By Sarah N. Lynch
WASHINGTON (Reuters) - Credit-rating agencies will have to disclose more details about their ratings process and better manage conflicts of interest under rules unveiled on Wednesday that are expected to lightly touch industry practices.
The 500-plus pages of proposals by the Securities and Exchange Commission aim to ensure credit-raters don't rubber-stamp complex financial products and would seek to manage conflicts that could arise if analysts leave their jobs to work for the firms issuing the products they rate.
The proposals are all required by the Dodd-Frank Wall Street overhaul law in an effort to hold the firms such as Moody's Corp <MCO.N>, McGraw Hill's <MHP.N> Standard and Poor's and Fimalac SA's <LBCP.PA> Fitch Ratings more accountable for their performance after they slapped inflated ratings on complex mortgage securities during the financial crisis.
However, none of Wednesday's proposals strike directly at the heart of what many say is an inherent conflict of interest at the big three credit-rating agencies which all get paid by issuers.
The measures being considered on Wednesday include requiring raters to provide the SEC with an annual report that assesses the effectiveness of each firm's internal controls, and establishing training and testing protocols for credit analysts to ensure they are well versed on rating methods.
Raters would also be subject to more robust disclosure rules about their initial ratings and any subsequent changes so the investing public can better gauge their accuracy and quality.
In order to make sure that rating methodologies are solid, each firm's board of directors will have to sign off on them. If any material errors are uncovered, the firm will have to publish a notice about the changes.
For addressing conflicts of interest, the proposal would create a firewall of sorts between the sales and marketing division and the division that establishes and monitors ratings. Any firm that violates this provision could be subject to penalties, and smaller companies with fewer resources could seek an exemption from this requirement.
In addition, the proposals would implement a "look back" provision by which credit-raters would need to establish procedures to monitor when employees leave the company to work for an issuer that received a rating within a one-year time frame.
The firms would be responsible for determining if any conflicts exist and whether they need to re-issue the rating.
In addition to rules targeting credit-raters, the SEC on Wednesday will also consider a plan that requires third-party firms conducting due diligence reviews of asset-backed securities to certify the information provided to the credit-raters.
Some of the proposals put forth on Wednesday build upon prior regulations previously adopted by the SEC. Some of the plans, such as the "look back" provisions and separations between commercial and analyst sides of the business, are already in place at the big firms.
A bipartisan report issued last month by the Senate Permanent Subcommittee on Investigations blamed Moody's and S&P for helping trigger the crisis after they were forced to downgrade inflated ratings en masse. The report highlighted the conflicts posed by the so-called "issuer-paid" model as well as other factors that led to inflated ratings.
In internal e-mails obtained by the committee, employees at both companies appeared to have a solid grasp of the deteriorating housing market well before the bubble burst, with one S&P employee describing it like "watching a hurricane from FL (Florida) moving up the coast."
Even with the findings of this latest report, the major credit-raters have not faced any civil or criminal charges in connection with their behavior in the crisis, and their earnings have not greatly suffered, either.
Dodd-Frank requires the SEC to address the inherent conflict discussed in the Senate report, but delays any immediate action on the matter.
Earlier this month, the SEC began the process by soliciting public comments for a study on the feasibility of establishing a system where a public or private utility would assign a credit-rater to determine ratings for structured products
(Reporting by Sarah N. Lynch, editing by Dave Zimmerman)