get to choose its rating agency. Cong. Record, May 10, 2010, S3465.
Crisis Commission examines credit raters
- Financial Crisis Inquiry Commission Holds Hearing Regarding Credit Rating Agencies Alston & Bird, June 3, 2010
- Source: Buffett, Moody's CEO to testify to US crisis panel Reuters, May 26, 2010
Warren Buffett, the chief executive of Berkshire Hathaway Inc (BRKa.N), will testify next week before the U.S. panel examining the causes of the deep financial crisis.
The Financial Crisis Inquiry Commission, a Congressionally appointed panel charged with writing by the end of the year a full account of the crisis, said Buffett will testify with Moody's Corp (MCO.N) Chief Executive Raymond McDaniel on June 2 in New York.
The hearing will look at the credibility of credit ratings, and the investment decisions made based on those ratings, the panel said in a release on Wednesday.
Credit rating agencies have been accused of contributing to the global financial crisis by assigning inflated ratings to subprime mortgage-related products.
Buffett earlier this month defended credit rating agencies as an investment, including stakes by Berkshire Hathaway.
He told Berkshire's annual meeting that rating agencies "made the same mistake" that he, politicians, mortgage brokers and others did in overestimating the health of the housing market.
During the first quarter of this year, Buffett further reduced his stake in Moody's, which stood at about 13 percent as of March 31.
Buffett said at the annual meeting on May 1 that the agencies, which also include McGraw-Hill Cos' (MHP.N) Standard & Poor's and Fimalac SA's (LBCP.PA) Fitch Ratings, have scant capital needs and have strong pricing power.
Buffett will be one of the biggest names to appear before the 10-member panel, which is modeled after the Pecora Commission that probed the 1929 Wall Street crash.
In the past few months, the commission has also heard from Goldman Sachs CEO Lloyd Blankfein, JPMorgan CEO Jamie Dimon, former Federal Reserve Chairman Alan Greenspan and former Bear Stearns CEO James Cayne.
It must deliver its findings to Congress and President Barack Obama by Dec. 15.
Also scheduled to testify on June 2 are current and former Moody's executives, including Nicolas Weill, the group managing director for Moody's Investors Service, and Brian Clarkson, former chief operating officer for Moody's Investors Service.
The full list of witnesses can be found at: here
Credit rating agencies are facing tough reforms in the financial regulation legislation moving through Congress.
The Senate version of the bill would have the government set up a clearinghouse to match rating agencies on a semi-random basis with debt issuers.
That could ease pressures the agencies face to assign rosy ratings to securities issued by the firms that hire them, backers said.
Another provision in the Senate's legislation would require federal regulators to develop their own standards of credit-worthiness rather than rely solely on assessments from rating agencies.
Shares of credit rating agencies dropped when the Senate approved the measures on May 13, but it is unclear whether they will make it into the final bill, which must be melded with a version passed by the U.S. House of Representatives
Senate to hold hearing on rating agencies April 23
- Source: WALL STREET AND THE FINANCIAL CRISIS: THE ROLE OF CREDIT RATING AGENCIES Senate Permanent Subcommittee on Investigations, Friday, April 23, 2010, 09:30 AM, Dirksen Senate Office Building, room G-50
The Permanent Subcommittee on Investigations has scheduled a hearing, "Wall Street and the Financial Crisis: The Role of Credit Rating Agencies," on Friday, April 23, 2010, at 9:30 a.m., in Room G-50 of the Dirksen Senate Office Building.
This hearing will be the third in a series of Subcommittee hearings examining some of the causes and consequences of the recent financial crisis. This third hearing will focus on the role of credit rating agencies in the financial crisis, using as case histories the credit rating agencies of Standard and Poor’s and Moody’s. A witness list will be available Monday, April 19, 2010.
- Source: E-Mails Offer Look at Rating Firms During Subprime Crisis New York Times, April 22, 2010
"... A Senate panel will release 550 pages of exhibits on Friday — including these and other internal messages — at a hearing scrutinizing the role the two rating agencies played in the 2008 financial crisis. The panel, the Permanent Subcommittee on Investigations, released excerpts of the messages Thursday.
“I don’t think either of these companies have served their shareholders or the nation well,” said Senator Carl Levin, Democrat of Michigan, the subcommittee’s chairman.
Neither company would comment saying that they had not been provided with the subcommittee findings.
The investigation, which began in November 2008, found that S.&P. and Moody’s used inaccurate rating models from 2004 to 2007 that failed to predict how high-risk residential mortgages would perform; allowed competitive pressures to affect their ratings; and failed to reassess past ratings after improving their models in 2006.
The companies failed to assign adequate staff to examine new and exotic investments, and neglected to take mortgage fraud, lax underwriting and “unsustainable home price appreciation” into account in their models, the inquiry found.
By 2007, when the companies, under pressure, admitted their failures and downgraded the ratings to reflect the true risks, it was too late..."
- Rating Agency Data Aided Wall Street in Mortgage Deals New York Times, April 23 2010
- Market share drove credit ratings, fmr execs say Reuters, April 23, 2010
- Yielding To Wall Street, Credit Raters 'Drink The Kool-Aid' Huffington Post Investigative Fund, April 22, 2010
- Now it's the Senate's turn to take on Goldman, Moody's McClatchy, April 19 2010
House Committee passes credit ratings legislation
- Source: The Accountability/Transparency in Credit Rating Agencies Act - H.R. 3890, approved by a vote of 49-14. (House Financial Services Committee) Octoberr 28, 2009
"Today, the House Financial Services Committee passed H.R. 3890, the Accountability and Transparency in Rating Agencies Act, introduced by Congressman Paul E. Kanjorski (D-PA), Chairman of the House Financial Services Subcommittee on Capital Markets, Insurance, and Government Sponsored Enterprises. The Committee passed H.R. 3890, with bipartisan support, by a vote of 49-14.
“The Accountability and Transparency in Rating Agencies Act aims to curb the inappropriate and irresponsible actions of credit rating agencies which greatly contributed to our current economic problems,” said Chairman Kanjorski. “This legislation builds on the Administration’s proposal and takes strong steps to reduce conflicts of interest, stem market reliance on credit rating agencies, and impose a liability standard on the agencies. As gatekeepers to our markets, credit rating agencies must be held to higher standards. We need to incentivize them to do their jobs correctly and effectively, and there must be repercussions if they fall short. This bill will take such steps. I look forward to moving it through the legislative process.”
A summary of H.R. 3890 follows:
- Stronger than the Administration's Plan on Rating Agencies. The Accountability and Transparency in Rating Agencies Act expands on the initial credit rating agency legislation proposed by the Administration in that it:
- Creates Accountability by Imposing Liability. The bill enhances the accountability of Nationally Recognized Statistical Rating Organizations (NRSROs) by clarifying the ability of individuals to sue NRSROs. The bill also clarifies that the limitation on the Securities and Exchange Commission (SEC) or any State not to regulate the substance of credit ratings or ratings methodologies does not afford a defense against civil anti-fraud actions.
- Duty to Supervise. The bill adds a new duty to supervise an NRSRO's employees and authorizes the SEC to sanction supervisors for failing to do so.
- Independent Board of Directors. The bill requires each NRSRO to have a board with at least one-third independent directors and these directors shall oversee policies and procedures aimed at preventing conflicts of interest and improving internal controls, among other things.
- Mitigate conflicts of interests. The legislation also contains numerous new requirements designed to mitigate the conflicts of interest that arise out of the issuer-pays model for compensating NRSROs. Additionally, the bill significantly enhances the responsibilities and accountability of NRSRO compliance officers to address conflicts of interest issues.
- Greater Public Disclosure. As a result of the bill, investors will gain access to more information about the internal operations and procedures of NRSROs. In addition, the public will now learn more about how NRSROs get paid.
- Revolving-Door Protections. When certain NRSRO employees go to work for an issuer, the bill requires the NRSRO to conduct a 1-year look-back into the ratings in which the employee was involved to make sure that its procedures were followed and proper ratings were issued. The bill also requires NRSROs to report to the SEC, and for the SEC to make such reports public, the names of former NRSRO employees who go to work for issuers.
- Barney Frank Vs. The Credit Raters Huffington Post, December 18, 2009
SEC action on credit raters Sept 17
- Source: SEC Votes on Measures to Further Strengthen Oversight of Credit Rating Agencies SEC release, September 17, 2009
"Among the Commission's actions today to create a stronger, more robust regulatory framework for credit rating agencies:
- Adopted rules to provide greater information concerning ratings histories - and to enable competing credit rating agencies to offer unsolicited ratings for structured finance products, by granting them access to the necessary underlying data for structured products.
- Proposed amendments that would seek to strengthen compliance programs through requiring annual compliance reports and enhance disclosure of potential sources of revenue-related conflicts.
- Adopted amendments to the Commission's rules and forms to remove certain references to credit ratings by nationally recognized statistical rating organizations.
- Reopened the public comment period to allow further comment on Commission proposals to eliminate references to NRSRO credit ratings from certain other rules and forms.
- Proposed new rules that would require disclosure of information including what a credit rating covers and any material limitations on the scope of the rating and whether any "preliminary ratings" were obtained from other rating agencies - in other words, whether there was "ratings shopping."
- Voted to seek public comment on whether to amend Commission rules to subject NRSROs to liability when a rating is used in connection with a registered offering by eliminating a current provision that exempts NRSROs from being treated as experts when their ratings are used that way.
Public comments on new rules or amendments proposed today must be received by the Commission within 60 days after their publication in the Federal Register.
The full text of the proposed and final rules and amendments voted on by the Commission today will be posted to the SEC Web site as soon as possible.
