Rating agencies are financial “gatekeepers” to the capital markets. Their ratings enable companies to sell debt and give investors critical information they need to make informed investment decisions.
Despite their semi-official status, rating agencies that are NRSROs (Nationally Recognized Statistical Rating Organizations) historically have faced minimal regulation. The Credit Rating Agency Reform Act of 2006 set standards for NRSRO registration but gave the SEC limited oversight. So it’s not surprising that rating agencies were at the heart of the global financial crisis. Credit rating agencies’ wildly inflated ratings of structured financial products helped to fuel the financial meltdown.
Stronger oversight and real accountability are needed to help restore the credibility of credit rating agencies as trusted financial gatekeepers. It's time for congress and the SEC to require rating agencies to stand or fall by their ratings.
Congress should:
- Beef up SEC oversight of credit rating agencies. The SEC needs more resources to police rating agency practices.
- Strengthen internal controls and governance of rating agencies. Compliance officers should be executive-level officers; stronger independence standards for compliance officers and rating agency boards are needed.
- Require credit raters to be more transparent about their methodologies and underlying assumptions. Rating agency practices are opaque. Investors need more detailed disclosures of rating methodologies, assumptions and conflicts of interest.
- Make rating agencies truly accountable to investors. Given the prominent role that NRSROs played in the financial crisis, there is no valid reason why they should be exempt from liability under Section 11 of the Securities Act of 1933. This provision shields only those few rating agencies designated as NRSROs from liability as experts, for making untrue or misleading statements when their ratings are included in registration statements.
- Reduce the federal government’s reliance on ratings. Statutes and rules that require pension funds and other institutional investors to hold only securities with specific credit ratings encouraged some funds to rely too heavily on ratings. Official references to ratings should be phased out. Congress and the SEC should clarify that reliance on ratings does not satisfy due diligence obligations.