By Sarah N. Lynch
WASHINGTON Dec 18 U.S. securities regulators on
Tuesday outlined potential ways to reduce conflicts of interest
at the country's largest credit-rating agencies, but failed to
take a strong stand on specific industry reforms.
Instead, the Securities and Exchange Commission's report
abstained on the next steps and recommended further discussion
of the matter.
The SEC's report was required by a provision known as the
"Franken" amendment in the 2010 Dodd-Frank Wall Street reform
Named for Democratic Senator Al Franken of Minnesota, the
provision required the SEC to conduct a review of the
feasibility of a new system in which a public or private utility
or board would assign work to the agencies on structured product
Assigning ratings work would represent a sea change for the
country's three largest credit-rating firms, Moody's Corp
, McGraw-Hill Cos Inc's Standard & Poor's, and
Fimalac SA's Fitch, which are all paid by the
companies they rate.
That "issuer-pay" model came under attack during the
2007-2009 financial crisis, with critics saying the agencies
gave overly rosy ratings to toxic subprime mortgage securities
that soured as the housing market crashed.
A U.S. Senate investigative report found that the inherent
conflicts of interest from the issuer-pay model likely
contributed to the slowness of the rating agencies in
downgrading the securities.
The question of how to tackle potential conflicts by raters
remains one of the largest issues still looming over the SEC
since the crisis.
The SEC's report on Tuesday said that having a board assign
ratings "could mitigate the issuer-pay conflict" and also help
open the doors for more competition in the industry.
At the same time, however, the SEC warned that such a system
may not address the practice of "ratings shopping" because
companies would still be allowed to hire credit-rating firms to
supplement the initial assigned rating.
The SEC's report suggests other options for handling
conflicts, such as enhancing rules on the books designed to make
sure that credit raters who are not hired by a company to
determine a rating can still get the same information to do
their own review.
The idea behind the rule was to make it difficult for
companies to exert influence over the rating agencies they hire
"because any inappropriate rating could be exposed to the market
through the unsolicited ratings" of competitors, the SEC said.
But the SEC noted that while the industry is already
well-versed in the rule and has established systems for
information sharing, most credit raters are not using it to
produce unsolicited ratings.
Although the agency has previously instituted some rules to
help prevent conflicts, critics say those are not enough and
that the issuer-pay model cannot be properly managed without an
overhaul of the system. The largest raters, by contrast, say
such conflicts can be properly managed with the right rule set.
Last month, SEC examiners said they continued to find
numerous compliance issues at large and small firms alike,
including one instance in which a larger rater may have let
"market share and business considerations" lead the company to
change its rating methods for asset-backed securities without
disclosing the change to the public.
Fitch said it supported the idea of open information for
each rating agency to do its own review, even if it is not hired
by the company to do so.
"We are pleased that the report recognizes that alternative
payment models each have their own conflicts," a Fitch spokesman
said. "What matters most is that potential conflicts are
identified and managed in a thoughtful and transparent manner."
A spokesman for S&P said it was important to address
conflicts of interest, but implementation of the amendment could
result in "unintended consequences," without specifying them.
A Moody's spokesman had no immediate comment on the SEC's
Franken said in a statement: "I'm pleased that the SEC
confirmed what I've always believed - that dangerous conflicts
of interest continue to put investors at risk - and I'm going to
work with the SEC to implement a solution to this problem."