- SEC to tighten grip on ratings agencies after role in crisis Financial Times, September 18, 2009
- U.S. SEC mulls stricter rules for credit agencies Reuters, September 15, 2009
Senate hearing, August 5th
EXAMINING PROPOSALS TO ENHANCE THE REGULATION OF CREDIT RATING AGENCIES
Wednesday, August 5, 2009, 09:30 AM, 538 Dirksen Senate Office Building
The witnesses will be:
- The Honorable Michael Barr, Assistant Secretary for Financial Institutions, U.S. Department of the Treasury
- Professor John C. Coffee, Adolf Berle Professor of Law, Columbia University School of Law
- Professor Lawrence White, Leonard E. Imperatore Professor of Economics, Stern School of Business, New York University
- Mr. Stephen Joynt, President and CEO, Fitch Ratings
- Mr. James Gellert, President and CEO, Rapid Ratings
- Mr. Mark Froeba, Principal, PF2 Securities Evaluations, Inc.
US Treasury proposal to the Congress
- Source: Treasury Sends Rating Agency Reform Proposal To Hill WSJ, July 21, 2009
"WASHINGTON (Dow Jones)--The U.S. Treasury Department on Tuesday unveiled a stronger-than-expected proposal to reform credit ratings agency regulation, but the proposal still doesn't go as far as some lawmakers and observers would like.
The proposed legislation, sent to Congress Tuesday, would ban firms from providing consulting services to firms they rate and require agencies to disclose fees issuers pay to obtain ratings. Ratings reports would have to include a history of issuers' fee payments dating back for two years.
It also calls for the disclosure of preliminary ratings sought by firms engaging in "ratings shopping," a practice by which companies seek a range of preliminary ratings, paying only for the highest.
Securities and Exchange Commission Chairman Mary Schapiro called the proposal "a valuable step forward, saying it "will help to better align the interests of credit rating agencies with the investors who rely on them."
"I look forward to working with Congress to ensure that there is meaningful oversight of these influential players in the market," she said.
The legislation, however, doesn't address the issue of making it easier for investors to file and win lawsuits against credit-ratings agencies for knowingly or recklessly failing to review key information, something Schapiro has said could result in higher quality work from the firms.
It could "certainly make a very big difference," she said recently, echoing the sentiments of Sen. Jack Reed, D-R.I.
Reed earlier this year introduced a bill that would make it easier for investors to file class-action cases against credit-rating firms for shoddy work by essentially scaling back some of the protections afforded to credit-rating agencies in the Private Securities Litigation Reform Act of 1995.
Treasury chose not to include a similar type of provision in the proposal in an effort to avoid boosting "blind-faith reliance" on ratings, said Michael Barr, the department's assistant secretary for financial institutions.
"Our view was that including such a provision in the statute would overly inflate the role of credit ratings agencies," he said in a conference call Tuesday. "We're not going to be able to eliminate the need for investors to use their own judgment."
The legislation also doesn't attempt to reform the methods through which major agencies generate revenue.
"This is a non-solution to a massive problem," said Sean Egan, managing director of the Egan-Jones Rating Co. "The incentives for issuing inflated ratings remain healthy and well. Unfortunately, the proposal issued by the Treasury will do nothing to correct that."
Unlike larger ratings firms like Standard & Poor's, Moody's Investors Service and Fitch Ratings which charge issuers for ratings, Egan-Jones earns fees through payments from institutional investors.
S&P, Moody's and Fitch came under scrutiny last year after they gave overly positive ratings to certain kinds of debt, including some backed by subprime mortgages. Critics have assailed the firms, saying their business model creates an inherent conflict because issuers of the structured products pay them to rate the debt.
The proposed legislation does, however, provide for the SEC to examine policies and procedures used in determining ratings. While the SEC would be able to review methodology used by ratings agencies, it wouldn't gain the power to rewrite those business practices.
The SEC also would get a dedicated office through which it could supervise ratings agencies and the power to require firms to register with it. The SEC already has established a branch of examiners specializing in overseeing credit-rating agencies.
Moody's on Tuesday expressed support for the Obama Administration's "goals of increased transparency and enhanced ratings quality," saying in a statement, "We look forward to engaging in a constructive dialogue with the Administration and the Congress over the coming months."
Fitch Ratings CEO Stephen Joynt issued a similar statement, saying the administration's proposal is "generally consistent" with Fitch's views on promoting transparency and managing conflicts of interest.
"Fitch supports a thoughtful review of ways to encourage the market to use ratings in a balanced and constructive manner," Joynt said.
S&P said it still is reviewing the proposal."
- Source: US Treasury Press release, July 21, 2009
Continuing its push to establish new rules of the road and make the financial system more fair across the board, the Administration today delivered proposed legislation to Capitol Hill to increase transparency, tighten oversight, and reduce reliance on credit rating agencies.
The legislation would also work to reduce conflicts of interest at credit rating agencies while strengthening the Securities and Exchange Commission's (SEC) authority over and supervision of rating agencies.
In recent years, investors were overly reliant on credit rating agencies that often failed to accurately describe the risk of rated products. This lack of transparency prevented investors from understanding the full nature of the risks they were taking. The Administration's legislation would tighten oversight of credit rating agencies, protect investors from inappropriate rating agency practices, and bring increased transparency to the credit rating process.
Conflicts of Interest
- Bar Firms From Consulting With Any Company That They Also Rate: Credit ratings agencies will face similar restrictions to other professional service providers, like accountants, and will be prohibited from providing consulting services to companies that contract for ratings.
- Strengthen Disclosure And Management Of Conflicts Of Interest: The legislation will prohibit or require the management and disclosure of conflicts arising from the way a rating agency is paid, its business relationships, affiliations or other conflicts.
- Disclose Fees Paid By An Issuer Along With Each Rating Report: Each rating report will disclose the fees paid by the issuer for a particular rating, as well as the total amount of fees paid by the issuer to the rating agency in the previous two years.
- Look-Back Requirement To Address The Conflicts From A "Revolving Door": If a rating agency employee is hired by an issuer and if the employee had worked on ratings for that issuer in the preceding year, the rating agency will be required to conduct a review of ratings for that issuer to determine if any conflicts of interest influenced the rating and adjust the rating as appropriate.
- Designate A Compliance Officer: Each rating agency will be required to designate a compliance officer – reporting directly to the board or the senior officer of the firm – with direct responsibility over compliance with internal controls and processes. The compliance officer will not be allowed to engage in any rating activities, marketing, sales, or setting of compensation; and will be required to submit a report annually to the SEC.
Transparency & Disclosure
- Require Disclosure Of Preliminary Ratings To Reduce "Ratings Shopping": Currently, an issuer may attempt to "shop" among rating agencies by soliciting `preliminary ratings' from multiple agencies and then only paying for and disclosing the highest rating it received for its product. We would shed light on this practice by requiring an issuer to disclose all of the preliminary ratings it had received from different credit rating agencies so that investors will see how much "shopping" happened and whether there were discrepancies with the final rating.
- Require Different Symbols To Be Used To Distinguish The Risks Of Structured Products: One of the challenges in the current crisis was that investors did not fully realize that the risks posed by structured products such as asset-backed securities are fundamentally different from those posed by corporate bonds, even with similar credit ratings. Our proposal requires rating agencies to use different symbols for structured finance products as an indication of these disparate risks.
- Require Qualitative And Quantitative Disclosure Of The Risks Measured In A Rating: Agencies will be required to provide a much fuller picture of the risks in any rated security through the addition of qualitative and quantitative disclosure of the risks and performance variance inherent in any given security. Ratings cannot be a substitute for investor due diligence. Therefore, to facilitate investor analysis, we will require that each rating also include a clear report containing assessments of data reliability, the probability of default, the estimated severity of loss in the event of default, and the sensitivity of a rating to changes in assumptions. This report will present information in a way that makes it simple to compare this data across different securities and institutions. This additional information will increase market discipline by providing clearer estimates of the risks posed by different investments.
Strengthen SEC authority and supervision
- Establish A Dedicated Office For Supervision Of Rating Agencies: Our legislative proposal establishes a dedicated office within the SEC to strengthen supervision of rating agencies and to carry out the enhanced regulations required.
- Mandatory Registration: Unlike the current voluntary system of registration, our proposal would make registration mandatory for all credit rating agencies. This will bring all ratings firms into a strengthened system of regulation.
- SEC Examination Of Internal Controls And Processes: The SEC will require each rating agency to document its policies and procedures for the determination of ratings. The SEC will examine the internal controls, due diligence, and implementation of rating methodologies for all credit rating agencies to ensure compliance with their policies and public disclosures.
Reduce Reliance on Credit Rating Agencies
- PWG Review of Regulatory Use of Ratings: Treasury will work with the SEC and the President's Working Group on Financial Markets to determine where references to ratings can be removed from regulations.
- SEC Recently Requested Public Comment on Whether to Remove References to Ratings in Money Market Mutual Fund Regulation: As part of a comprehensive set of money market fund reform proposals, the SEC requested public comment on whether to eliminate references to ratings in the regulation governing money market mutual funds, as a way to reduce reliance on ratings. Treasury will work with the SEC to examine opportunities to reduce reliance and increase the resilience of the money market mutual fund industry.
- Require GAO Study On Reducing Reliance: In addition to regulatory efforts to reduce reliance on credit ratings, this legislation would require the GAO to study and issue a report on the reliance on ratings in federal and state regulations.
Strongly support SEC actions on credit rating agencies
- Enable Additional Ratings On Structured Products: Because structured products are often complex and require detailed information to assess, it can be difficult for a rating agency to provide "unsolicited ratings" – ratings on products it was not paid to rate. These ratings, while in existence previously, were ineffective because investors understood that these unsolicited ratings did not benefit from the same information as the fully contracted ratings. The SEC has proposed a rule that would require issuers to provide the same data they provide to one credit rating agency as the basis of a rating to all other credit rating agencies. This will allow other credit rating agencies to provide additional, independent analysis to the market.
