SEC OKs broader conflict-of-interest rules for credit-rating firms

Credit-rating firms, whose lapses played a central role in the 2008 financial crisis, face broader restrictions on conflicts of interest under rules adopted by the U.S. Securities and Exchange Commission.

The rules, approved on a 3-2 vote Wednesday, require firms including Moody’s Investors Service, McGraw Hill Financial Inc.’s Standard & Poor’s and Fitch Ratings Ltd. to ensure they insulate analysts from pressure to please bond issuers, who pay for the ratings. The rules include a strict prohibition on allowing sales motives to influence grades.

Firms also will have to reveal more about the accuracy of ratings, including a common method for disclosing default and downgrade rates of bonds. Credit-rating analysts who leave to join a firm whose product they have graded will have their work immediately reexamined.

“This package of reforms will improve the overall quality of credit ratings and protect against the reemergence of practices that contributed to the recent financial crisis,” SEC Chairwoman Mary Jo White said.

The Financial Crisis Inquiry Commission said in its January 2011 report that debt graders led by S&P and Moody’s helped ignite the credit squeeze that began in August 2007 by lowering standards to win business. Investors who bought the complex bonds often relied on ratings that indicated the securities had a very low probability of default.

“The credit-rating agencies, which should have been on the front line sounding the alarm to warn against the coming financial firestorm, instead helped fan the flames,” SEC Commissioner Kara M. Stein said Wednesday.

The Dodd-Frank Act of 2010, enacted in response to the crisis, directed the SEC to prevent conflicts of interest from creeping into ratings decisions. The law also required that rating symbols — such as Moody’s Aaa or S&P’s AAA — are applied consistently among the different kinds of bonds that credit raters examine.

The rules require that firms establish controls to ensure they follow their own criteria for rating bonds. SEC examinations over the last several years have found that some rating firms didn’t follow their own methodologies while others failed to separate analytical and business functions.

Moody’s “believes that a modernized oversight regime will help increase confidence in the ratings process as well as instill greater discipline in the industry,” said Anthony Mirenda, a company spokesman. “While we have yet to digest the SEC’s new rules fully, we intend to implement and abide by them as published.”