SEC Notes Progress, Room for Improvement at Credit Rating Agencies

Annual report to Congress says smaller competitors are gaining market share, but persistent problems include lack of sufficient independence at the agencies

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As 2013 drew to a close, the SEC issued its annual report to Congress on credit rating agencies (called nationally recognized statistical rating organizations, or NRSROs). The reports began after ratings agencies gave top ratings to mortgage-backed securities that subsequently tanked, helping to create the financial crisis of 2008-2009.

In the latest report, the SEC listed the 10 firms currently registered as NRSROs and reviewed "the state of competition, transparency, and conflicts of interest among NRSROs."

In addition to pointing out that the credit rating market is dominated by the big three agencies--S&P, Fitch and Moody's--the report broke down the concentration of reports by category (financial institutions, insurance companies, corporate issuers, asset-backed securities and government securities) by each of the 10 registered firms. It also said that, despite the existence of economic and regulatory barriers to entry into the field, "smaller NRSROs have made notable progress in gaining market share in some of the ratings classes."

However, barriers do still exist, with smaller NRSROs citing contractual and statutory obstacles, such as contracts from institutional fund managers that require minimum ratings requirements and then specify certain NRSROs' ratings.

Another handicap for smaller firms cited by the report is lack of access to information needed to assign ratings, especially for asset-backed securities. When a rating is paid for by the issuer of a security, the ratings agency makes use of nonpublic information to determine the security's rating; other NRSROs in the past may not have been able to review such data to make their own determinations.

And since firms have moved more toward issuer-paid ratings from subscriber-paid ratings, this would exacerbate the problem, if not for a requirement put in place in 2009 "prohibiting an NRSRO from issuing an issuer-paid rating on a structured finance product unless certain information about the transaction is disclosed to other NRSROs."

The report also identified some additional problems, including a continuing lack of sufficient independence from influencing factors such as market share and business concerns and a number of other failures in areas such as recordkeeping, supervision and the isolation of analysts from any data regarding fees. Some firms' proactive steps to correct the problems were also noted.

Most failures were not identified by firm, but one was: Egan Jones Ratings Company (EJR) was barred in January 2013 for a period of 18 months from rating asset-backed and government securities issuers as an NRSRO, on SEC findings that the firm "made willful and material misstatements and omissions when registering with the SEC to become an NRSRO for asset-backed securities and government securities." EJR's return to NRSRO status will depend on reapplication and will be conditional on, among other things, its compliance with the SEC settlement order.

In addition, the report gave an update on the status of the creation of supervisory colleges for the Big Three. The colleges were recommended in July by the International Organization of Securities Commissions (IOSCO) "to enhance communication and coordination among global credit rating agency regulators with respect to examinations of the relevant credit rating agencies," and their first meetings were November 5 and 6. The Office of Credit Ratings (OCR) chaired the colleges for S&P and Moody's, while the European Securities and Markets Authority chaired the college for Fitch.

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