WASHINGTON — The Securities and Exchange Commission took the first step yesterday toward increasing rating agency liability to investor lawsuits over the failure to accurately rate securities, part of a series of measures it unanimously adopted or floated to enhance disclosure and improve the quality of credit ratings.
The regulatory actions, which included the adoption of rules requiring the rating agencies to disclose a complete history of their ratings, are the latest aimed at improving rating agency performance. The agencies, which are also known as nationally recognized statistical rating organizations, or NRSROs, are widely considered to have played a central role in the financial crisis by giving unduly high ratings to mortgage-related structured products.
“These proposals are needed because investors often consider ratings when evaluating whether to purchase or sell a particular security,” SEC chairman Mary Schapiro said at the meeting. “That reliance did not serve them well over the last several years and it is incumbent upon us to do all that we can to improve the reliability and integrity of the ratings process and give investors the appropriate context for evaluating whether ratings deserve their trust.”
The measures include a “concept release” in which the SEC asked for public comments on whether it should rescind a rule that currently shields the rating agencies from investor lawsuits. If such a change were eventually approved, the agencies could be sued as “experts” for misstatements in prospectuses of registered securities. However, the SEC stressed that it is merely seeking comments on the idea and is not yet ready to propose such a change.
Among the several rule changes that the commission voted to adopt, one would require NRSROs to disclose the full history of their ratings actions — upgrades, downgrades, affirmations and withdrawals —going back to June 26, 2007, the date the SEC first passed rules tied to NRSROs.
The historical disclosures would need to be made online on their Web sites and in a searchable format, though a lag would apply. Their disclosures could be delayed two years for subscriber-paid ratings and one year for issuer-paid ratings. Currently, over 98% of all ratings are issuer-paid ratings, according to the SEC.
The disclosures are meant to augment an existing rule that requires NRSROs with 500 or more paid issuer ratings to disclose a random 10% sample of its rating history, subject to a six-month lag.
In an effort to reduce reliance on the rating agencies, the SEC voted to adopt several rule changes that would strip references to NRSRO ratings from its rules, but not its Rule 2a-7 on money market funds.
The SEC is already considering NRSRO rating references for money market funds in proposed changes to Rule 2a-7. It also voted to reopen the comment period on several additional proposals that would strip NRSRO rating references from other rules.
One of the measures for which the SEC voted to strip references to rating agencies is Rule 10f-3 of the Investment Company Act of 1940, which permits funds to purchase securities in an offering in which a fund affiliate is a member of the underwriting syndicate.
The change is significant for the municipal market because under the current rule, munis that a fund purchases must have received a top rating from a NRSRO. But under the adopted rule change, the munis instead would have to meet certain liquidity and credit-risk standards designed to protect the fund and its investors.
To limit conflicts of interest, the SEC voted to propose a rule that would require the rating agencies to disclose the percentage of their net revenue attributable to the 20 largest users of their rating services as well as the percentage of net revenue attributable to other services and products.
Though all of the commissioners voted for the measures, some expressed strong reservations about them. Republican Commissioner Kathleen Casey, for instance, said she is skeptical that the SEC’s actions would lead to higher-quality credit ratings. Such ratings will only occur when there is sufficient competition so that users of ratings are able to migrate to the rating agencies that have good track records.
“The market, not the government, should decide which credit ratings have value,” Casey said. She added that she is “deeply skeptical” whether increasing the liability of rating agencies would do anything other than raise the barriers to new entities becoming NRSROs.