- Require Disclosure Of Full Ratings History: The SEC has proposed to require NRSROs to disclose, on a delayed basis, ratings history information for 100% of all issuer-paid credit ratings.
- Strengthen Regulation And Oversight Of Credit Rating Agencies: In response to the credit market turmoil, in February the SEC adopted several measures to increase the transparency of the rating agencies' methodologies, strengthen disclosure of ratings performance, prohibit certain practices that create conflicts of interest, and enhance recordkeeping and reporting obligations to assist the SEC in performing its regulatory and oversight functions. The SEC has allocated resources to establish a branch of examiners dedicated specifically to conducting examination oversight of rating agencies.
The President's Plan
The President's Whitepaper for financial markets reform says about credit rating agencies:
“The SEC should continue its efforts to strengthen the regulation of credit rating agencies, including measures to promote robust policies and procedures that manage and disclose conflicts of interest, differentiate between structured and other products, and otherwise strengthen the integrity of the ratings process.”
Proposed legislation by the US Congress
- S. 1073, Senator Reed's bill
A bill to provide for credit rating reforms, and for other purposes. Sponsored by Sen. Jack Reed.
- Accountability and Transparency in CRA Act
- Source: The Accountability and Transparency in Credit Rating Agencies Act - H.R. 3890 approved by a vote of 49-14. (House)
Congressman Paul E. Kanjorski (D-PA), Chairman of the House Financial Services Subcommittee on Capital Markets, Insurance, and Government Sponsored Enterprises today sponsored the Accountability and Transparency in Credit Rating Agencies Act.
- Source: Response to the Discussion Draft/Enhanced Accountability and Transparency in Rating Agencies Act Kurt Schacht, Managing Director of the CFA Institute Centre for Financial Market Integrity, September 30, 2009
- H.R. 2549 Muni bond fairness act
- To ensure uniform and accurate credit rating of municipal bonds and provide for a review of the municipal bond insurance industry. Sponsored by Chairman Frank.
- Government Finance Officers Association letter in support of standardizing (uniform) rating scales between corporate and municipal issuers.
The current US law for credit rating agencies
SEC rules and oversight
- Source: Emerging Regulation of Credit Rating Agencies FinReg21, December 14, 2009
"...Since September 2006, the Commission has engaged in several rounds of rulemaking and has conducted examinations of NRSROs under its new authority. The first round of rulemaking established the Commission’s rating agency oversight program. Specifically, in June 2007 the Commission adopted six rules and an application and public disclosure form.
The first rule, among other things, requires an NRSRO to publicly disclose information about the firm’s: (1) ratings performance statistics (e.g., default and transition statistics); (2) methodologies for determining credit ratings; (3) policies for preventing the misuse of material non-public information; (4) organizational structure; (5) code of ethics; (6) conflicts of interests; (7) policies for managing conflicts of interest; (8) credit analysts; and (9) designated compliance officer.
The second rule, among other things, requires an NRSRO to make and retain certain financial records; document the identities of the credit analysts who determine a rating action and persons who approve the rating action; document the identities of issuers that have paid for ratings and the ratings determined for them; and document all ratings methodologies. NRSROs also are required to retain records such as compliance and internal audit reports, marketing materials, and communications (e.g., emails) relating to determining ratings actions. 
The third rule, among other things, requires an NRSRO, on a confidential basis, to furnish the SEC with annual reports that include: (1) audited financial statements; (2) an unaudited report of revenues received from the different types of rating services offered by the NRSRO; (3) an unaudited report of the aggregate and median compensation of the NRSRO’s credit analysts; and (4) an unaudited report of the 20 largest clients of the NRSRO as determined by revenues received.
The fourth rule, among other things, requires an NRSRO to establish, maintain, and enforce procedures reasonably designed to prevent: the inappropriate dissemination of material, non-public information received during the rating process; the trading of securities while in possession of material, non-public information; and the selective disclosure of a pending ratings decision.
The fifth rule, among other things, requires an NRSRO to disclose and manage each conflict of interest resulting from its business activities, including from the issuer-pay and the subscriber-pay models. It also prohibits an NRSRO from having the following conflicts: (1) receiving more than 10% of its annual revenues from a single client; (2) having an analyst rate or approve the rating for a security the analyst owns; (3) rating an affiliate; and (4) having an analyst rate or approve the rating for a security of a company where the analyst is a director or officer of the company. 
Lastly, the sixth rule, among other things, prohibits an NRSRO from engaging in certain practices that are unfair, coercive, or abusive. Such practices include: (1) conditioning a rating on the rated person buying another service of the NRSRO; (2) deviating or threatening to deviate from established methodologies for determining credit ratings because an issuer did not agree to pay for the rating; (3) modifying or threatening to modify a rating because the issuer does not agree to continue to pay for the rating; and (4) employing a methodology for rating structured finance products that discounts or “notches,” for anticompetitive purposes, the ratings of other NRSROs for assets underlying the structured finance product. 
In September 2007, the first seven credit rating agencies were registered with the Commission as NRSROs. Around that time, and in response to gradually worsening market conditions, the Commission used its new oversight authority to initiate examinations of the three largest NRSROs. Specifically, the Commission staff examined Fitch, Moody’s, and Standard & Poor’s and reviewed their policies and practices relating to ratings of structured finance products linked to aggressively underwritten mortgages. The period reviewed by the examination generally covered January 2004 through July 2008. All three NRSROs agreed to undertake remedial actions as a result of the examinations. The staff published a summary of their findings and observations in July 2008.
The examinations revealed a number of troubling results. In particular, the examinations raised serious questions about the NRSROs’ management of: (1) conflicts of interest, (2) internal audit processes, and (3) due diligence activities.
For example, the examiners found that analysts appeared to be aware, when rating an issuer, of the firm’s business interest in securing the rating of the deal; that there did not appear to be any internal effort to shield analysts from emails and other communications that discussed fees and revenues from the issuers; and that, in some instances, analysts were involved in fee discussions for a rating. In addition, the NRSROs did not appear to take steps to prevent the possibility that considerations of market share and other business interests could influence ratings or ratings criteria. Accordingly, the staff recommended that each NRSRO consider and implement steps that would insulate or prevent the possibility that considerations of market share and other business interests could influence ratings or ratings criteria.
The examiners found that the internal audits of the ratings processes of two NRSROs appeared to be inadequate. For example, at one NRSRO, the internal audits of its RMBS and CDO groups constituted a one-page checklist to evaluate the completeness of deal files. As a consequence of the examinations, the staff recommended that two of the NRSROs review whether their internal audit functions are adequate and whether they provide for proper management follow-up.
The staff found that the NRSROs did not engage in due diligence or otherwise seek to verify the accuracy or quality of the loan data underlying the RMBS pools they rated during the review period. The NRSROs each relied on the information provided to them by the sponsor of the RMBS.
The findings from these initial examinations informed another round of rule amendments, which the Commission proposed in June 2008 and adopted in February 2009. These amendments enhanced requirements to disclose ratings performance statistics and ratings methodologies, and imposed additional recordkeeping and reporting requirements. They also prohibited additional conflicts of interest; in particular, the conflict of rating a product that the NRSRO or its affiliate had provided advice on how to structure.
In September 2009, the Commission adopted additional amendments. One amendment is designed to create a mechanism for NRSROs not hired to rate structured finance products to nonetheless determine and monitor credit ratings for these instruments. To this end, the new amendments require an NRSRO that is hired to provide an initial credit rating for a structured finance product to disclose on a password-protected Internet website: (1) that it is in the process of determining such a credit rating; and (2) the location where information provided by the issuer to determine and monitor the credit rating can be located. The hired NRSRO must make this information available to any other NRSRO that provides it with a copy of a certain certification. The hired NRSRO also is required to obtain representations from the arranger that, among other things, the arranger will provide the same information to the non-hired NRSROs.
The design of this rule is to enable non-hired NRSROs to provide unsolicited ratings in the structured finance market, just as is done in the corporate debt market. NRSROs can determine unsolicited ratings in the corporate debt market using information filed with the Commission by public companies. There have been calls to make the structured finance market more transparent by enhancing issuer disclosure requirements. This new rule – by requiring issuers to disclose information to all NRSROs – is an incremental step in that direction. The goal is to improve the quality of credit ratings by increasing the number of NRSROs (hired and not hired) that rate structured finance products.
The second amendment adopted by the Commission requires an NRSRO to disclose, on a delayed basis, ratings history information in a downloadable format for all credit ratings initially determined on or after June 26, 2007. This new disclosure requirement is designed to foster greater transparency of ratings quality as well as increase accountability among NRSROs, by making it easier for persons to analyze the actual performance of credit ratings. To this end, the ratings history information will generate “raw data” that market observers can use to statistically analyze performance across NRSROs.
Current SEC rules
- XBRL Implementation Guide for Nationally Recognized Statistical Rating Organizations SEC
- Final Rule: Amendments to Rules for Nationally Recognized Statistical Rating Organizations (February 2, 2009)
- Final Rule: Oversight of Credit Rating Agencies Registered as Nationally Recognized Statistical Rating Organizations (June 5, 2007)
- Source More SEC Rulemaking on NRSROs Securities Law Prof Blog, November 24, 2009
The SEC continues its rulemaking to improve rating agencies. Today it adopted rule amendments that impose additional disclosure and conflict of interest requirements on nationally recognized statistical rating organizations (“NRSROs”) in order to address concerns about the integrity of the credit rating procedures and methodologies at NRSROs.
In addition, the agency is proposing rule amendments and a new rule that would impose additional requirements on nationally recognized statistical rating organizations (“NRSROs”). The proposed amendments and rule would require an NRSRO:
- to furnish a new annual report describing the steps taken by the firm’s designated compliance officer during the fiscal year with respect to compliance reviews, identifications of material compliance matters, remediation measures taken to address those matters, and identification of the persons within the NRSRO advised of the results of the reviews;
- to disclose additional information about sources of revenues on Form NRSRO; and
- to make publicly available a consolidated report containing information about revenues of the NRSRO attributable to persons paying the NRSRO for the issuance or maintenance of a credit rating.
