SEC Examinations Find Shortcomings in Credit Rating Agencies’ Practices

Washington, D.C., July 8, 2008
— The Securities and Exchange Commission today released findings from
extensive 10-month examinations of three major credit rating agencies
that uncovered significant weaknesses in ratings practices and the need
for remedial action by the firms to provide meaningful ratings and the
necessary levels of disclosure to investors.

Under new statutory
authority from Congress that enabled the SEC to register and examine
credit rating agencies, the agency’s staff conducted examinations of
Fitch Ratings Ltd., Moody’s Investor Services Inc., and Standard &
Poor’s Ratings Services to evaluate whether they are adhering to their
published methodologies for determining ratings and managing conflicts
of interest. With the recent subprime market turmoil, the SEC has been
particularly interested in the rating agencies’ policies and practices
in rating mortgage-backed securities and the impartiality of their


The SEC staff’s
examinations found that rating agencies struggled significantly with
the increase in the number and complexity of subprime residential
mortgage-backed securities (RMBS) and collateralized debt obligations
(CDO) deals since 2002. The examinations uncovered that none of the
rating agencies examined had specific written comprehensive procedures
for rating RMBS and CDOs. Furthermore, significant aspects of the
rating process were not always disclosed or even documented by the
firms, and conflicts of interest were not always managed appropriately.

"We’ve uncovered
serious shortcomings at these firms, including a lack of disclosure to
investors and the public, a lack of policies and procedures to manage
the rating process, and insufficient attention to conflicts of
interest," said SEC Chairman Christopher Cox. "When the firms didn’t
have enough staff to do the job right, they often cut corners. That’s
the bad news. There’s also good news. And that’s that the problems are
being fixed in real time. The recent events affecting our economy and
our markets have galvanized regulators around the world to re-examine
the regulatory framework governing credit rating agencies, but
ultimately the responsibility for providing meaningful ratings to
investors begins with the credit rating firms themselves."

Lori Richards,
Director of the SEC’s Office of Compliance Inspections and
Examinations, said, "These examinations found shortcomings in the
ratings processes used by each of the firms examined. The firms have
all agreed to implement broad reforms to address the letter and the
spirit of the findings, to better ensure that investors can have
confidence in their ratings."

The Summary Report of Issues Identified in the Commission Staff’s Examinations of Select Credit Rating Agencies
describes the significant weaknesses in the rating agencies’ processes
in rating subprime RMBS and CDOs linked to subprime residential
mortgage-backed securities from January 2004 to the present.


Specifically, the examinations found:


  • There was a
    substantial increase in the number and in the complexity of RMBS and
    CDO deals since 2002, and some of the rating agencies appear to have
    struggled with the growth.
  • Significant aspects of the ratings process were not always disclosed.

  • Policies and procedures for rating RMBS and CDOs can be better documented.

  • The rating agencies are implementing new practices with respect to the information provided to them.

  • The
    rating agencies did not always document significant steps in the
    ratings process – including the rationale for deviations from their
    models and for rating committee actions and decisions – and they did
    not always document significant participants in the ratings process.

  • The
    surveillance processes used by the rating agencies appear to have been
    less robust than the processes used for initial ratings.

  • Issues were identified in the management of conflicts of interest and improvements can be made.

  • The rating agencies’ internal audit processes varied significantly.

The examinations were
conducted by staff in the SEC’s Office of Compliance Inspections and
Examinations, Division of Trading and Markets, and Office of Economic
Analysis. The report summarizes generally the remedial actions that
credit rating agencies are expected to take as a result of the
examinations, and includes observations by the SEC’s Office of Economic
Analysis about conflicts of interest that are unique to these products.
A factual summary of the models and methodologies used by the rating
agencies is provided in the report to provide transparency to the
ratings process and the activities of the rating agencies in connection
with the recent subprime mortgage turmoil.


The SEC last
month proposed a three-fold set of comprehensive reforms to regulate
the conflicts of interests, disclosures, internal policies, and
business practices of credit rating agencies. The first portion of
rulemaking would address conflicts of interest in the credit ratings
industry and require new disclosures designed to increase the
transparency and accountability of credit ratings agencies. The second
portion would require credit rating agencies to differentiate the
ratings they issue on structured products from those they issue on
bonds through the use of different symbols or by issuing a report
disclosing the differences. The third part of the SEC’s proposed
rulemaking would clarify for investors the limits and purposes of
credit ratings and ensure that the role assigned to ratings in SEC
rules is consistent with the objectives of having investors make an
independent judgment of credit risks.

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