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September 30, 2009
SEC Approves Proposals to Strengthen Oversight of Credit Rating Agencies
    by Robert Kropp

Finding that the failure of credit rating agencies to adequately serve investors' interests contributed to the economic crisis, the Commission's proposals include rules to increase disclosure.

The collapse in value of mortgage-based securities that included subprime, and often predatory, loans are generally considered to be the match that lit the economic meltdown. When the factors that led to investor overconfidence in financial products consisting of adjustable rate mortgage loans to individuals who often were not required to provide such basic information as income verification are considered, the role of credit rating agencies in fueling overconfidence has taken center stage.

There are ten companies registered with the Securities and Exchange Commission (SEC) as Nationally Recognized Statistical Rating Organizations (NRSRO). It is the responsibility of these organizations to determine the creditworthiness of financial products. Critics have seized upon the fact that NRSROs are most often paid for their ratings by the issuers of financial products themselves as evidence of a clear conflict of interest.

This month, the SEC responded to the failure of NRSROs to serve the interests of investors by unanimously approving proposed rule changes that would increase its oversight of NRSROs in a number of areas. The rule changes include requiring NRSROs to disclose the history of all ratings they have made since June 26, 2007. Among the failures of credit rating agencies was their delay in downgrading their ratings of mortgage-backed securities until July 10, 2008, long after knowledge of problems relating to those products was widespread.

In order to help foster competition in a sector where it is estimated that Moody's Investors Services and Standard and Poor's account for 80% of market share, the SEC voted to require that information provided to an NRSRO for the purpose of obtaining a credit rating be shared with other NRSROs seeking to rate the product.

The SEC also voted to require annual reporting by NRSROs on compliance reviews they have undertaken, in order to ensure compliance with securities laws. To address investor concerns over conflict of interest, the proposals include a requirement that NRSROs make publicly available information about each person who paid for a credit rating.

In announcing the proposed rules, SEC Chairman Mary Schapiro said, "It is incumbent upon us to do all that we can to improve the reliability and integrity of the ratings process and give investors the appropriate context for evaluating whether ratings deserve their trust."


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