The SEC should consider taking action against credit-rating agencies that consistently miss the mark, including stripping them of their national certification status if they continue to engage in shoddy work, top Senate Banking Committee members suggested today. Both Chairman Christopher Dodd and ranking member Richard Shelby in a hearing today raised the specter of imposing a “death penalty” on firms whose ratings were widely off and triggered serious market turmoil. They made their remarks as Congress is focusing on the industry for its role in the subprime mortgage meltdown, when it rated thousands of mortgage-backed securities with an investment grade quality that later turned out to be faulty because the securities were made up of predatory and no-documentation loans. “If some firm is consistently wrong on their ratings … wouldn’t that call in, just common sense, their competence?” Shelby asked SEC Chairman Christopher Cox. “Why wouldn’t we jerk their license, whatever they have, to do business?” Cox replied that his agency has authority to impose sanctions and even revoke a firm’s status as a “nationally recognized statistical rating organization” under a 2006 law that gave his agency more regulatory authority. The industry is dominated by two firms, Moody’s Investors Service and Standard & Poor’s Rating Service.
The SEC is currently updating its rules on oversight of the credit-rating industry, with preliminary rules to be issued by early summer. But Cox said such action to revoke a charter would have to be predicated on areas such as a lack of transparency and conflicts of interest, and not because they simply missed the mark because the firms have free-speech protection covered under the Frist Amendment. “Chairman, we’re not asking you for being wrong once … Chairman Dodd used the word ‘consistently’ wrong, which would bring about incompetence, the lack of due diligence,” Shelby said. “[A] lot of these ratings agencies have been consistently wrong in subprime.”
Dodd noted that under the 2006 law, the SEC has the authority to not to grant a charter to a firm if it found “the applicant does not have adequate financial and managerial resources to consistently produce credit ratings with integrity.” He then asked why the SEC couldn’t suspend a charter if a firm’s integrity was compromised. Cox reiterated he has sufficient authority to impose tough sanctions, but was concerned about any attempt to play umpire with a firm’s call if it was made with due diligence. “What we can’t do is regulate the substance of credit ratings. And we can’t write regulations describing methodologies by which [they issue],” Cox said.
This article appears in the April 26, 2008 edition of National Journal Daily PM Update.