Finally, the SEC announced that it is deferring consideration of action with respect to a proposed rule that would have required an NRSRO to include, each time it published a credit rating for a structured finance product, a report describing how the credit ratings procedures and methodologies and credit risk characteristics for structured finance products differ from those of other types of rated instruments, or, alternatively, to use distinct ratings symbols for structured finance products that differentiated them from the credit ratings for other types of financial instruments.
The SEC is also soliciting comments regarding alternative measures that could be taken to differentiate NRSROs’ structured finance credit ratings from the credit ratings they issue for other types of financial instruments through, for example, enhanced disclosures of information.
The Commission also is soliciting comment on whether the rule amendments being adopted today in a separate release designed to remove impediments to determining and monitoring non-issuer-paid credit ratings for structured finance products should be extended to create a mechanism for determining non-issuer-paid credit ratings for structured finance products that were issued prior to the rule becoming effective (e.g., to allow for non-issuer-paid credit ratings for structured finance products of the 2004-2007 vintage).
SEC puts money funds NRSRO designations on hold
- SEC Issues No-Action Letter, Allows Putting NRSRO Designations on Hold Crane Data, August 23, 2010
At the end of last week, the U.S. Securities & Exchange Commission issued a "no-action" letter entitled "Investment Company Act of 1940 -- Section 2(a)(41) and Rules 2a-4 and 22c-1 Investment Company Institute Designated NRSROs", which allows fund board to delay implementation of the designation of NRSROs (nationally-recognized statistical ratings organization) until further notice.
In the letter, the SEC's Associate Director of the Division of Investment Management Robert Plaze writes Investment Company Institute General Counsel Karrie McMillan, "As you know, the amendments to rule 2a-7 under the Investment Company Act of 1940 that the Commission adopted last February require boards of directors of money market funds to designate at least four nationally recognized statistical rating organizations ('NRSROs') whose ratings the fund would use to determine the eligibility of portfolio securities under the rule. The rule also requires funds to disclose designated NRSROs in their statements of additional information. In order to meet the December 31, 2010 compliance date, boards of directors will likely have to designate NRSROs no later than the Fall of this year."
Equivalent disclosure for SF to begin June 2, 2010
- Source: New Information-Posting Requirements for Issuers, Sponsors and Underwriters of Rated SF Securities Credit Writedowns, March 9, 2010
Rules adopted in November 2009 by the Securities and Exchange Commission (the SEC) under the Credit Rating Agency Reform Act of 2006 will require issuers, sponsors or underwriters (referred to as “arrangers”) of structured finance securities to post on a password-protected internet website, the information provided by arrangers to credit rating agencies hired by an arranger to rate or monitor the credit ratings of the securities. The new rules will require the arranger to provide access to the website to other credit rating agencies that provide the arranger with a required certification.1 The deadline for compliance with these new rules is June 2, 2010.
Rules 17g-5(a) and 17g-5(b) under the Securities Exchange Act (the Exchange Act) require credit rating agencies registered with the SEC (NRSROs) to disclose and manage certain specified types of conflicts of interest and prohibit NRSROs from rating securities where other specified conflicts of interest exist. The recently adopted Rule 17g-5(b)(9) identifies as a new conflict (referred to as an “issuer-pay” conflict) the issuance or maintenance by an NRSRO of a credit rating for a security or money market instrument issued by an asset pool or as part of any asset-backed or mortgage-backed securities transaction (referred to as a “structured finance product”)2 that was paid for by a related arranger.
New Rule 17g-5(a)(3) will require each hired NRSRO to maintain a password-protected internet website listing each structured finance product for which the hired NRSRO is in the process of determining an initial credit rating and for which there is an issuer-pay conflict. The list must be in chronological order and identify the type of structured finance product, the name of the issuer, the date the rating process was initiated and the internet website address where the issuer, sponsor or underwriter of the structured finance product provides the required information described below. Once the hired NRSRO issues the final credit rating or determines that it will not provide a final credit rating on a structured finance product, information on that structured finance product may be removed from the list.
The hired NRSRO will be required to provide free, unlimited access to the website to any other NRSRO that provides the hired NRSRO with the certification specified in Rule 17g-5(e) under the Exchange Act (described below). The SEC’s stated purpose for requiring the hired NRSRO’s listing is to alert other NRSROs to the new transactions and to direct them to the arranger’s website to obtain the information that would enable the non-hired NRSROs to rate and monitor the structured finance products on an unsolicited basis.
A hired NRSRO also will have to obtain from the issuer, sponsor or underwriter of a structured finance product with an issuer-pay conflict a written representation that can reasonably be relied upon that the issuer, sponsor or underwriter:
- will maintain an identified password-protected internet website that includes all information an arranger provides to the hired NRSRO, or contracts with a third party to provide, for the purpose of determining the initial credit rating and for undertaking credit rating surveillance for the structured finance product, in each case at the same time the information is provided to the hired NRSRO; and
- will provide access to the website to any NRSRO that provides a 17g-5(e) certification.
The website maintained by the arranger also must identify the information currently used to determine or monitor the credit ratings.3 Note that the rule applies to all information provided to a hired NRSRO and in the text of the adopting release, the SEC contemplates a transition to a more formalized process through which structured finance products will be rated. “The [SEC] acknowledges that the requirements of paragraph (a)(3) of Rule 17g–5 as a whole likely will formalize the process of information exchange from the arranger to the NRSRO for structured finance products, including the written submission of information that may, in the past, have been provided orally.”4
Under Rule 17g-5(e), any NRSRO accessing a password-protected internet website of an arranger or a hired NRSRO listing issuer-pay conflict structured finance products will be required to provide an annual certification to the SEC (with a copy to the arranger and the hired NRSRO) that, among other things, such non-hired NRSRO:
- is accessing the website solely for purposes of determining or monitoring credit ratings;
will keep the information it accesses confidential and treat it as material non-public information; and
- will determine and maintain credit ratings for at least 10% of the issued structured finance products for which it accesses information if it accesses information for 10 or more issued structured finance products in the calendar year covered by the certification.
In order to monitor compliance with the Rule 17g-5(e) certifications, Rule 17g-5(a)(3)(ii) limits access to the issuer-pay NRSRO lists and arranger information to NRSROs, which are registered with, and regulated by, the SEC, rather than all credit rating agencies.
Corresponding Amendments to Regulation FD.
Regulation FD contains the SEC’s rules addressing selective disclosure and generally requires that an issuer of a security publicly disclose material non-public information if the issuer, or any person acting on its behalf, provides the material non-public information to certain enumerated persons. Information provided to credit rating agencies solely for the purpose of determining a credit rating that is publicly available is excepted from the public disclosure requirements of Regulation FD. As adopted, Rule 100(b)(2)(iii) under Regulation FD expands this exception to cover information provided to NRSROs pursuant to Rule 17g-5(a)(3) regardless of whether the credit rating is publicly available. Therefore, information provided to “subscriber pay” NRSROs, the credit ratings of which are generally private, pursuant to Rule 17g-5(a)(3), would not be subject to the Regulation FD disclosure requirements.
If you have questions about any of these items, please contact your regular Sidley Austin LLP contact.
- The text of the new rules, together with the adopting release, is available at here. In contrast to the originally proposed rules, the information provided by the arranger is not required to be made available to the public. See Recent Developments Related to Credit Ratings on Structured Finance Securities; SEC Proposes New Rules under the Credit Rating Agency Act of 2006, Sidley Austin LLP, June 26, 2008 available at here and SEC Adopts Final Rule Amendments and Proposes New Rules under the Credit Rating Agency Reform Act of 2006, Sidley Austin LLP, February 23, 2009, available here for a summary of the rules as originally proposed and the re-proposed rules, respectively.
- The SEC specifically states in the adopting release, that the reference to a security or money market instrument issued by an asset pool or as part of any asset-backed or mortgage-backed securities transaction is not limited to asset-backed securities as defined in Regulation AB, and also states that “the [SEC] intends this provision . . . to cover the full range of structured finance products, including, but not limited to, securities collateralized by static and actively managed pools of loans or receivables (e.g., commercial and residential mortgages, corporate loans, auto loans, education loans, credit card receivables, and leases), collateralized debt obligations, collateralized loan obligations, collateralized mortgage obligations, structured investment vehicles, synthetic collateralized debt obligations that reference debt securities or indexes, and hybrid collateralized debt obligations.” See adopting release at page 63844.
- For example, if the pool collateral changed, the arranger website would need to identify the current pool information and the information used by the hired NRSRO in the final rating.
- See adopting release at page 63847.
- What Rule 17g-5 looks like FT Alphaville, July 29, 2010
- ABS market freed! Ford rejoices! Ratings agencies make provisos! FT Alphaville, July 28, 2010
Moody's will standardize rating scales
- Source: Moody’s Muni Bond Ratings Will Move to Global Scale (Update2) March 16, 2010, Bloomberg
Municipal debt rankings by Moody’s Investors Service will shift to a global rating system next month that will put the 70,000 state and local bonds it assesses on a scale that’s comparable with corporate securities.
“We are responding to the evolving needs of the market for greater comparability between the ratings of these obligations and those issued by other entities,” Gail Sussman, group managing director at New York-based Moody’s, said in a press release today.
The new ratings don’t “represent a change in our opinion of the credit quality of affected issuers.” U.S. Representative Barney Frank, a Massachusetts Democrat who chairs the House Financial Services Committee, called the different rating scales “ridiculous” at a hearing on the $2.8 trillion market in May 2008.
