Buzz Archive:
SEC Proposes New Rating Agency Rules

by Davis Polk & Wardwell, 11/25/2008

What if Steven Spielberg had hired and worked closely with Siskel and Ebert to get a "Two Thumbs Up" rating on his Raiders of the Lost Ark movie? What if the Four Seasons Resort in Maui were in cahoots with Frommer's to ensure a 3-Star Rating for its hotel? What if General Motors selects and compensates the Consumer Report analyst who will critique its upcoming line of new automobiles? What if your child who dreams of attending an Ivy League college could appoint and pay the teachers who will determine his grade point average? Perhaps some strict rules and regulations would need to be in place in order to ensure that no unfairness or impropriety takes place . . . ya think?

This summer, the SEC proposed rule amendments to the Securities Exchange Act of 1934 in an effort to reduce conflicts of interest, foster competition and comparability, increase transparency and improve investor understanding in the credit rating process. Standard & Poor's, Moody's Investors Services and Fitch Ratings, the three companies that hold sway over the annual $5 billion credit rating industry, are considered by many to be partially responsible for the current economic crisis by failing to identify risks in subprime mortgage investments. The hundreds of billions in losses suffered this year by major banks and investment firms are largely a result of downgrades in thousands of securities backed by mortgages as home-loan delinquencies have skyrocketed and the value of those investments has taken a nosedive.

With the responsibility of issuing ratings on the creditworthiness of public companies and securities, the credit rating agencies are thought to be in some ways the gatekeepers of our financial system. The SEC was scheduled last week to discuss and most likely adopt the proposed rule amendments aimed at stemming conflicts of interest by these gatekeepers; however, the commissioners at the last minute deferred the discussions on this issue until December 3, 2008 when they will also be considering other proposals for significant changes to the credit rating industry.

As we await this important public meeting next week, let's gain a better understanding of some of the issues surrounding the upcoming decision by reading this week's Buzz article entitled, "SEC Proposes New Rating Agency Rules" by Davis Polk & Wardwell.