SEC's Cox Talks on New Transparency Rules

WASHINGTON - Securities and Exchange Commission chairman Christopher Cox described soon-to-be-proposed rules for boosting rating agency accountability, transparency, and competition yesterday, while members of the Senate Banking Committee gave representatives of the three major raters a rhetorical beating for their role in the subprime mortgage crisis.

Speaking before the committee, Cox said that SEC staff will propose the rules "in the near future" to strengthen accountability by, among other things, allowing market participants to better compare one rater with another. He also said the staff may propose specific prohibitions on certain practices, as well as requirements designed to address conflicts of interests that may arise during the process for rating structured products.

To increase transparency, Cox said the SEC may require the rating agencies to disclose information about the assets underlying the mortgage-backed securities, collateralized debt obligations and other types of structured products they rate so that market participants can better analyze the securities "and reach their own conclusions about their creditworthiness."

He added that the SEC may also consider rules requiring the disclosure of ratings information in a way that makes it possible for investors to "readily distinguish among ratings for different types of securities, such as structured products, corporate securities and municipal securities."

"The problem is that there isn't any distinction made in the nomenclature for very different things," Cox told reporters after he testified. "One potential way to draw attention to the fact that these are apples, oranges and kumquats is different symbology."

He stressed that he is aware of the push by some state officials to urge the credit rating agencies to "harmonize" separate municipal and corporate rating scales. But he said the SEC is not endorsing that proposal, only suggesting that "different labels be used for different products."

Meanwhile, Cox said the proposed rules will improve competition by ensuring that all nationally registered statistical rating organizations have access to the information underlying credit ratings.

Regardless of whether the Nationally Recognized Statistical Rating Organization follows an "issuer pays" or a subscriber-based model, "there would be no competitive disadvantaged based on lack of access to the information on the assets underlying the structured credit product," he said. "To the extent both models were to flourish in a competitive marketplace, each could act as a healthy competitive check on the other."

Cox has said that the new round of proposed credit rating agency rules could be issued by the end of June.

Since last year, the SEC has registered certain credit rating agencies that meet its criteria as nationally recognized statistical rating organizations so that their ratings can be used by market participants to comply with commission and other rules.

Though Cox repeatedly called for greater competition among rating agencies and characterized the rating structure as an "oligopoly," the strongest criticisms of the raters came from a bipartisan contingent of the senators.

"They alone, along with mortgage brokers, are probably more at the center of this than just about anybody else," Sen. Chuck Schumer, D-N.Y., who referred to the raters as the "weakest link" in the subprime crisis.

Both banking committee chairman Christopher Dodd, D-Conn., and the committee's ranking minority member, Richard Shelby, R-Ala., urged Cox to withdraw or suspend the registrations of rating agencies that consistently issue "wrong ratings."

"If some firm is consistently wrong on their ratings, wouldn't that call [into question] -just common sense - the competence of that firm?" Shelby asked. "Why wouldn't we jerk their license, whatever they have, to do business?"

But Cox said Congress reached "an appropriate balance" in the 2006 law that gave the SEC oversight over raters but which prohibits it from specifying how they can rate individual securities.

"If the federal government were to be the ultimate arbiter of whether ratings approaches were good or bad, that would probably result in poor ratings performance over time because people would not be able to update their models without waiting [for] approval [from the SEC], and their standards would be second guessed," he said. "I think the system that you designed, in which everyone has to be aboveboard about the approaches that they are taking... [in which] they are accountable and transparent, I think is most likely to get the results that you want to achieve."

Several senators compared the credit crisis to a grocery store in which most of the food in the store is safe and healthy, but a small fraction of the items contain a toxic substance that can cause serious illness.

"It's doubtful that you or anyone is going to do much shopping there without some assurance that it was free of the tainted substance," said Dodd, who added that investors have a "right to sound, reliable, credible information" and to know that a regulatory agency will apply the law with "vigor on their behalf." He also said that rating agencies should learn from their mistakes and reform their practices so that "this very sorry chapter in their history will never be repeated."

Continuing Dodd's grocery store metaphor, Sen. Robert Menendez, D-N.J., added that Congress is still "mopping up the aisles and trying to figure out what broke."

At issue for many of the senators is how Moody's Investors Service, Standard & Poor's and Fitch Ratings gave triple-A ratings to tainted mortgage-backed securities and collateralized debt obligations.

As of February, Moody's had respectively downgraded 53.7% and 39.2% of its overall 2006 and 2007 subprime tranches, while by March Standard & Poor's had downgraded 44.4% of the subprime tranches it rated between the first quarter of 2005 and the third quarter of 2007, according to statistics provided by Cox.

Meanwhile, as of December, Fitch had downgraded about 34% of the subprime tranches it rated in 2006 and in the first quarter of 2007 and placed all of the debt issued in the same period and backed by subprime first-lien mortgages on negative watch.

Referencing the downgrades, Dodd wondered if the raters have a policy of giving overly optimistic ratings in order to obtain more business, and if they sufficiently analyze the data they are given by clients before issuing ratings, among other things.

For their part, representatives of Standard & Poor’s and Fitch conceded that they do not perform due diligence to ensure the accuracy of the information provided to them, arguing that it is up to market participants to ensure the accuracy of that information.

"The accuracy of the information is very important, but there are others whose role it is to check and verify the information," said Vickie Tillman, Standard & Poor’s executive vice president. "First of all, it's primarily the responsibility of the issuer and the loan originator to provide information to rating agencies and others that is accurate. Furthermore, the underwriters, the investment bankers who market the securities, have an obligation to perform due diligence on the loans included in the securitization. And finally the information presented in the offering documents...is vetted by accounting firms."

Stephen W. Joynt, president and chief executive officer at Fitch, said his agency recognized that the underlying loans on some MBS were subprime and of "quite poor quality," but did not perform the due diligence to determine if there was fraud involved in their origination.


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