U.S. Securities and Exchange Commission inspectors said a large credit-rating firm’s procedures “appeared to allow” for a pending rating decision to be disclosed to certain people before the action was publicly announced.
The findings, based on inspections conducted in 2009 and 2010, were part of the SEC’s first annual report on credit-rating firms mandated by the Dodd-Frank Act. Carlo di Florio, head of the Office of Compliance Inspections and Examinations, declined to identify any of the firms referenced in the report.
“If we find any concerns or significant violations of law we make referrals to the Enforcement Division and they take appropriate action,” di Florio said in a conference call with reporters today.
Regulators are evaluating credit raters’ policies to determine whether firms have provided some investors more information than others, the report said.
The report highlights issues similar to those at the center of a review of whether Standard and Poor’s employees improperly gave certain investors information about its decision to downgrade U.S. debt before doing so on Aug. 5, according to a person with direct knowledge of the matter. The U.S. downgrade occurred more than a year after the period covered by the SEC report.
S&P warned on July 14 that there was a “one-in-two likelihood” it would reduce the U.S.’s AAA grade to AA+ in the absence of a credible plan to decrease deficits even if the nation’s $14.3 trillion debt limit were lifted.
SEC inspectors have examined whether meetings between S&P staff and certain investors to discuss the possible rating cut violated rules that prohibit confidential information from being disclosed selectively to some market participants, according to the person with direct knowledge of the matter. The SEC has also reviewed S&P’s methodology for the downgrade and whether proper review procedures were followed, the person said.
Blackrock Inc., Western Asset Management, and TCW Group Inc., which oversee almost $4 trillion, were visited by S&P after the firm’s July statement, according to people briefed on the conversations who spoke on condition of anonymity because the meetings were private.
S&P, Moody’s Investors Service, and Fitch Ratings are the largest of 10 firms approved by the SEC to assign credit rankings used by investors and regulators to evaluate securities. Many pension and mutual funds require minimum ratings to buy debt, and banks generally must hold more capital to back bonds deemed of lower quality.
Laws that forbid companies from privately disclosing material information generally don’t extend to conversations between corporations and ratings companies, which are designated by the SEC as Nationally Recognized Statistical Rating Organizations, or NRSROs. The rating firms must create and follow internal policies governing disclosure and obey insider trading statutes.
“We are pleased that The Commission recognizes the improvements we have undertaken over the last few years,” Ed Sweeney, an S&P spokesman, said in a statement today. “Since 2009, we have invested over $200 million to improve our quality, criteria, compliance and risk management functions. We are committed to making further enhancements.”
In August, Sweeney said the firm “takes its confidential information and securities trading policies, and the related securities regulation, very seriously. Our policies prohibit analysts or rating committee members from trading and holding securities or options of the companies or governments they rate.”
Such conflicts were also highlighted by today’s report, which said the SEC found instances in which conflict-of-interest policies “may have been unclear or not as comprehensive as may be prudent.”
The report said two smaller firms had problems with employees holding securities potentially related to their work. The report also found that two larger firms rate for issuers that are “significant shareholders” in the ratings companies, which “could present a conflict of interest.”
Daniel Noonan, a spokesman for Fitch, didn’t immediately respond to an e-mail and a phone call seeking comment. Anthony Mirenda, a spokesman for Moody’s, said he couldn’t comment right away.
The SEC’s report details several other problems with unnamed NRSROs, saying that at one “larger” rater, high turnover and lack of access to executives may prevent the compliance officer from carrying out duties. The company has had four different compliance officers since 2008, and its current officer is serving on an interim basis, the SEC said.
Moody’s named Janet Holmes interim compliance officer on April 13, replacing Jeffrey Schwartz as the person responsible for reporting to regulators on compliance with securities laws, the company said in documents on its website. In 2009, Scott McClesky, a former Moody’s compliance executive, told the House Oversight Committee that the company ignored his warnings about municipal bond ratings.
The report also noted some smaller firms are moving away from charging subscribers for ratings and are switching to the wider industry practice of collecting fees from issuers of products being rated. The practice has drawn criticism as an inherent conflict of interest, and Dodd-Frank required the SEC to consider establishing an independent board to assign ratings for structured financial products.
Examinations for next year’s report are set to begin soon, di Florio said, and the firms’ progress in addressing SEC recommendations will be evaluated.
“We will give them a reasonable opportunity to develop remediation plans,” he said. If the rating companies fail to fix problems urgently enough, that “would lead to more robust action on our part.”
Dodd-Frank also required the SEC to set up an independent office to oversee credit ratings. The formation of that office has been blocked by House Republicans who have criticized the agency’s performance.