Those waiting (and waiting) for stricter oversight of the rating agencies shouldn't hold their breath. The current plan under review is far weaker than what the Securities and Exchange Commission (SEC) was preparing just last year, and self-policing aspects of the plan have industry critics worried.
The framework, which is still under review but has begun to leak out, spells out policies and procedures for the agencies to follow on a voluntary basis in areas such as systemic rating procedures, conflicts of interest and dissemination of information, according to a regulatory source. Short of outright fraud, it would be up to the agencies themselves to enforce compliance. The SEC is also expected to create a rule that formally defines, for the first time, criteria that must be met to become a nationally recognized statistical rating organization (NRSRO), the designation that determines which credit raters can provide the debt ratings required by law. Today's list includes Moody's Investors Service, Standard & Poor's Corp., Fitch Ratings Ltd. and Dominion Bond Rating Service Ltd.
Hopes for a tougher approach were deflated recently when Annette Nazareth, head of the SEC's market regulation division, remarked publicly that she believed the commission lacked the authority to oversee the rating agencies and added that the rating agencies could sue the SEC if it tried to impose stricter guidelines. She has made that determination despite the fact that it was the SEC that created the NRSRO model and has been determining which companies make the cut ever since. The SEC, however, has not ruled out requesting from Congress a broader set of powers to clarify its oversight of the rating agencies, according to a source, but it appears the voluntary framework is the most likely option for the near-term.
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The new framework will likely be the subject of debate when released. "We would find that [SEC solution] absolutely inadequate in moving forward," says Jim Kaitz, president and CEO of the Association for Financial Professionals (AFP). "The linchpin for a lot of this is what the SEC comes back with. If they say they have no statutory authority over these agencies then Congress should come back and establish it. If they have oversight authority, then this is wholly inadequate." For their part, the rating agencies argue that they have made their rating practices and methodologies more transparent and instituted more safeguards. The concern is that other practices that give at least the perception of a conflict of interest could be swept under the rug. Some see the whole compensation model, in which the major rating agencies make their money from fees paid by companies they rate, as seriously flawed. It's unlikely, however, that the SEC would consider changing that structure without authorization from Congress.
Kreag Danvers, assistant professor of accounting at Wayne State University, wonders why there isn't a ban on rating agency executives sitting on the boards of companies they issue ratings on. "That's like having a partner at PwC sitting on the board of a company they audit," says Danvers. Perhaps most famously, Moody's chairman Clifford Alexander Jr., who retired in 2003, was a director for years at WorldCom Inc. and Wyeth, two companies on which Moody's had issued ratings. "No member of our board of directors is or was involved in any way, shape or form in our rating practices," says a spokeswoman for Moody's. Another sore spot is the issue of unsolicited ratings. In these cases, a rating agency will issue an opinion about a transaction, even though the issuer has not requested one, and then seek to collect a fee. Some executives, like James Kaplan of Northern Trust Corp., consider the practice coercive–or so he wrote in a letter to the SEC in 2003 when he was associate general counsel at Northern. "Northern has been sent bills by rating agencies for ratings that were not requested by Northern, and for which Northern had not previously agreed to pay," said Kaplan. "On occasion, we have paid such invoices in order to preserve goodwill with the rating agency, but we feel that this practice…is prone to abuse." Some agencies, including Moody's, say they have done away with the practice.
Even so, such descriptions have done little to snap regulators into action. Barring an act of Congress, the drive for tighter rating agency controls may end up being lost altogether.
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