The Moody’s announcement came a day after Senator Christopher Dodd proposed, as part of the biggest Wall Street regulatory overhaul since the 1930s, that municipalities be assessed in the same manner as companies. The same requirement was included in Frank’s financial-services legislation last year.
“This represents a transfer of money from wealthy investors back to municipalities,” Frank said in a telephone interview. “This recognizes what we have been saying all along.”
SEC, FBI and DOJ examining raters
- Source: Feds target rating agencies' role in meltdown AP, December 9, 2009
"Enforcement officials from the Securities and Exchange Commission and Justice Department said Wednesday that their staffs are targeting the role of Wall Street rating agencies in the financial meltdown.
The three dominant agencies -- Moody's Investors Service, Standard & Poor's and Fitch Ratings -- have been widely criticized for failing to give investors adequate warning of the risks in subprime mortgage securities, whose collapse touched off the financial crisis.
SEC Enforcement Director Robert Khuzami told the Senate Judiciary Committee that his staff is "looking very closely at credit rating agencies" and is "focused on that area."
A 2007 law empowers the SEC to bring enforcement actions against rating agencies based on false statements they may have made, he said.
Assistant U.S. Attorney General Lanny Breuer said the Justice Department also is "looking at" rating agencies.
New York Attorney General Andrew Cuomo pursued the three big Wall Street raters last year, securing an agreement from them to overhaul how they evaluate investments backed by risky mortgage debt. The accord was meant to end what the industry calls "ratings shopping" that pits the agencies against one another.
The agencies are crucial financial gatekeepers. Their grades of creditworthiness can be key factors in determining at what cost securities will be purchased by banks, mutual funds, state pension funds or local governments.
Khuzami, Breuer and Kevin Perkins, assistant director of the FBI's Criminal Investigative Division, detailed federal efforts to pursue fraud and rising abuses in the aftermath of the financial crisis.
Mortgage fraud, which spiked to record levels in the wake of the subprime loan collapse in 2007, is an especially intense area of focus by federal and state prosecutors. Mortgage fraud investigations by the FBI now total more than 2,700, compared with 881 three years ago..."
Moody's publicly reprimanded by SEC
- Source: SEC Says It Declined to Sue Moody’s for Fraud Over CDO Ratings Bloomberg, August 31, 2010
The U.S. Securities and Exchange Commission said today that it decided not to pursue a fraud case against Moody’s Investors Service over the company’s ratings of collateralized-debt obligations in 2007.
The SEC released a report saying that even after discovering that some CDO ratings were incorrect, a Moody’s committee decided not to correct them, “in part because of concern that doing so would negatively impact” Moody’s reputation.
The SEC said it decided not to bring a fraud case against Moody’s because of jurisdictional “uncertainties.”
- SEC Says Dodd-Frank Law Lets Agency Chase Overseas Ratings Fraud Bloomberg, September 1, 2010
- Report of Investigation Pursuant to Section 21(a) of the Securities Exchange Act of 1934: Moody's Investors Service, Inc. SEC, August 31, 2010
SEC IG Audit Report, August, 2009
- “The SEC’s Role Regarding and Oversight of Nationally Recognized Statistical Rating Organizations (NRSROs)”, Office of the Inspector General of the SEC
- Source: S.E.C. Audit Urges Changes to Rating Agency Rules New York Times, August 28, 2009
The inspector general of the Securities and Exchange Commission said in a report released Friday that the commission has “historically been slow to act” in regulating the nation’s credit ratings agencies before the financial crisis and recommended a broad range of improvements to the S.E.C.’s oversight.
The report, released Friday, also called for further evaluation of several controversial policies, such as the ability of debt issuers to shop among different rating agencies for the highest possible rating.
The S.E.C. ordered the internal audit after the financial crisis raised serious questions about the rating agencies, including Moody’s, Fitch and Standard and Poor’s, which often gave top ratings to mortgage-backed securities that now may be worthless.
The audit report found that the commission delayed adopting rules on the rating agencies, and sometimes failed to follow the rules that existed.
- SEC Criticized on Raters WSJ, August 29, 2009
SEC 2008 Examinations of Select Credit Rating Agencies
Federal Reserve rules for TALF lending
- Source: Final Rule: Extensions of Credit by Federal Reserve Banks Federal Reserve System, December 4, 2009
SUMMARY: This final rule amends Regulation A to provide a process by which the Federal Reserve Bank of New York may determine the eligibility of credit rating agencies in the Term Asset-backed Securities Loan Facility. The final rule does not apply to discount window lending or other extensions of credit provided by the Federal Reserve System. In addition, the final rule only applies to asset-backed securities that are not backed by commercial real estate. The amendment does not represent a change in the stance of monetary policy.
- Source: Which nationally recognized statistical rating organizations (NRSROs) will be eligible rating agencies for ABS other than CMBS? Federal Reserve Bank of New York, December, 2009
The set of eligible credit rating agencies will be determined by the New York Fed in accordance with a final rule adopted by the Federal Reserve Board that establishes criteria in designating an NRSRO as TALF-eligible within each of the seven non-mortgage-backed ABS TALF asset sectors referenced in the TALF haircut schedule (excluding securities backed by collateral originated under SBA's 7(a) and 504 programs which do not require credit ratings). The set of NRSROs eligible pursuant to the final rule will take effect commencing with the February 2010 non-mortgage-backed ABS subscription. The current list of TALF-eligible NRSROs specified in the FAQs will continue to apply for the December and January non-mortgage-backed ABS subscriptions.
Under the rule, credit rating agencies that wish to have their ratings accepted for TALF transactions should send a written notice as soon as possible to the Credit, Investment and Payment Risk Group of the New York Fed including the information required by the rule. Such written notice can be submitted via the TALF mailbox (firstname.lastname@example.org, placing "Credit Rating Agency Submission" in the subject line). Any questions about the process or required documentation should be forwarded to the same mailbox address with the same subject line. The New York Fed intends to announce the list of TALF-eligible rating agencies for the February 2010 non-mortgage-backed ABS subscription as soon as possible after it has completed its review of the submissions and notified each of the applicable credit rating agencies regarding its eligibility to have its ratings accepted at TALF.
Global regulatory efforts on credit rating agencies
State insurance commissioners pick PIMCO to replace raters
- Pimco Picked by Regulators to Evaluate Mortgage Bonds Bloomberg, November 17, 2009
Pacific Investment Management Co., manager of the world’s largest bond fund, was selected by the National Association of Insurance Commissioners to help assess companies’ portfolios of residential mortgage-backed securities.
Pimco will help evaluate about 18,000 RMBS owned by U.S. insurers, the NAIC said in a statement today. The evaluations will help regulators determine how much capital insurers need to guard against losses on slumping home-loan investments.
Regulators are seeking assistance in valuing investments after the housing slump pushed up mortgage defaults. State insurance commissioners, which monitor portfolios to make sure carriers have enough money to pay claims, discontinued their use of RMBS credit grades issued by ratings firms including Moody’s Investors Service after downgrades caused a fivefold increase in capital requirements this year.
Pimco, a unit of Munich-based Allianz SE, was selected from a short list of 11 vendors that were considered by the NAIC, the regulator group said. Mark Porterfield, a spokesman for Pimco, didn’t immediately return a call seeking comment.
- Source: NAIC Calls Ratings Firms To Defend Their Work, National Underwriter, September 10, 2009
State insurance commissioners plan to grill the top credit rating agencies as to why the commissioners shouldn’t seek other guidance in evaluating insurers’ securities holdings, a key regulator said.
“The commissioners are going in with an open mind, but there’s been a lot of criticism out there,” said Hampton Finer, deputy superintendent and chief economist with the New York Insurance Department.
Mr. Finer spoke in advance of a hearing set for Sept. 24 by a unit of the National Association of Insurance Commissioners, to which the Nationally Recognized Statistical Rating Organizations (NRSROs) have all been invited.
NAIC evaluates the holdings of insurers, and based on how the NRSROs rate the carriers’ securities, the NAIC sets a minimum required amount of capital reserves that the insurer most hold against possible equity losses, Mr. Finer said.
Mr. Finer said there was a “view that there’s been an overreliance on rating agencies,” mentioning recommendations by the U.S. Treasury and the Group of 20 Finance Ministers and Central Bank Governors.
He said the NAIC Rating Agency Working Group, which has invited insurance companies, pension funds and others to testify on the NAIC reliance on NRSRO ratings, will among other things ask about ratings of “structured securities where there’s been a problem.”
As an example, he mentioned residential- mortgage backed securities that plunged in value after receiving satisfactory ratings from the NRSROs.
Mr. Finer said the Working Group has sent the NRSROs questionnaires and have received “voluminous responses that were quite helpful,” but he said the NAIC wants clarification of some questions that were not answered completely.
NAIC, he said, does not believe the NRSROs have a monopoly on good rating models for securities, and the organization may perhaps use “another vendor to do some calculations and use those to develop and appropriate capital charge” for insurers.
The organization wants to “see if anybody else has a better mousetrap that can provide better warnings and more transparency,” noting that there “are a lot of folks that have very advanced models that are quite state of the art.
He mentioned Black Rock, Risk Metrics and Andrew Davidson among other firms.
Rating firms that were contacted had no immediate comment.
In its announcement of the hearing, which will be held at Gaylord Convention Center in National Harbor Md., the NAIC noted that insurance companies hold nearly $3 trillion in rated bonds, and the insurance industry constitutes the largest sector of the financial services industry to rely on credit ratings to supervise capital asset adequacy.
Insurance regulators, it noted, currently mandate the use of credit ratings to determine capital reserves and other regulatory requirements for insurance companies.
The Working Group is co-chaired by Acting New York Insurance Superintendent James J. Wrynn and Illinois Insurance Director Michael T. McRaith.
