Credit-rating firms, whose lapses played a central role in the2008 financial crisis, will face new restrictions on conflicts ofinterest under rules adopted by the U.S. Securities and ExchangeCommission (SEC).

The rules, approved on a 3-2 vote today, require firms includingMoody's Investors Service and Standard & Poor's to ensure theyfollow internal methods when grading debt and revising ratings.They will also have to boost disclosure on their accuracy,including a common way of presenting default and downgrade ratesfor bonds backed by loans for homes and commercial buildings.

Seeking to prevent graders from pandering to the bond issuers,who pay for the ratings, the rules include a strict prohibition onallowing sales motives to influence them. Firms also would have tore-examine the ratings of analysts who leave to join companieswhose products they rated.

“This package of reforms will improve the overall quality ofcredit ratings and protect against the re-emergence of practicesthat contributed to the recent financial crisis,” SEC Chair Mary JoWhite said in a statement before today's vote.

The Financial Crisis Inquiry Commission said in its January 2011report that debt graders led by S&P and Moody's helped ignitethe credit squeeze that began in August 2007 by lowering standardsto win business. Investors who bought the complex bonds oftenrelied on ratings that indicated the securities had a very lowprobability of default.

The Dodd-Frank Act of 2010, enacted in response to the creditcrisis, directed the SEC to institute controls on the firms'conflicts of interest and ensure their rating symbols—such asMoody's Aaa or S&P's AAA—are applied consistently amongsecurities including corporate bonds, sovereign debt, andmortgage-backed securities.

The rules require that firms such as S&P, Moody's, and FitchRatings Ltd. establish internal controls over the quality ofratings, including policies that provide for public input on theirratings methodologies and a judgment of whether some innovativesecurities are simply too complex to rate.

“The Commission's examinations of the rating agencies continueto identify situations where agencies fail to follow theirprocedures and methodologies for producing ratings,” CommissionerLuis A. Aguilar, a Democrat, said today.

The SEC's detailed requirements for internal controls are tooprescriptive, said Commissioner Michael Piwowar, who voted againstthe requirements. Piwowar, a Republican, also objected to the banon sales and marketing, which he said was too broad.

“This new rule text sets an impossible standard for complianceand has no limiting principle,” Piwowar said at today'smeeting.

'Critical Protections'

The SEC also unanimously approved a separate set of rules thatenhance protections for investors who buy bonds backed bymortgages, auto loans and leases, and commercial buildings. Sellersof the bonds will have to provide investors with loan-level datathat can be used to judge the riskiness of the securities. Thedetails include the borrowers' debt levels and credit scores,according to two people briefed on the plan.

The new requirements would apply to the $750 billion market forprivate mortgage-backed securities, which imploded in 2008 andfinanced just 1 percent of new mortgages in 2013.

Banks eligible to accelerate sales of asset-backed bonds withminimal SEC review will have to provide an executive'scertification that investor disclosures are accurate. They alsowill have to provide a process for reviewing soured assets that maybe eligible to be repurchased.

“The reforms before us today will add critical protections forinvestors and strengthen our securities markets by targetingproducts, activities, and practices that were at the center of thefinancial crisis,” White said in a statement before the vote.“Investors will have powerful new tools for independentlyevaluating the quality of asset-backed securities and creditratings.”

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