SEC Finds Problems At Rating Agencies
July 8, 2008
The Securities and Exchange Commission delivered a blistering report Tuesday that detailed the shortcomings of Fitch Ratings, Moody's Investors Service and Standard & Poor's in rating residential mortgage-backed securities and collateralized debt obligations.
"In the course of our examination, serious shortcomings were found at these firms," SEC Chairman Christopher Cox said.
The SEC investigated how the three major rating agencies actually went about rating RMBS, specifically subprime collateral, CDOs. The 10-month review was executed by 40 SEC staff members, who combed through hundreds of thousands of pages of information from the rating agencies and their internal emails.
The SEC found that significant aspects of the rating process were not always disclosed, a problem at all three rating agencies. For example, out-of-model adjustments were made to rating models, but the rationale for these deviations were not documented.
"It was impossible for us, as examiners, to understand the rationale, to determine what happened," said Lori Richards, director of the Office of Compliance Examinations and Inspections.
Conflicts of interest with regards to issuers were also found at all three firms.
"While analysts were prohibited from fee discussions with issuers, their managers were [not], at some firms," Richards said. At one credit rating firm, the SEC found emails that included members of marketing teams, who expressed concerns that changes to a ratings model would impact the firm's market share.
However, there is no evidence that firms' models were actually adjusted in order to secure a deal.
The SEC declined to name which agency they were referring to in any individual case. Also, individual examination findings are non-public, Richards added, unless the commission decides to take enforcement action.
As a result of the examination, the SEC will release proposed reforms aimed at fixing the problems found at the rating agencies for RMBS and CDOs, said Cox. "Each agency has agreed to take measures to address issues we have identified, to ensure that investors have confidence in a system of ratings," he said.
These recommendations include using different symbols for structured finance ratings from the ones used for traditional bonds, or at least issuing reports that disclose those differences. Also, the SEC wants the firms to clarify the limits and purposes of ratings.
The ultimate goal is for structured finance ratings to help investors make independent assessments of the collateral in question, said Cox, and to eliminate any conflicts of interest. Roughly 80% of RMBS deals were arranged by 12 investment banking firms and 90% of CDO deals were arranged by 11 investment banks, the SEC found. In the coming months, the other seven credit rating agencies registered with the SEC will also be examined.
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