New rules set for credit rating firms

Federal regulators on Wednesday adopted rules designed to stem conflicts of interest and provide more transparency for Wall Street’s credit-rating industry, widely faulted for its role in the subprime mortgage debacle and ensuing credit crisis.

The five-member Securities and Exchange Commission voted unanimously at a public meeting to adopt the rules, most of which take effect in about 60 days.

SEC Chairman Christopher Cox called adoption of the rules “a significant and substantive action” that would affect every aspect of the rating business and would give the investing public access to a trove of new information while promoting needed competition in the industry. After nearly a century of policing itself, the industry came under SEC oversight through a 2007 law.

The commission did not adopt a proposal floated last spring to require ratings of complex securities, such as those underpinned by mortgages, student loans or auto loans, to be distinguished by a special identifier from those for more traditional securities like corporate or municipal bonds. That proposal drew opposition from Wall Street.

European Union regulators, who last month put forward strict rules for the rating companies that would hold them liable for their opinions, also proposed a similar system of flagging complex securities. Cox said after the meeting that the proposal would be subject to further study by the SEC and public comment.

The three firms that dominate the $5-billion-a-year industry -- Standard & Poor’s, Moody’s Investors Service and Fitch Ratings -- have been widely criticized for failing to identify risks in subprime mortgage investments, whose collapse helped set off the global financial crisis.

The rating firms had to downgrade thousands of securities backed by mortgages as home-loan delinquencies have soared and the value of those investments plummeted. The downgrades have contributed to hundreds of billions of dollars in losses and write-downs at major banks and investment firms.

Some critics, including investor advocates, say the SEC rules don’t go far enough. They want new requirements to govern how the rating companies are paid and to provide for the suspension of their licenses if they engage in unfair practices.

“Any steps they take to further reduce conflicts of interest are critical to reforming the industry,” said Jeff Glenzer, managing director of the Assn. for Financial Professionals, a group representing finance executives at U.S. corporations that has been active on the issue.

Some recommendations the group made to the SEC, such as requiring strict separation at rating companies between credit analysts and employees responsible for generating revenue, weren’t adopted, Glenzer said.

The rating companies are crucial financial gatekeepers, issuing ratings on the creditworthiness of public companies and securities. Their grades can be key factors in determining a company’s ability to raise or borrow money and at what cost securities will be bought by banks, mutual funds, state pension funds or local governments.

Among other things, the conflict-of-interest rules bar the rating companies from advising investment banks on how to package securities to secure favorable ratings. Gifts valued at more than $25 from clients also will be prohibited.

Rating firms will be barred from issuing ratings in cases in which a firm made recommendations to the company issuing securities or the investment bank underwriting them concerning the corporate structure, assets or activities of the issuing company.

In addition, rating firms will be required to disclose statistics on all their upgrades and downgrades for each asset type.

They also will have to disclose how much verification they performed on the quality of complex securities in determining ratings for them.

Spokesmen for Fitch, Moody’s and S&P; said Wednesday that the firms supported the SEC’s efforts, already had taken steps to increase transparency and would continue to make further enhancements.