According to the announcement, the hearing will examine the historical reliance of insurance regulators on ratings and the impact of this reliance.
Issues concerning ratings, particularly related to structured securities and municipal bonds, recent systemic remedies or procedural changes enacted by NRSROs, recommendations and alternatives to NRSROs for prudential regulation, will also be looked at.
Following the hearing, the Working Group said it will develop and present a final report documenting the findings and any recommendations for corrective action available to the NAIC and its members, as well as recommendations to the federal government on NRSRO regulation.
California AG subpoenas raters
- Source: California AG launches probe of credit rating agencies Associated Press,September 17, 2009
California's attorney general said Thursday his office is investigating Wall Street's big credit rating agencies to determine what role they may have played in the collapse of the financial markets.
Attorney General Jerry Brown said he has issued subpoenas to Moody's Investors Service, Standard & Poor's and Fitch Ratings to determine whether they violated state law in "recklessly giving stellar ratings to shaky assets."
The agencies are crucial financial gatekeepers, and investors depend on their ratings of public companies and securities to gauge risk and make investment decisions.
At the peak of the housing boom, the agencies gave their highest ratings to securities backed by subprime mortgages that later fell apart. The agencies had to downgrade thousands of securities as the value of those investments plummeted, contributing to hundreds of billions of dollars in losses and write-downs at big banks and investment firms.
The rating agencies either ignored or didn't understand the risks, Brown said. He added that the agencies made billions of dollars in revenue from the securities they rated.
Michael Adler, a spokesman for Moody's, said the company will review Brown's inquiry "and we will offer our cooperation as appropriate."
Chris Atkins, a spokesman for Standard & Poor's, said the agency couldn't comment because it hasn't yet seen the subpoena. A representative of Fitch did not immediately return a call for comment.
Brown gave the agencies an Oct. 19 deadline to respond to the subpoenas to determine whether they did due diligence in the rating process and whether they profited from giving inaccurate ratings to particular securities, among other questions.
Brown's announcement came the same day federal regulators proposed new rules designed to stem conflicts of interest and provide more transparency on the credit rating industry. The five members of the Securities and Exchange Commission voted at a public meeting to propose rules that would open the agencies' practices to wider public view and subject them to some restraints.
One SEC proposal discussed Thursday is intended to bar companies from "shopping" for favorable ratings of their securities.
California's probe comes on the heels of similar investigations under way in other states.
In July, the California Public Employees' Retirement System sued Moody's, Fitch and S&P, saying they lured the fund into bad investments. The nation's largest public pension fund blames them for more than $1 billion in investment losses.
Calpers sues rating agencies
Source: Calpers Sues Rating Companies Over $1 Billion Loss July 15 (Bloomberg)
"The California Public Employees’ Retirement System, the largest U.S. public pension fund, sued the three major bond-rating companies for $1 billion in losses it said were caused by “wildly inaccurate” risk assessments.
Standard & Poor’s, Moody’s Investors Service and Fitch Ratings used methods to analyze medium-term notes and commercial paper that were “seriously flawed in conception and incompetently applied,” Calpers said in a lawsuit filed July 9 in state court in San Francisco.
The companies all gave their highest ratings to Cheyne Finance Ltd., Stanfield Victoria Funding LLC and Sigma Finance Inc., prompting Calpers to invest in them in 2006, the fund said in its complaint. The Structured Investment Vehicles collapsed in 2007 and 2008, defaulting on payments to Calpers, it said. The underlying assets of the three firms, Calpers said, consisted primarily of risky subprime mortgages."
N.Y. insurance regulator suggests limiting Moody’s as rater
- Source: N.Y. Insurance Regulator Suggests Limiting Moody’s as Rater Bloomberg, September 19, 2009
"New York state’s insurance regulator suggested Moody’s Investors Service should have its authorization to rate insurers’ holdings scaled back after the firm declined to attend a public hearing set for next week.
“This is the thing that forces one to ask questions about the role that a company like that can play in our regulatory system,” Hampton Finer, deputy superintendent and chief economist at the New York Insurance Department, said yesterday in a phone interview. “We think there should be discussion about whether Moody’s will have its authorization status going forward or having it curtailed in some fashion.”
Finer said he may advocate that regulators throughout the country rely on Moody’s competitors to rate securities held by insurance companies. Moody’s could lose business if that that happens, he said. Insurers can hold certain securities without explicit regulatory approval if those investments are rated by an authorized firm.
Standard & Poor’s, Fitch Ratings and Dominion Bond Rating Service Ltd. plan to meet next week with U.S. state regulators on the role the firms play in grading the insurers’ fixed-income holdings, the National Association of Insurance Commissioners said in a statement posted on the Web. Moody’s was invited and won’t attend, said Scott Holeman, a spokesman for the NAIC.
Thomas Lemmon, a spokesman for Moody’s, declined to immediately comment. Vanessa Sink, a spokeswoman for the NAIC, declined to discuss Finer’s remarks.
New York Insurance Superintendent James Wrynn and Michael McRaith of Illinois convened the meeting as heads of a group appointed by the NAIC to evaluate watchdogs’ reliance on the firms. U.S. insurance companies hold about $3 trillion in rated bonds including corporate debt and mortgage-linked bonds."
Source:SEC Considering Rule to Curb Credit-Rating ‘Shopping’ Bloomberg, July 14, 2009
"U.S. Securities and Exchange Commission Chairman Mary Schapiro said the agency will consider rules to keep debt underwriters from soliciting ratings from firms willing to assign the highest letter grade.
The SEC staff has been told to research regulations to prevent “rating shopping” where firms gain business in return for generous grades, Schapiro said in testimony prepared for a House Financial Services subcommittee hearing today.
One approach would require issuers to release preliminary ratings from firms such as Standard & Poor’s and Moody’s Investors Service before one is hired to give a final ranking, she said.
The SEC is moving to curb conflicts at rating companies after S&P, Moody’s and Fitch Ratings were faulted by lawmakers for assigning mortgage bonds their highest rankings and maintaining the assessments after home-loan defaults accelerated in 2007. Shopping remains a “problem,” Andrew Kimball, Moody’s head of global structured finance business, said last month.
The Federal Reserve’s Term Asset-Backed Securities Loan Facility, which makes low-cost loans to investors buying AAA- rated debt instruments, puts issuers under pressure to get a top rating, regardless of the quality of the evaluation, Kimball said June 4, during the company’s investor day.
The SEC has established a unit of examiners to oversee the rating firms, Schapiro said today. The agency may also require disclosure of data used to create rankings, a step that could encourage unsolicited ratings by letting companies grade bonds even if they weren’t paid by debt underwriters.
“Then you would have competition and diversity of perspective about the quality” of new instruments, Schapiro told lawmakers.
The SEC in December approved rules prohibiting credit- rating analysts who assess debt from discussing fees with underwriters. The agency also limited gifts from securities firms to rating-company employees and restricted analysts from offering advice on structuring securities to win top grades.
Additional measures required firms to publish statistics showing how well their ratings predicted the risk of default and disclose how frequently grades are re-evaluated."
"Bankers said ‘Anything’ to get high rating"
- Source: Bankers Said ‘Anything’ to Get High Rating, S&P Ex-Analyst Says Bloomberg, April 26, 2010
Just past midnight on May 3, 2005, Standard & Poor’s analyst Chui Ng e-mailed co-workers to broker a solution to demands by Goldman Sachs Group Inc. bankers that he said violated two or more of the ratings company’s internal guidelines.
Goldman Sachs was adding $200 million in debt at the “last minute” to a $1.5 billion bond pool called Adirondack Ltd., Ng wrote. That meant the New York investment bank would originate 13 percent of the pool itself, two-and-a-half times the 5 percent limit set by S&P.
Goldman Sachs also balked at Ng’s request to pay in advance for an insurance policy known as a credit default swap, which was being used to create the additional debt obligation.
The e-mails from Ng, who negotiated a compromise on Goldman Sachs’s requests, provide a rare window into the back-and-forth between the bank and a rating company assessing the risks in a financial product linked to subprime mortgages. The exchange was among 581 pages of private communications released last week by Senate investigators.
NY AG opens investigation into investment banks
- Source: Prosecutors Ask if 8 Banks Duped Rating Agencies New York Times, May 13, 2010
"...The agencies themselves have been widely criticized for overstating the quality of many mortgage securities that ended up losing money once the housing market collapsed. The inquiry by the attorney general of New York, Andrew M. Cuomo, suggests that he thinks the agencies may have been duped by one or more of the targets of his investigation.
Those targets are Goldman Sachs, Morgan Stanley, UBS, Citigroup, Credit Suisse, Deutsche Bank, Crédit Agricole and Merrill Lynch, which is now owned by Bank of America.
The companies that rated the mortgage deals are Standard & Poor’s, Fitch Ratings and Moody’s Investors Service. Investors used their ratings to decide whether to buy mortgage securities.
Mr. Cuomo’s investigation follows an article in The New York Times that described some of the techniques bankers used to get more positive evaluations from the rating agencies.
Mr. Cuomo is also interested in the revolving door of employees of the rating agencies who were hired by bank mortgage desks to help create mortgage deals that got better ratings than they deserved, said the people with knowledge of the investigation, who were not authorized to discuss it publicly..."
Credit rating agency definition
A credit rating agency (CRA) is a company that assigns credit ratings for issuers of certain types of debt obligations as well as the debt instruments themselves. In some cases, the servicers of the underlying debt are also given ratings. In most cases, the issuers of securities are companies, special purpose entities, state and local governments, non-profit organizations, or national governments issuing debt-like securities (i.e., bonds) that can be traded on a secondary market. A credit rating for an issuer takes into consideration the issuer's credit worthiness (i.e., its ability to pay back a loan), and affects the interest rate applied to the particular security being issued. (In contrast to CRAs, a company that issues credit scores for individual credit-worthiness is generally called a credit bureau or consumer credit reporting agency.)
