It Appears That The Credit Rating Agencies Have Gotten The Obama Administration's Attention

White House targets ratings firms for oversight
3:50 pm ET 07/21/2009 - MarketWatch Databased News
WASHINGTON (MarketWatch) -- The Obama administration moved Tuesday to crack down on credit-ratings agencies' conflicts of interest and other controversial practices, in a bid to rein in a part of the financial services industry that has been blamed for contributing to the credit crunch by issuing overly rosy ratings.
A central feature of the proposal unveiled by the White House would bar rating firms from consulting with companies they rate.
Rating agencies have come under stinging criticism for their role in the financial crisis, in part, because many of the leading firms gave AAA ratings -- the highest mark available -- to problematic mortgage securities containing sub-prime loans.
The proposed regulations, which are subject to Congressional approval, also would require corporations to disclose "pre-ratings" -- those obtained from rating agencies before a rating firm is actually selected to conduct a rating.
Under another provision, investors would have access to all the pre-ratings a corporation received for a particular security before a final rating firm is selected.
That measure is intended to eliminate a practice known as ratings shopping, in which a corporation solicits preliminary ratings from multiple agencies and then only pays for and discloses the highest rating it received.
The proposal will be considered by key lawmakers on Capitol Hill, including House Financial Services Committee Chairman Barney Frank, D-Mass. Frank and his counterpart in the Senate, B Christopher Dodd, D-Conn., have both indicated that they will seek to introduce some sort of legislation to reform rating agencies.
On Wednesday, Securities and Exchange Commission Chairwoman Mary Schapiro is due to testify before Frank's committee and she is expected to discuss ratings agency reform.
Oversight package
Ratings legislation is expected to be lumped in together with bills seeking to hike oversight of hedge funds, executive pay packages, credit cards and reform of bank regulators. A legislative effort in the House to create a Consumer Financial Protection Commission will be put off until September.
Some ratings-agency proposals don't require legislation and could be approved by the SEC.
The White House proposes to have the SEC set up a special office to watch over rating agencies. Schapiro indicated last week at a congressional hearing that she may support disclosures about such "pre-ratings."
However, Columbia Law School professor John Coffee argued that rating agencies would simply stop doing pre-ratings to corporations and instead provide broad qualitative descriptions about whether they have a high or cautious opinion of the security being reviewed.
"There will be a mutual agreement between the corporation and the rating agency not to provide a pre-rating because of the disclosure requirement," said Coffee, who specializes in securities law. "It will be easily evaded."
At the same time, Coffee backed the idea of barring rating agencies from providing consulting services to companies that are also ratings clients.
'Protective walls'
"This was a major problem, even if rating agencies said they had protective walls between the rating divisions and the consulting divisions," Coffee said.
The proposal also seeks to have a credit agency disclose the fees paid by a corporation for a particular rating as well as the total amount of fees paid by the corporation to the rating agency for the previous two years, in order to reveal any conflicts of interest between the two entities.
"Corporations pick and choose their favorite, in part, because of previous ratings," Coffee said.
Michael Barr, assistant Treasury secretary for financial institutions, said the Treasury examined a variety of models, including a mandate that investors, rather than corporations, pay for ratings. Barr pointed out that some companies are offering investor-paid ratings, which "add to the diversity" of ways ratings are produced. "We think it is good; we like diversity," he said.
The proposal also would require seek to limit conflicts that occur when a rating agency employee goes to work for a corporation that is having its securities rated. In such a circumstance, it would require agencies to conduct a review of ratings of the corporation to determine if any conflicts of interest influenced the ratings.
The White House's proposal also would have each rating agency designate a compliance officer responsible for overseeing internal controls. The credit rating firm would need to provide more details about risks related to any rated security, such as data about the probability of default.
Barr argued that investors will be able to rely on the data in addition to the ratings. "Having that information is good for the investors and markets," Barr said. "This additional information will increase market discipline by providing clearer estimates of the risks posed by different investments."
However, Evan M. Drutman, partner at Alston & Bird LLP in New York , questioned whether all that information will have any impact on investor decision making when it comes to ratings. "With the investor has all that information are they going to rely less on the numerical rating?" he said. "My guess is they will still rely on the numerical rating."

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