Aug 31 2009 Ted Knutson in Washington, DC
The Securities and Exchange Commission released a report Friday in which its Office of Inspector General raised alarms of a serious breakdown in regulating credit rating agencies and made 24 recommendations for reform.
The 124-page study (PDF) said the SEC has been slow to strengthen its oversight of credit rating agencies, or "nationally recognized statistical rating organizations." Noting that the Division of Trading and Markets had identified numerous significant concerns about several agencies, OIG chastised T&M for accepting NRSRO reports or forms that did not include a required financial statement or certifications.
The report targeted the SEC for approving one application despite T&M concerns such as inadequate NRSRO managerial resources, doubts over the accuracy of financial data and red flags over the authenticity of some certifications required by the Credit Rating Agency Reform Act of 2006, and section 15E of the Securities Exchange Act of 1934.
"Our review found that a (T&M-recommended) examination of this firm was not initiated until ten months after the SEC approved its application and that this examination still has not been completed," the OIG reported.
In a letter to OIG director David Kotz, acting T&M co-director Daniel Gallagher stood by the approval, saying the deficiencies his staff cited did not provide a legally viable basis for denying the application.
The report did not identify any of the NRSROs cited for problems.
The OIG's recommendations include:
• requiring examinations of would-be NRSROs as part of the application process, instead of after the application has been received;
• requiring NRSRO applicants to submit financial statements audited by a Public Company Accounting Oversight Board-regulated auditing firm;
• adopting rules to curtail the practice of issuers shopping for the NRSRO likely to give it the highest rating, which could mislead investors;
• requiring that all significant issues T&M identifies in the application process for an NRSRO be resolved before the division recommends SEC approval; and
• having the SEC study whether the revolving door of NRSRO analysts working at issuers they examined harms the quality of credit ratings.
The report also urged Congress to authorize the Office of Compliance Inspections and Examinations to examine NRSROs as part of the application process.
The OIG also recommended rotating lead credit rating analysts who look at a particular company to reduce pressure on them, a practice Standard & Poor's, one of the two largest NRSROs, already does.
"A credit rating agency analyst rotation requirement could bring a 'fresh look' to the independence of the credit rating process," the report said.
Chairman Mary Schapiro responded to the report by saying that the SEC will finalize and introduce new proposals for NRSRO reform in the next several weeks, and is working to establish a branch of NRSRO examiners.
As Complinet has reported, earlier in the week House Financial Services Capital Markets subcommittee Chairman Paul Kanjorski (D-Pennsylvania) unveiled the creation of a high-powered academic task force to offer solutions for NRSRO reform.
The Senate is already working on NRSRO reform. In March, Rhode Island Democrat, Jack Reed, introduced the Rating Accountability and Transparency Enhancement Act of 2009, which includes many of the remedies the OIG report suggested.
Reed is considered a potential replacement for Connecticut Democrat, Chris Dodd, to chair the Banking Committee which oversees the SEC if Dodd steps down to lead the Health, Labor, Education and Pensions Committee in the wake of the death of Ted Kennedy.
Michael Barr, assistant Treasury secretary for financial institutions, earlier this month urged the Banking Committee to defer to the Treasury over NRSRO reform.
"The government should not be in the business of regulating or evaluating the methodologies themselves or the performance of ratings," he testified. "To do so would put the government in the position of validating private sector actors and would likely exacerbate over-reliance on ratings."
