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SEC: Tighter oversight of rating firms needed

The head of the Securities and Exchange Commission says the agency must do more to tighten oversight of Wall Street's credit-rating industry to help bolster investor confidence.
/ Source: The Associated Press

The head of the Securities and Exchange Commission said Wednesday the agency must do more to tighten oversight of Wall Street’s credit-rating industry to help bolster investor confidence.

SEC Chairman Mary Schapiro spoke as the agency considers possible action affecting the $5 billion-a-year industry, dominated by Standard & Poor’s, Moody’s Investors Service and Fitch Ratings. The companies have been widely criticized for failing to give investors adequate warning of the risks in subprime mortgage securities, whose collapse helped set off the global financial crisis.

“As much as (the SEC has) done, there is still more to do,” Schapiro said. “The status quo just isn’t good enough.”

The SEC was examining the industry’s business practices, competitive issues, potential conflicts of interest and government oversight at a public “roundtable” meeting.

Elsewhere Wednesday, European Union governments and the European Parliament agreed on a preliminary deal on new rules that will expand oversight for the rating agencies. Among other changes, the agencies would become liable for their opinions and could face EU sanctions if found guilty of professional misconduct. That would bring the loss of their license to rate debt in the 27-nation bloc.

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 agencies had to downgrade thousands of securities backed by mortgages as home-loan delinquencies soared and the value of those investments plummeted. The downgrades contributed to hundreds of billions in losses and writedowns at major banks and investment firms.

Officials of S&P, Moody’s and Fitch speaking at the SEC event said their firms have taken steps to enhance accountability and transparency.

“We have been actively applying lessons from the current crisis to adopt a number of measures aimed at restoring investor confidence,” said Deven Sharma, S&P’s president.

The agencies’ officials maintained that conflicts of interest could arise just as easily from investors paying them a fee as under the current system of companies that issue securities paying for ratings. A small number of large investors could represent such a heavy portion of a particular security that they could unduly influence its rating, they suggested.

But Sean Egan, managing director and co-founder of Egan-Jones Ratings Co., called that argument “a red herring.”

“We’re paid to give (companies) information on where credit quality’s likely to be,” he said.

New legislation proposed by Sen. Jack Reed, D-R.I., chairman of a Senate Banking subcommittee, would make it easier for investors to bring class-action lawsuits against rating agencies if they misrepresented the risks of securities they assessed.

Schapiro said the SEC must ask some basic questions, such as whether the market’s reliance on ratings by the big agencies should be reduced.

The SEC has undertaken several actions to enhance oversight of the industry under authority it gained in 2006 legislation, Schapiro said, but more must be done.

“The role of credit-rating agencies must be an area for our intense review as we think about how to promote investor protection and market integrity, and restore confidence in our financial system,” she said.

In December, the SEC adopted new rules designed to stem conflicts of interest and provide more transparency for the ratings industry.

Among other things, the rules ban the rating agencies from advising investment banks on how to package securities to secure favorable ratings. Gifts over $25 from clients also are prohibited.

Rating agencies are 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.

But the SEC commissioners did not adopt a controversial proposal to require ratings of complex securities, such as those underpinned by mortgages, student 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 when it was floated previously.