The SEC has approved new rules for credit rating agencies designed to increase transparency of the rating process and decrease conflicts of interest.
Some critics contend the big three credit-rating agencies (Standard & Poor’s, Moody’s, and Fitch) bear significant blame for the current economic crisis because they over-rated what turned out to be risky subprime mortgage investments.
Rating agencies issue grades on the creditworthiness of public companies and securities. Good grades substantially increase a company’s ability to raise and borrow money.
The new rules require more disclosure about how much verification a rating agency does of the complex assets underlying a security. Rating agencies must also make available a random sample of 10% of their issuer-paid credit ratings no later than 6 months after the rating is made.
Most importantly, there are new limits on the conflicts of interest that plague rating agencies: Rating agencies can no longer structure the same products they rate. This rule is designed to prevent companies from paying for advisory services in order to get the rate they want.
One proposal not adopted was to tag structured finance products linked to mortgages and other loans (cars, student debt, etc.) with a special symbol. The symbol would alert investors that even though a structured finance product has a similar rating as traditional corporate or municipal bonds, the risks may be different. This proposal is still being considered.
