Mary Jo White. (Photo: Diego M. Radzinschi/NLJ)
A divided U.S. Securities and Exchange Commission on Wednesday adopted new rules for credit-rating agencies, stepping up review and disclosure requirements and adding safeguards to prevent sales and marketing considerations from influencing the ratings.
The new rules “create an extensive framework of robust reforms,” said SEC Chairwoman Mary Jo White at a meeting at the agency’s headquarters in Washington. “Together, this package of reforms will improve the overall quality of [credit ratings] and protect against the re-emergence of practices that contributed to the recent financial crisis.”
Rating agencies such as Standard & Poor’s, Moody’s and Fitch Group were blamed during the financial crisis for giving high ratings to toxic residential mortgage-backed securities. The Justice Department is suing Standard & Poor’s in U.S. district court in Santa Ana, Calif., for $5 billion, accusing the company of inflating its ratings to win more fees from customers and failing to downgrade bad securities quickly enough.
“Many believe the ratings agencies were not just facilitators of the crisis, but its linchpin,” said Commissioner Luis Aguilar, who hailed the SEC’s final rule as a “marked improvement” over the its initial proposal issued in 2011, which was criticized by consumer advocates as too lax. He voted in favor of the rule, as did fellow Democrat Kara Stein who called the rule “long overdue.”
Commissioner Daniel Gallagher, however, criticized “last minute, hasty additions” to the rule that he said create “potential, unintentional loopholes.” Gallagher, a Republican, said the rule should have been re-proposed and voted against it. Commissioner Michael Piwowar also voted no, arguing the SEC overstepped, making “discretionary changes … that go well beyond the prescriptions of the Dodd-Frank Act.”
The new rule requires credit-rating agencies to “establish, maintain, enforce and document an effective internal control structure” for determining ratings. That includes regular review and allowing market participants to comment on whether the rating methodology should be updated.
The new rules also bar any credit-rating agency employee—including senior managers—who “participates in sales or marketing of a product or service” to determine or monitor credit ratings, or to be involved in developing the methodology used to set the ratings (though very small credit raters can apply for an exemption).
Gallagher called the provision, which also includes people “influenced” by sales and marketing factors, “a novel approach of establishing what amounts to a thought crime. … It’s terrible precedent,” he said. “I can’t imagine any court in this land not failing to strike down this vague clause.”
The ratings agencies must also conduct a “look-back” review to determine whether the “prospect of future employment by an issuer or underwriter influenced a credit analyst in determining a credit rating.” If so, they have 15 days to determine whether to affirm or revise the rating, and to include a public explanation.
In addition, the raters must publicly disclose information about their initial credit ratings and subsequent changes to the credit ratings so investors and others who rely on the ratings can evaluate the accuracy and compare the performance of credit ratings from agency to agency.