Credit-Rating Oversight Sought
Citing the failure of credit-rating firms to protect investors from financial disasters such as the Enron Corp. bankruptcy case, some lawmakers are pushing the Securities and Exchange Commission to step up its oversight of the industry.
At a hearing Wednesday of the House Financial Services subcommittee on capital markets, several lawmakers criticized the SEC for lax regulation of the credit-rating industry.
“A fire needs to be lit under you,” Rep. Christopher Shays (R-Conn.) told Annette L. Nazareth, director of the SEC’s division of market regulation.
The SEC is considering imposing new record-keeping requirements and perhaps regular inspections and examinations on credit-rating firms, which perform a crucial watchdog function in the financial markets, yet are lightly regulated.
The top three rating firms -- Moody’s Investors Service, Standard & Poor’s and Fitch Inc. -- have been criticized along with the accounting industry, corporate directors and Wall Street analysts for missing glaring problems that brought down Enron, WorldCom Inc. and Global Crossing Ltd., among others. The major rating firms rated their bonds as “investment grade” within a few months of their bankruptcy filings.
Nazareth told the House panel that the SEC will outline preliminary plans for regulating the credit-rating firms within a few weeks. Any proposal would require extensive comment before taking effect, and certain measures might require legislation to grant the SEC greater authority.
The SEC was directed to undertake its study of the credit-rating industry under the Sarbanes-Oxley reform legislation passed in the summer.
Although stronger oversight of rating firms is one direction the SEC could take, Nazareth said the commission also could decide to abandon one of its current roles, that of designating firms as “nationally recognized statistical rating organizations,” or NRSROs.
The designation isn’t merely honorary, since companies that wish to float sizable bond issues are routinely required to obtain credit ratings from at least two NRSROs. In some cases, such requirements are written into law.
Critics say the NRSRO designation functions mainly to preserve the tight oligarchy atop the industry. Moody’s and S&P; together control 85% of the market. They, along with Fitch, reigned for more than a decade as the only three NRSROs until February, when the SEC designated a new one, Toronto-based Dominion Bond Rating Service.
Sean Egan, managing director of Egan-Jones Ratings Co., which has unsuccessfully pursued NRSRO status for years, told lawmakers that new competition would make the industry more innovative and better at predicting financial problems.
Nazareth acknowledged that the SEC needs to make up its mind whether to be “in or out” of the oversight game. As long as it grants the NRSRO designation, it gives the impression that the SEC is scrutinizing the industry more closely than is actually the case, she said.
Rep. Paul E. Kanjorski (D-Pa.) said the SEC should address potential conflicts of interest, such as the fact that the bigger rating firms get the lion’s share of their revenue in fees from companies whose bonds they rate and that they sometimes sell ancillary consulting services to the firms.
Shays noted that Clifford Alexander, chairman of Moody’s parent company, Moody’s Corp., served on the board of WorldCom until a year before its bankruptcy filing.
Raymond McDaniel, president of the rating firm, said that Alexander is a “non-executive chairman” and that company executives are barred from serving as directors for any of Moody’s rating clients.
In written testimony, S&P; Executive Vice President Vickie A. Tillman defended the existing system as efficient and effective and said further regulation is unwarranted.
