Federal regulators on Wednesday adopted new rules designed to stem conflicts of interest and provide more transparency for Wall Street’s credit-rating industry, widely faulted for its role in the subprime mortgage debacle and ensuing credit crisis.
The action by the five-member Securities and Exchange Commission was another government response touching on the global financial crisis set off by mortgage securities. The commissioners voted unanimously at a public meeting to adopt the new rules, most of which will take effect in about 60 days.
SEC Chairman Christopher Cox called adoption of the new rules “a significant and substantive action” that affects every aspect of the rating agency business and will give the investing public access to a trove of new information while promoting needed competition in the industry. After nearly a century of policing itself, the industry came under SEC oversight through a 2007 law.
But the SEC commissioners did not adopt a controversial proposal floated last spring to require ratings of complex securities, such as those underpinned by mortgages, student loans or auto loans, to be distinguished by a special identifier from those for more traditional securities like corporate or municipal bonds. That proposal drew opposition from Wall Street.
European Union regulators, who last month put forward strict new rules for the rating agencies that would hold them liable for their opinions, also proposed a similar system of flagging complex securities. Cox said after the meeting that the proposal would be subject to further study by the SEC and public comment.
The three firms that dominate the $5 billion-a-year industry — Standard & Poor’s, Moody’s Investors Service and Fitch Ratings — have been widely criticized for failing to identify risks in subprime mortgage investments, whose collapse helped set off the global financial crisis.
The rating agencies had to downgrade thousands of securities backed by mortgages as home-loan delinquencies have soared and the value of those investments plummeted. The downgrades have contributed to hundreds of billions in losses and writedowns at major banks and investment firms.
Some critics, including investor advocates, say the SEC rules don’t go far enough. They want new requirements to govern how the rating agencies are paid and to provide for the suspension of their licenses if they engage in unfair practices.
“Any steps they take to further reduce conflicts of interest are critical to reforming the industry,” said Jeff Glenzer, managing director of the Association for Financial Professionals, a group representing finance officials at U.S. corporations that has been active on the issue.
Some recommendations the group made to the SEC, such as requiring strict separation at rating agencies between credit analysts and employees responsible for generating revenue, weren’t adopted, Glenzer said.
The rating agencies are crucial financial gatekeepers, issuing ratings on the creditworthiness of public companies and securities. Their grades can be key factors in determining a company’s ability to raise or borrow money, and at what cost which securities will be purchased by banks, mutual funds, state pension funds or local governments.
The SEC commissioners last June proposed the new rules and opened them to public comment.
Among other things, the conflict-of-interest rules ban the rating agencies from advising investment banks on how to package securities to secure favorable ratings. Gifts over $25 from clients also will be prohibited.
Rating agencies will be banned from making ratings in cases where the agency made recommendations to the company issuing securities or the investment bank underwriting them concerning the corporate structure, assets or activities of the issuing company.
In addition, rating agencies will be required to disclose statistics on all their upgrades and downgrades for each asset type. They also will have to disclose how much verification they performed on the quality of complex securities in determining ratings for them.
Investors will receive detailed information on the ratings process for complex securities, thereby exposing potential conflicts of interest for the agencies, SEC officials said.
The commissioners also voted to propose and open to public comment other rules that would require rating agencies to disclose in interactive electronic format the ratings history information for all of their assessments that companies issuing the securities pay them to do.
Spokesmen for Fitch, Moody’s and S&P on Wednesday said they supported the SEC’s efforts, already have taken steps to increase transparency and will continue to make further enhancements in the future.