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August 27, 2014

SEC’s Rule on Credit Rating Agencies Is a Big Improvement, but It Must Still End the Egregious Conflicts of Interest

Washington, D.C. August 27, 2014 — Today, the U.S. Securities and Exchange Commission finalized an important rule that will help strengthen oversight of credit rating agencies, which played a major role in the financial crisis of 2008.  Dennis Kelleher, President and CEO of Better Markets issued the following statement in response to the SEC’s vote on the rule on regulating credit rating agencies:

“Without credit rating agencies slapping Triple AAA ratings on trillions of worthless or defective securities, Wall Street’s too big to fail banks wouldn’t have been able to peddle toxic junk to investors throughout the globe and the worst of the financial crisis might have been avoided.  While the final rule text is not yet available, it appears that the SEC’s rule today on credit rating agencies made at least two significant improvements, particularly after the initial proposal drew well-deserved fire.  First, there are now key provisions that should prevent sales and marketing incentives from influencing the ratings process.  The proposed rule was narrowly focused simply on preventing sales personnel from participating in the ratings process, thus ignoring the many ways that sales and revenue incentives can corrupt the ratings that a firm issues.  Second, the rule today identifies specific factors that the rating agencies must consider as they develop their internal controls over the ratings process.  The proposed rule provided no concrete guidance, deferring entirely to industry to decide how to set those internal controls.

“Credit rating agencies were major contributors to the financial crisis because they gave AAA ratings to trillions of dollars in toxic mortgage-backed securities.  Because most investors will not buy such securities unless they are rated AAA, these egregiously inaccurate ratings induced investors worldwide to buy the toxic subprime securities in massive amounts.  As the world learned when the financial system collapse in 2008, those ratings were grossly inflated due to a whole range of irresponsible and in some cases fraudulent practices, many tied to the raters’ ability to extract huge compensation from issuers in exchange for distorted ratings.

“As with the other rule adopted today, which addresses asset-backed securities, the SEC has more critical work to do to eliminate the core conflicts of interest that persist in the ratings industry.  For example, as mandated under the Dodd-Frank financial reform law, the SEC must adopt a system that will prevent issuers from essentially buying good ratings by selecting and paying the agencies to rate their complex securities.  Congress has already identified the assignment system that would address this problem, and it has required the SEC to adopt it in a rule, but after years of deliberation, including a public roundtable, the SEC has yet to act.  Until the conflict of interest inherent in the ‘issuer-pay’ model is eliminated or at least significantly limited, truly objective and reliable credit ratings will remain a lofty goal, not a reality and investors will remain at grave risk.”

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