SEC Cautions Credit Rating Agencies

by Glen Shapiro, LawAndTax-News.com, New York

03 September 2010

The United States Securities and Exchange Commission (SEC) has issued a report cautioning credit rating agencies about their ratings conduct and the importance of sufficient internal controls over the policies, procedures, and methodologies the firms use to determine credit ratings.

The SEC's report stems from an inquiry into whether Moody's Investors Service, Inc. (MIS), the credit rating business segment of Moody's Corporation, violated the registration provisions or the antifraud provisions of the federal securities laws.

The report notes that the recently-enacted Dodd-Frank Wall Street Reform and Consumer Protection Act amended the securities laws to require nationally recognized statistical rating organizations (NRSROs) to "establish, maintain, enforce, and document an effective internal control structure governing the implementation of and adherence to policies, procedures, and methodologies for determining credit ratings."

"Investors rely upon statements that NRSROs make in their applications and reports submitted to the SEC, particularly those that describe how the NRSRO determines credit ratings," said Robert Khuzami, Director of the SEC's Division of Enforcement. "It is crucial that NRSROs take steps to assure themselves of the accuracy of those statements and that they have in place sufficient internal controls over the procedures they use to determine credit ratings."

According to the report, an MIS analyst discovered in early 2007 that a computer coding error had upwardly impacted by 1.5 to 3.5 notches the model output used to determine MIS credit ratings for certain constant proportion debt obligation notes. Nevertheless, shortly thereafter during a meeting in Europe, an MIS rating committee voted against taking responsive rating action, in part because of concerns that doing so would negatively impact MIS's business reputation.

In the report, the SEC makes clear that credit rating agencies registered with the SEC must implement and follow appropriate internal controls and procedures governing their determination of credit ratings, and must also take reasonable steps to ensure the accuracy of statements in applications or reports submitted to the SEC.

The report cautions NRSROs that, when appropriate, the SEC will pursue antifraud enforcement actions against deceptive ratings conduct, including actions, pursuant to the Dodd-Frank Act provisions, regarding conduct that physically occurs outside the United States but involves significant steps or foreseeable effects within the US.

The SEC has acknowledged the assistance and cooperation of foreign regulatory authorities in Europe in this investigation but the report says that, because of uncertainty regarding a jurisdictional nexus between the US and the relevant ratings conduct, the SEC has declined to pursue a fraud enforcement action.

Recommended