New York – The Securities and Exchange Commission’s internal watchdog turned up the heat on the SEC’s implementation of its regulation of credit rating agencies. However lax the SEC’s regulation of NRSRO’s, more stringent oversight is not the solution to ratings agency problems. Nevertheless, the report makes interesting reading for some of the nuggets it reveals.
The SEC’s Office of Inspector General (OIG) released a report Friday criticizing the SEC’s oversight of credit-rating firms, saying it was slow to implement regulations and in “certain instances” failed to comply with U.S. rules. In one case, the regulator approved a credit-rating company even though agency staff members had “numerous significant concerns” with the firm’s application. The inspector general made 24 recommendations for strengthening oversight.
The findings in the report paint a picture of the SEC’s Division of Trading and Markets (TM) rubber-stamping NRSRO applications in the effort to elicit more competition to the largest NRSRO’s, S&P, Moody’s and Fitch. In TM’s response to the report, it points out that NRSRO applicants must be approved if the application is complete – there is little guidance given in the Rating Agency Act legislation or subsequent rule making on what criteria are necessary for a firm to meet NRSRO guidelines. The reality is that the legislative intent was to create competition for the three largest ratings agencies, and the SEC was diligently implementing Congress’ directives.
The OIG report cites one specific example of an application that was tenuous, but approved anyway. The issues identified by TM in reviewing the application included concerns about the firm’s “managerial resources, suspicions regarding the accuracy of the financial information provided in its application and concerns about the authenticity of a number of certifications required by the rating agency act.” TM was also concerned about how to gauge whether the subscription fees charged were reasonable, as directed in the original legislation.
The name of the firm was redacted from the OIG report, but since it is a subscriber-paid firm, it could only be one of three: Egan-Jones, Realpoint or LACE Financial. We suspect it is LACE Financial, primarily because of the nature of the redacting. In fairness to LACE, it is a tiny firm with limited resources, and cannot compare favorably with the resources of an S&P or Moody’s making over $1 billion in ratings revenues.
The bottom line is that the attempt to make NRSRO status more attainable has not changed the oligopolistic nature of the ratings business. Deciphering a redacted table in the OIG report, we infer that S&P, Moody’s and Fitch made a combined $3.6 billion in revenues last year, while the other seven NRSROs made $230 million.
Further, the OIG report should give pause to any firms considering applying for NRSRO status. If its recommendations are implemented, NRSRO status will become much more expensive. It is not clear that NRSRO status provides real benefits to firms, yet the costs may become very real. Ultimately, we don’t see the value for subscriber-paid firms to participate, yet issuer-paid firms should probably be required to be regulated.
The most effective reform would be to eliminate NRSRO references from existing regulations, but the SEC does not appear to have the appetite for such a far-reaching change. Making detailed data on structured deals available to all NRSROs (or all credit rating agencies whether they are NRSROs or not as the OIG report helpfully suggests) would also help level the playing field. As we have been saying for some time, we suspect the most likely reform will be to increase the liability of the NRSROs. Making the SEC more proactive in its enforcement of NRSRO rules is likely to have little meaningful impact on addressing the ills afflicting credit ratings.