* Annual exams find lack of disclosure, methods not followed
* One large unnamed rater cited for weak supervision
* Large rater also did not disclose method change on ABS
* Regulators say business factors may be to blame
* S&P says it has enhanced its ratings process
By Sarah N. Lynch
WASHINGTON, Nov 15 Some credit-rating agencies
failed to disclose ratings method changes or were lax in
following policies on timely downgrades of securities, according
to a report issued by U.S. securities regulators on Thursday.
The Securities and Exchange Commission summarized the
results of its annual examination of raters, a requirement under
the 2010 Dodd-Frank Act that called for greater scrutiny of
ratings agencies following the 2007-2009 financial crisis.
The largest ratings firms, Moody's Corp and
McGraw-Hill Cos Inc's Standard & Poor's, have been
criticized for helping to exacerbate the crisis by giving rosy
ratings to subprime mortgage securities that quickly turned
Thursday's SEC report does not name which firms had
violations, but does distinguish between larger versus smaller
The SEC's exams were conducted on site at all nine raters
registered with the SEC, which include smaller firms like
Egan-Jones, as well as the big three - Moody's, Standard &
Poor's and Fimalac SA's Fitch.
The SEC found that each of the larger raters and two smaller
firms failed to follow their own methodologies and policies for
In one case, the SEC said, one of the big three changed its
method for calculating a key financial ratio for asset-backed
securities ratings and failed "for several months" to publicly
disclose the change and its impact.
This firm, the SEC said, "appeared to have weak internal
supervisory controls and lacked transparency over the process of
rating these asset-backed securities."
The SEC added that market share and business considerations
may have played a role in how this rater applied its
methodology - a potential conflict of interest that many critics
see as a problem in the industry.
The big three use what is called an "issuer-paid" business
model, in which companies seeking ratings pay for them.
The big raters say this conflict can be managed but critics
argue this model should be scrapped.
The Dodd-Frank law requires the SEC to study possibly
replacing the model with a new method in which a public or
private utility would assign structured product ratings to firms
at random. So far, its findings have not been released.
S&P said on Thursday it has "enhanced its ratings process,
governance and compliance function, including proactively making
a number of the changes that are now being recommended by the
Spokesmen for Moody's Investors Service and Fitch both said
they were working with regulators and looking for ways to
improve their processes.
Sean-Egan, president of the smaller rival firm Egan-Jones
and a vocal critic of the issuer-paid model, said Thursday's
report only underscores his concerns.
"This is the elephant in the room that keeps appearing,"
said Egan, whose firm is compensated by its subscribers and not
by the companies seeking ratings.
"There isn't an activity on the face of the earth where
motives are not relevant and compensation for actions is not
It is unclear whether any of the compliance deficiencies
uncovered in the SEC's exams could lead to enforcement actions.
The SEC has been criticized by some for failing to hold
credit-raters accountable for their role in the financial
In July, S&P disclosed that the Justice Department and the
SEC were probing potential violations in connection with its
ratings of structured products.
Earlier this year, the SEC did file civil charges against
credit-rater Egan-Jones for allegedly making false statements.
That was only the second time ever the SEC has taken action
against a rating agency, and it was not for anything related to
the financial crisis.
The matter is still pending. Egan on Thursday called it an
"obvious case of selective enforcement" by the SEC.
But making a case against raters is difficult, especially
when dealing with the financial crisis.
That is because the SEC only started overseeing rater
conduct in September 2007, when a new 2006 law went into effect
giving the SEC authority to regulate raters for the first time.
In addition, the SEC is prohibited from regulating the
substance of ratings, a provision that has helped shield raters
from enforcement actions.
The 2010 Dodd-Frank law strengthened the SEC's oversight of
raters and required annual exams, though the agency still cannot
meddle in the ratings process itself.
Last year was the first time the SEC released a report with
the results of the exams.