No Drastic Changes for Standard & Poor’s

In comments to Reuters, Standard & Poor’s President Deven Sharma said that a credit rating agency board, as proposed by the bank reform bill, would not disrupt his firm’s business model.

“We will have to go to investors and convince them that, ‘look, you still want a rating from us.’ We’ll have to work harder to get those mandates from the investors and from the issuers directly.”

Mr. Sharma also commented that his company had taken measures to add more checks and balances since the subprime mortgage crisis. “For example, it is going to be much more difficult for a mortgage-backed security to get a triple-A going forward.”

After pointing out various changes in his organization around analytics and various other governances, he offered, “Not everything went right in the past, and we recognize that. And there were analytical misses, and we know we have to learn from that and fix things. But at the same time, we are going to stay true to our purpose, which is offering a risk benchmark and calling it as we see it and taking the heat as it comes along.”

Proposed Credit Rating Agency Regulation Requires Compromise

September 10, 2010 by · Leave a Comment
Filed under: SEC, The Rating Agencies, Wall Street Reform 

The Senate financial reform bill does not currently contain a provision included in the House version of the bill that overturns a Securities and Exchange Commission (SEC) rule that has shielded credit rating agencies from civil lawsuits for nearly 30 years.

Rule 436(g) exempts recognized rating agencies from experts’ liability under the Securities Act. In an extreme case, a credit rating agency would even be protected from liability if they knowingly made false or misleading statements in connection with securities registration statements. It is argued that this rule is needed to protect credit rating agencies’ First Amendment rights to free speech.

An amendment included in the Senate bill, introduced by Senators George LeMieux (R-FL) and Maria Cantwell (D-WA), does eliminate some statutory protections for credit rating agencies and applies new standards of credit worthiness, but it does not go as far as the House version of the bill.

The House bill is direct and reads, “Rule 436(g), promulgated by the Securities and Exchange Commission under the Securities Act of 1933, shall have no force or effect.”

This idea is awful. Leave the legal protectors for NRSROs. Let’s all try “caveat emptor” instead.

Cuomo Suspects That Banks Lied to Ratings Agencies

On May 12, New York Attorney General Andrew Cuomo subpoenaed eight banks in an effort to discover whether they had intentionally misled rating agencies to inflate the grades of certain mortgage securities.

The banks involved are Goldman Sachs Group Inc., Morgan Stanley, UBS AG, Credit Suisse, Deutsche Bank AG, Citigroup Inc., Credit Agricole SA and Merrill Lynch & Co (recently acquired by Bank of America Corp.). The major ratings agencies, Moody’s Investors Service, Standard & Poor’s and Fitch Ratings, were also subpoenaed.

Since 2008, New York State and federal regulators have been looking into why the agencies gave top grades to subprime-mortgage backed securities and collateralized debt obligations that later fell dramatically in value.

Reportedly, Mr. Cuomo is also interested in learning why bank mortgage desks hired former rating agency analysts. He is examining whether the analysts’ experience and relationships at the rating agencies contribute to inflated ratings for these mortgage deals.

Data that banks provide to the ratings agencies to evaluate their securities is generally verified through third-party due diligence. It is not known whether these third parties will also be subpoenaed.

No New Business Model for Credit Rating Agencies

While both the House financial reform bill approved in December and the current Senate bill call for tighter regulation of credit rating agencies, critics are upset that neither improves on the “issuer pays” business model.

Because most of the agencies’ revenue comes from issuers of bonds and other debt that the agencies evaluate and rate, critics say this is an unacceptable conflict of interest — that ratings could too easily be tainted by business needs.

Congressional aides defended the bill, saying that the business model could not be changed without destroying the industry. The Senate bill is now on its way to the floor for debate and a final vote.

Let’s let the ratings agencies alone. You can’t legislate morality or virtue in a free market. If nobody trusts the NRSROs, the companies will cease to exist. Let’s let the market participants decide the usefulness of ratings, not Congressmen.

Goldman Sachs Hit With Civil Fraud Charge

July 2, 2010 by · Leave a Comment
Filed under: General, SEC, Wall Street Reform 

The Securities and Exchange Commission (SEC) has announced a lawsuit against Goldman Sachs for creating and selling a mortgage investment that was secretly intended to fail. Goldman repudiated the charges, calling them “completely unfounded in law and fact,” and that it would “vigorously contest them and defend the firm and its reputation.” Furthermore, Goldman pointed out that it lost money on the transactions in question.

Central to the SEC’s case against Goldman and numerous others is how credit-rating firms downgraded 99% of the underlying mortgage securities by January 2008.

Though the SEC had informed Goldman as far back as the middle of last year of a possible suit, the fact that it was a civil fraud lawsuit came as a surprise. Goldman was not given the normal opportunity to discuss a settlement or prepare for the announcement.

Politicizing the SEC isn’t good for anyone. The market demands a level playing field. That the SEC terms some actors as worse than others is not good public policy. Everyone should get the same treatment, neither better nor worse.

Standard & Poor’s Striving to Change Bill

McGraw-Hill, which owns Standard & Poor’s, wants to change language in a Senate financial overhaul bill. It believes the current language would put credit-rating companies at a disadvantage in court.

McGraw-Hill Executive Vice President Ted Smyth issued a statement Wednesday that said the bill “creates a discriminatory pleading standard for credit rating agencies, with many unintended consequences for the market.”

Smyth was referring specifically to the portion of the bill that would enable investors to take legal action against rating firms that “knowingly or recklessly” fail to conduct a reasonable investigation of a company when developing ratings.

Instead McGraw-Hill argues that a credit rating agency could be sued for failing to predict a bankruptcy, for example, which occurred without fraud while auditors, lawyers, bankers and equity analysts would have no liability. The firm wants the provision altered to remove this discriminatory language and instead retain the agencies’ current liability standard that requires that fraud be present.

If we are trying to create a Full Employment Act for class action securities lawyers, this will do it. Can’t we just use a simple, elegant age-old solution? Fully disclose any conflicts of interest and then its caveat emptor.

Senator Reed Blasts Credit Rating Agencies

Bloomberg News obtained an email by a McGraw-Hill lobbyist urging Senators Bob Corker (R-TN) and Judd Gregg (R-NH) to come out against financial regulatory reform.

In response, Senate Banking Committee member Jack Reed (D-RI) said, “This cynical attempt by Wall Street lobbyists to kill Wall Street reform before it has a chance to see the light of day must be resoundingly rejected. Credit rating reform addresses one of the systemic failures that caused the financial crisis.”

High standards regarding negligence have until now protected rating agencies from lawsuits. But under Mr. Reed’s proposed “narrowly tailored” legislation, investors would be able to sue ratings agencies if they could prove they had “knowingly or recklessly failed to review key information in developing ratings.”

Current “reform” measures for rating agencies will make the ratings worthless, as the rating opinion will be about the creditworthiness of the asset, and eluding legal liability. Ratings will all be warm, generic vanilla pudding.