Is Credit Rating Agency Reform Being Lost in the SEC Shuffle?

Is Credit Rating Agency Reform Being Lost in the SEC Shuffle?

Is Credit Rating Agency Reform Being Lost in the SEC Shuffle?

 As the SEC undergoes a reorganization process, how much attention will it pay to critical oversight of credit-rating agencies?


Securities and Exchange Commission chairman Mary Shapiro testified before the House Financial Services Committee today about the continuing challenges her agency faces in implementing the Dodd-Frank reforms, given the potential budget restrictions placed on the agency by House Republicans as well as several proposed laws that would curtail the agency’s enforcement and monitoring efforts.

Shapiro—testifying on the three-year anniversary of the collapse of Lehman Brothers—argued sharply against the low budgetary appropriations her agency has received. “I think it’s very difficult for us to cast aside whole areas of responsibility and announce that we won’t be doing them any more because we don’t have the funding,” she said. “Across the agency I think you’ll find there are real impacts on investor protection but also on capital formation and those processes that are critical right now.”

Several Republican members of the panel are also proposing onerous new rules that would slow SEC actions—for example, Representative Scott Garrett is proposing extensive new cost-benefit analyses for agency actions. His bill would deepen the existing requirements and also subject simple enforcement orders to a cost-benefit review. Shapiro said that bill would have “huge implications for the prosecution of securities fraud.”

At least in the area of funding, there was some unexpected bright news. The chairman of the committee, Representative Spencer Bachus—famous for noting when he took the chairmanship that Washington’s role is to “serve the banks”—said that he supports increased SEC funding, and saw it as “necessary as part of the reform process.”

Shapiro was joined by representatives of the Boston Consulting Group (BCG), which completed a major study of the SEC and recommended extensive reforms—including increased funding—that the agency is using as a template for reorganization and enhancement efforts.

But Representative Brad Sherman had some serious concerns about BCG’s failure to examine how the SEC will implement a rule in the Dodd-Frank financial reform bill that governs credit-rating agencies. Sherman crafted the rule along with Senator Al Franken (and with support from then–Attorney General of Ohio Richard Cordray, who is now nominated to head the Consumer Financial Protection Bureau).

The Franken-Sherman amendment requires the SEC to create a nonprofit board that would assign private credit-rating agencies to businesses seeking their ratings, instead of letting businesses cherry-pick a rating agency—a process that can lead to agencies potentially giving favorable ratings to companies in order to keep their business. “[Right now], the home team selects the umpire, and whoever’s selected gets a million bucks, or two million bucks, or whatever their fee is,” Sherman noted in the hearing.

After facing pushback in the Senate and from the Obama administration during the creation of the Dodd-Frank legislation, the Franken-Sherman rule was modified to allow the SEC to come up with a different way of regulating rating agencies with the same goal, and if the agency doesn’t do so within two years, the Franken-Sherman proposal automatically goes into effect.

But the BCG report offered only cosmetic recommendations for how the SEC should improve its supervision of credit rating agencies and didn’t directly address that amendment. “I don’t think the BCG focused really at all on the Franken and Sherman effort here,” Sherman told me afterwards.

In response to Sherman’s questioning, Shapiro said the SEC believes the Franken-Sherman amendment is “tremendously consequential” and that the agency is working on designing a “better, less-conflicted business model” for overseeing rating agencies.

Sherman told me afterward that “the body language from Mary Shapiro was good—she seemed to be planning to come up with an entirely different system,” and he reiterated that “what’s critical is that the SEC follows the mandate to create a system where credit-rating agencies don’t get multimillion-dollar contracts on the basis of being an easy grader.”

“The only folks they’ve downgraded that I’m aware of is the one issuer that doesn’t pay them—the United States government,” Sherman added.

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