SEC report reveals failings at top three rating agencies

The US Securities and Exchange Commission (SEC) has identified "apparent failures" harking back to the peak of the financial crisis at all three of the largest US credit rating agencies (CRAs), according to a report released on September 30.

The SEC examined the three main credit rating agencies – Standard & Poor's (S&P), Moody's and Fitch Ratings – as part of an annual investigation required by the Dodd-Frank Act to improve the regulation of Nationally Recognised Statistical Rating Organisations (NRSROs).

The SEC recognised that the three agencies had "devoted notable resources and effort" to responding to the concerns and recommendations outlined in the 2008 Public Report, but said all three still had significant problems.

Two of them – the SEC did not say which two – lacked specific policies and procedures to manage conflicts that might arise from rating financial products issued by banks that are major shareholders in the CRAs themselves.

Some of the world's leading financial institutions are majority shareholders in the three main CRAs. JP Morgan holds 5.2% of shares in Fitch's parent company, Fimalac, Morgan Stanley owns 2.27% of Moody's shares, and State Street owns both 4.28% of McGraw-Hill shares (McGraw-Hill is S&P's parent company) and 3.3% of Moody's shares.

The SEC is considering charging S&P with breaking federal security laws in its rating of a 2007 collateralised debt obligation because of such a conflict of interests.

The report also identified other failings. One of the three main agencies was not correctly following rating methodologies, and the report expressed alarm at the time it took to discover and remedy the error. Although the report did not name the agency, the case might be similar to the 2007 misrating scandal at Moody's, which saw the rating agency's credibility damaged by the news it had covered up flaws in one of its credit risk models.

All the NRSROs failed to follow their ratings procedures in some instances, the SEC found – the regulator has recommended enhanced internal controls and training regarding new procedures to rectify these issues.

"We expect the credit rating agencies to address the concerns we have raised in a timely and effective way," said Norm Champ, deputy director of the SEC's office of compliance inspections and examinations. "We will be monitoring their progress."

This article was first published on Risk.net.