SEC finds conflicts at rating agencies

S&P, Moody's, Fitch advised issuers of high-risk securities

Associated Press

July 9, 2008

WASHINGTON - The three main credit rating agencies failed to rein in conflicts of interest in giving high ratings to risky securities backed by subprime mortgages, federal regulators said yesterday.

The results of the yearlong review by the Securities and Exchange Commission illuminate the role of Wall Street's credit rating industry in the turmoil that has gripped the financial markets in recent months.

The three agencies that dominate the industry - Standard & Poor's, Moody's Investors Service and Fitch Ratings - have been widely criticized for failing to identify risks in investments tied to high-risk subprime mortgages.

The agencies have had to downgrade thousands of securities backed by mortgages as home loan delinquencies have soared and the value of those investments has plummeted. The downgrades have contributed to hundreds of billions in losses and write-downs at major banks and investment firms.

Among the conflicts of interest cited in the SEC report were the practice of companies that issue the securities paying the rating agencies for their work.

"Issues were identified in the management of conflicts of interest, and improvements can be made," according to the report compiled by more than 50 SEC staff members from hundreds of thousands of pages of records provided by the rating agencies and through employee interviews.

The agencies are crucial financial gatekeepers, issuing evaluations of the creditworthiness of public companies and securities. Their grades can be key factors in determining a company's ability to raise or borrow money, and the cost at which securities will be purchased by banks, mutual funds, state pension funds or local governments.

The SEC proposed new rules last month designed to stem conflicts of interest and expand disclosure for credit rating agencies that would require them to flag the ratings of more complex securities.

Among other things, the rules would ban the rating agencies from advising the investment banks on how to package securities to secure favorable ratings. Also, gifts valued at more than $25 from the agencies' clients would be prohibited.

The big rating agencies, meanwhile, have "committed to taking remedial measures to address the issues identified," the SEC report said.

S&P has said it is taking "27 specific steps in hopes of restoring confidence in the ratings process, and to address issues of relevance and transparency."

"Standard and Poor's is fully committed to increased openness and transparency, and building on the reforms we announced in February, we look forward to taking any additional steps needed to improve our processes and ensure they are of the highest quality," spokesman Ed Sweeney said yesterday.