The value of such ratings has been widely questioned after the 2008 financial crisis when the Securities and Exchange Commission submitted a report to Congress detailing plans to launch an investigation into the anti-competitive practices of credit rating agencies and issues including conflicts of interest.
Credit rating agencies have been subject to the following criticisms:
10 notch rating reversal in one week
Bloomberg reports on a NRSRO changing ratings 10 notches in one week on commercial mortgage backed securities.
Source: S&P Restores Top-Ratings to Commercial-Mortgage Bonds Bloomberg, July 21, 2009
"Standard & Poor’s backtracked on ratings cuts issued last week and raised the ranking on commercial mortgage-backed debt from three bonds sold in 2007.
The securities, restored to top-ranked status, had been downgraded as recently as last week, making them ineligible for the Federal Reserve’s Term Asset-Backed Securities Loan Facility to jumpstart lending.
S&P lowered the ratings on a class of a commercial mortgage-backed bond offering from AAA to BBB-, the lowest investment-grade ranking, on July 14. The New York-based rating company reversed the cut today, S&P said in a statement. In a related report, S&P said it adjusted assumptions on the timing of projected losses on the mortgages.
“It is a stunning reversal and certainly raises questions concerning the robustness of their revised model,” said Christopher Sullivan, chief investment officer at United Nations Federal Credit Union in New York. “It may engender further uncertainty with respect to ratings outlooks.”
Debt rated below AAA isn’t eligible for the Federal Reserve’s TALF. Investors sought $668.9 million in loans from the Fed to purchase so-called legacy commercial mortgage-backed bonds on July 16, the first monthly deadline to finance the purchase of the securities."
Additional reporting: S&P Shift on Ratings Unsettles Investors WSJ, July 23, 2009
"...The CMBS market has been on the rise since March, when the Federal Reserve announced it would expand TALF to investors buying CMBS bonds. However, the rally was interrupted in late May on S&P's warning. One month later, the market fell further after S&P tightened its ranking criteria for CMBS and said some $235 billion of CMBS debt could lose triple-A ratings. Essentially, S&P said commercial real-estate values had fallen so much that bonds that had been considered triple-A faced a higher risk of losses.
The potential downgrades raised doubts about how effective the TALF program would be in terms of restarting the securitization market for commercial real estate. Explaining the new ratings methodology in May, S&P said the loans made from 2005 through 2007 featured "increasingly more aggressive underwriting" than those made in prior years. In other words, lenders were overly optimistic about rents, occupancies and values. In fact, they have all fallen sharply. Anticipating such ratings cuts, some investment banks in recent weeks have been repackaging existing bonds to make them more downgrade-proof by adding "credit support," decreasing the potential for losses to be taken by top-rated bonds. That triggered a market rally.
The $7.6 billion benchmark deal at the center of the ratings controversy is commonly known as GG10. It was sold by RBS Greenwich Capital and Goldman Sachs Group Inc. in 2007.
When S&P downgraded the GG10 deal last week as a result of the new criteria, some investors and analysts noted that although some of the classes in the deal deserved to be cut, the ratings agency shouldn't have treated all triple-A bonds the same way. In other words, even on assumptions of bigger losses on the loan pool, investors in some of the top-rated bonds would still get repaid before those below them. After receiving inquiries from market participants on how it applied losses in the triple-A category, S&P corrected its approach and restored some of its downgraded bonds to triple-A. "They're getting to the right spot," Aaron Bryson, a CMBS analyst at Barclays Capital, said of the correction. But the ratings firm had "poor communications" with the market, Mr. Bryson said."
Lack of equivalent disclosure
The ability of issuers to selectively disclose material non-public information to NRSROs is a substantial regulatory gap. This gap reduces market transparency and stability. It was always puzzling why Federal statutes and regulations gave issuers the right to selectively disclose material non-public information to chosen NRSROs. This practice seems fundamentally unfair and potentially abusive on the part of the issuers.
It could be argued that the issuer's right to selectively disclose material non-public information to favored NRSROs (who they pay) is one cause of the significant concentration of ratings from the dominant NRSROs (Fitch, Standard & Poors and Moody's). And the reason that investors abandoned the use of credit ratings when the financial system froze.
During the Internet boom the equity markets had their own form of selective disclosure and corrupt market practices. Prior to the adoption of Regulation Fair Disclosure (Reg FD) equity issuers would disclose material non-public information to favored equity analysts. Those analysts would impart this material non-public information to their favored clients (generally institutional clients) who would trade on this knowledge ahead of other market participants. This inequality of information flows to market participants was cured with the adoption of Reg FD for the equity markets.
Former SEC Chairman William Donaldson made the following remarks to the Subcommittee on Capital Markets, Insurance, and GSEs, House Committee on Financial Services, May 21, 2001 in reference to the adoption of Reg FD.
"Selective disclosure raises several concerns. The primary issue is the basic unfairness of providing a select few with a significant informational advantage over the rest of the market. This unfairness damages investor confidence in the integrity of our capital markets. To the extent some investors decide not to participate in our markets as a result, the markets lose a measure of liquidity and efficiency, and the costs of raising equity capital are increased.
Further, if selective disclosure is permitted, corporate management can treat material information as a commodity to be used to gain or maintain favor with particular analysts or investors. This practice could undermine analyst objectivity, in that analysts will feel pressured to report favorably about a company or slant their analysis to maintain access to selectively disclosed information. Thus, selective disclosure may tend to reduce serious, independent analysis."
The proposed change to SEC Rule 17g-5 will began to address this significant information inequality for structured products. This change should be adopted for all classes of credit ratings and apply equally to all types of issuers. Issuer and investor compensated NRSROs should have equivalent disclosure upon which to render credit analysis.
Slow to downgrade
Credit rating agencies do not downgrade companies promptly enough. For example, Enron's rating remained at investment grade four days before the company went bankrupt, despite the fact that credit rating agencies had been aware of the company's problems for months.  
Some empirical studies have documented that yield spreads of corporate bonds start to expand as credit quality deteriorates but before a rating downgrade, implying that the market often leads a downgrade and questioning the informational value of credit ratings. See, variously,
- Kliger, D. and O. Sarig (2000), The Information Value of Bond Ratings, Journal of Finance, December: 2879-2902
- Galil, Koresh (2003). The quality of corporate credit rating: An empirical investigation. EFMA 2003 Helsinki Meetings, European Financial Management Association.
This has led to suggestions that, rather than rely on CRA ratings in financial regulation, financial regulators should instead require banks, broker-dealers and insurance firms (among others) to use credit spreads when calculating the risk in their portfolio.
Rating agency and issuer familiarity
Large corporate rating agencies have been criticized for having too familiar a relationship with company management, possibly opening themselves to undue influence or the vulnerability of being misled. ("Financial gatekeepers: Can they protect investors?", Brookings Institution, 2006) 
These agencies meet frequently in person with the management of many companies, and advise on actions the company should take to maintain a certain rating. Furthermore, because information about ratings changes from the larger CRAs can spread so quickly (by word of mouth, email, etc.), the larger CRAs charge debt issuers, rather than investors, for their ratings. This has led to accusations that these CRAs are plagued by conflicts of interest that might inhibit them from providing accurate and honest ratings.
At the same time, more generally, the largest agencies (Moody's and Standard & Poor's) are often seen as agents of globalization and/or "Anglo-American" market forces, that drive companies to consider how a proposed activity might affect their credit rating, possibly at the expense of employees, the environment, or long-term research and development.
These accusations are not entirely consistent: on one hand, the larger CRAs are accused of being too cozy with the companies they rate, and on the other hand they are accused of being too focused on a company's "bottom line" and unwilling to listen to a company's explanations for its actions.
Downgrades creating "vicious cycles"
The lowering of a credit score by a CRA can create a vicious cycle, as not only interest rates for that company would go up, but other contracts with financial institutions may be affected adversely, causing an increase in expenses and ensuing decrease in credit worthiness.
In some cases, large loans to companies contain a clause that makes the loan due in full if the companies' credit rating is lowered beyond a certain point (usually a "speculative" or "junk bond" rating).
The purpose of these "ratings triggers" is to ensure that the bank is able to lay claim to a weak company's assets before the company declares bankruptcy and a receiver is appointed to divide up the claims against the company. The effect of such ratings triggers, however, can be devastating: under a worst-case scenario, once the company's debt is downgraded by a CRA, the company's loans become due in full; since the troubled company likely is incapable of paying all of these loans in full at once, it is forced into bankruptcy (a so-called "death spiral").
These rating triggers were instrumental in the collapse of Enron. Since that time, major agencies have put extra effort into detecting these triggers and discouraging their use, and the U.S. Securities and Exchange Commission requires that public companies in the United States disclose their existence.
Agencies are sometimes accused of being oligopolists,  because barriers to market entry are high and rating agency business is itself reputation-based (and the finance industry pays little attention to a rating that is not widely recognized).
Of the large agencies, only Moody's is a separate, publicly held corporation that discloses its financial results without dilution by non-ratings businesses. The high profit on Moody's revenues (>50% gross margin), which are consistent with the high barriers to entry, do nothing to allay market fears of monopoly pricing.
Massive misrating of structured products
- Credit Rating Agencies have made errors of judgment in rating structured products, particularly in assigning AAA ratings to structured debt, which in a large number of cases has subsequently been downgraded or defaulted. This has led to problems for several banks whose capital requirements depend on the rating of the structured assets they hold, as well as large losses in the banking industry.
- Source: Banks learn to reprice risk in post-crisis credit market Financial News Online, Duncan Kerr, 2007-10-18
AAA rated mortgage securities trading at only 80 cents in the dollar, implying a greater than 20% chance of default, and 8.9% of AAA rated structured CDOs are being considered for downgrade by Fitch, which expects most to downgrade to an average of BBB to BB-. These levels of reassessment are surprising for AAA rated bonds, which have the same rating class as US government bonds.  
As part of the Sarbanes-Oxley Act of 2002, Congress ordered the U.S. SEC to develop a report, titled Report on the Role and Function of Credit Rating Agencies in the Operation of the Securities Markets detailing how credit ratings are used in U.S. regulation and the policy issues this use raises.
Partly as a result of this report, in June 2003, the SEC published a "concept release" called Rating Agencies and the Use of Credit Ratings under the Federal Securities Laws that sought public comment on many of the issues raised in its report. Public commentson this concept release have also been published on the SEC's website.
In December 2004, the International Organization of Securities Commissions (IOSCO) published a Code of Conduct for CRAs that, among other things, is designed to address the types of conflicts of interest that CRAs face. All of the major CRAs have agreed to sign on to this Code of Conduct and it has been praised by regulators ranging from the European Commission to the U.S. Securities and Exchange Commission.
- Being Kept in the Dark on Wall Street Floyd Norris, New York Times, November 2, 2007
- Basel II: back to the drawing board? The Financial Times, Willem Buiter, 2007-09-21
- The Curse of the Triple AAA Speech by David Einhorn, Greenlight Capital, May 27, 2009
- It’s Time for an Independent Audit of Rating Agency Corporate Bond Rating Performance Kamakura, July 22, 2009
- Ratings agencies at the crossroads The Globe and Mail, September 18, 2009
- When Bond Ratings Get Stale New York Times, October 10, 2009
- Credit ratings and credit risk Jens Hilscher, Brandeis and Mungo Wilson, Oxford University, August, 2010
Lobbying by credit rating agencies
From the WSJ, June 23, 2009, "If world-class lobbying could win a Stanley Cup, the credit-ratings caucus would be skating a victory lap this week. The Obama plan for financial re-regulation leaves unscathed this favored class of businesses whose fingerprints are all over the credit meltdown."
Litigation related to credit rating agencies
- Executive Who Questioned Moody’s Ratings Sues New York Times, September 13, 2010
- California Public Employees' Retirement Systems v. Moody's Corp et al, Superior Court of California, San Francisco County, No. 09-490241
- Connecticut ratings cases may proceed Reuters, August 20, 2010
- Councils launch class action against S&P over lost millions Sydney Morning Herald, July 28, 2010
- Moody’s, S&P, Fitch Seek to Dismiss Negligence Suit Bloomberg, July 9, 2010
- Moody's, S&P not 'underwriters,' judge rules Reuters, June 1, 2010
- Suddenly, the Rating Agencies Don’t Look Untouchable New York Times, May 21, 2010
- Lawsuits Against S&P and Moody’s Dismissed The Ratings Debate, May 5, 2010
- Standard & Poor’s, Moody’s Win Dismissal of Mortgage Bond Suit Bloomberg, April 1, 2010
- Connecticut AG Sues Moody's and S&P, Alleging Tainted Credit Ratings for Risky Investments Securities Law Prof Blog, March 10, 2010
- Agency ratings put to the legal test The Age, March 9, 2010
- Courts Examine Credit Raters' 'Intimate Relationship' With Bankers Huffington Post, December 7, 2009
- Cordray Says Ohio Suing S&P, Moody's, Fitch Over Ratings: Video Bloomberg, Nov. 20, 2009
- Ohio Sues Credit Rating Agencies New York Times, November 20, 2009
- Abu Dhabi Commercial Bank v. Morgan Stanley & Co.,(S.D.N.Y. Sept. 2, 2009)
- S&P Parent McGraw-Hill, Moody’s Tumble on Lawsuit Bloomberg, September 3, 2009
- Rating Services in Free Speech Battle Bloomberg News video (running time 3:30 minutes) Sep. 03, 2009
- Ruling Against Ratings Firms a 'Game-Changer': Einhorn CNBC.com, September 8, 2009
- Pending class action lawsuits against rating agencies for their questionable practices.
- Cave, vomiturus sum FT Alphaville, September 11, 2009
- Heads of Rating Agencies Testify on Capitol Hill - Analysis and Discussion with Ira Press of Kirby McInerney Bloomberg News, September 30, 2009
Credit rating agencies
- A. M. Best (U.S.)
- Dominion Bond Rating Service(DBRS) (Canada)
- Egan-Jones Rating Company (U.S.)
- Fitch Ratings (U.S.)
- Japan Credit Rating Agency, Ltd. (Japan)
- LACE Financial Corp. (U.S.)
- Moody's (U.S.)
- Rating and Investment Information, Inc.
- Realpoint LLC (U.S.)
- Standard & Poor's (U.S.)
Additional rating agencies:
- Baycorp Advantage (Australia)
- Benchmark Bond Ratings (U.S.)
- Capital Intelligence Ltd (Cyprus)
- CreditPointe (U.S.)
- Creditsights (U.S.)
- Credit Rating Agency of Bangladesh Ltd (CRAB) (Bangladesh)
- CRISIL (India)
- Dagong (China)
- Gimme Credit (U.S.)
- ICRA (India)
- Malaysian Rating Corporation (Malaysia)
- Pacific Credit Rating (Peru)
- Global Rating Intelligence Services (Middle-East and Africa)
- Rating Agency Malaysia (Malaysia)
- Credit ratings Treasury, Risk and Finance Professionals
- The Optimal Regulation of Credit Rating Agencies Ebook
- Do Rating Agencies Cater? Evidence from Rating-Based Contracts Pepa Kraft, NYU - Leonard N. Stern School of Business, December 16, 2010
- The credit rating agencies are leading an assault on nations and peoples The Guardian, December 16, 2010
- SEC Allows Asset-Backed Bond Issuers to Omit Ratings Bloomberg, November 23, 2010
- The Uses and Abuses of Sovereign Credit Ratings IMF, September 30, 2010
- China Group Said to Form New Credit Rating Company Bloomberg, September 27, 2010
- Dagong accuses U.S. regulator of discrimination after registration bid denied People's Daily Online, September 26, 2010
- Credit Ratings and Credit Risk Jens Hilscher, Brandeis University & Mungo Wilson of Oxford University, August, 2010
- Credit Ratings During Credit Crunch: Implications for Investors/Regulators Ali Ebrahimnejad, Queen's School of Business, Aug 23, 2010
- Solicited and Unsolicited Credit Ratings: A Global Perspective EconPapers, August 23, 2010
- Ratings Reform: The Good, The Bad, and The Ugly Credit Risk Chronicles, August 13, 2010
- Chinese rating agency criticises … Chinese rating agencies FT Alphaville, July 27, 2010
- Why repealing Rule 436(g) violates the first amendment and other rating agency guff FT Alphaville, July 22, 2010
- Davis-Polk Guidance on Use of Credit Ratings in Securities Offerings Following Dodd-Frank Credit Risk Chronicles, July 21, 2010
- A Chinese rating agency critique FT Alphaville, July 21, 2010
- Best independent research provider: CreditSights Risk.net, July 19, 2010
- Sovereign ratings made in China FT Alphaville, July 13, 2010
- S&P Rejects Muni-Bond Rating Postings Without Payment Bloomberg, June 23, 2010
- The Ratings Game - Senate Leaders Focus Reform on Credit Rating Agencies Association for Financial Professionals, June 15, 2010
- Lawmakers delay credit ratings change, seek study AP, June 15, 2010
- Credit Ratings Offensive? ZeroHedge, June 3, 2010
- Number of the Week: Misrated Mortgages Wall Street Journal, May 29, 2010
- Bloomberg to launch rival credit service The Daily Mail, May 10, 2010
- Finance bills wouldn't fully fix credit-rating agencies McClatchy, May 5, 2010
- WHITE PAPER ON RATING AGENCY REFORM Arturo Cifuentes and Jose Miguel Cruz, May, 2010
- Finra cracks down on credit disclosure Investment News, April 11, 2010
- Finra warns B-Ds about their bond ratings Investment News, April 9, 2010
- Where was Moody's board when top-rated bonds blew up? McClatchy, April 2, 2010
- Letter: Credit Ratings: The View From Standard & Poor's New York Times, March 28, 2010
- Barney Frank Vs. The Credit Raters Huffington Post, December 18, 2009
- Ratings Companies Exit Retail Market on New Rules, Review Says Bloomberg, November 19, 2009
- Securities regulator developing transparency, disclosure rules The Australian, Nov 18, 2009
- How Credit Raters Fended Off Oversight From Congress And The SEC Huffington Post, November 11, 2009
- Kroll to launch credit ratings business Financial Times, October 18, 2009
- S&P Says It Can’t Be Sued Over Lehman Bond Ratings Bloomberg, July 31, 2009
- IOSCO Report on the Activities of Credit Rating Agencies
- IOSCO Statement of Principles Regarding the Activities of Credit Rating Agencies
- CFA Institute on credit rating agencies
- Credit Rating Agency Task Force, SIFMA
- Credit Rating Agencies: Current Federal Oversight and Congressional Concerns, Congressional Research Service, August 1, 2005
- What role did the credit rating agencies play in the financial crisis? University of Iowa, Amanda Bahena
- Report on the Role and Function of Credit Rating Agencies in the Operation of the Securities Markets SEC, January, 2003
- SEC’s New and Proposed Credit Rating Agency Rules Morrison Foerster, December 4, 2008
- Lehman CDO case has broader rating implications Structured Credit Investor, August 19, 2009
- Why Competition May Not Improve Credit Rating Agencies Harvard Business School interview with Bo Becker, August 31, 2009
- SEC Regulation of Credit Agencies a Problem for Past Decade AEI.org, March 20, 2006
- “Take away the credit rating agencies’ licenses” Financial Times, March 13, 2006
- We do not need more competition among the rating agencies Financial Times, July 12, 2004