By Rodney F. Tonkovic, J.D.
A group of researchers and policy advisors has asked the SEC to clarify certain aspects of its policies concerning credit ratings agencies. The petition asks the Commission to clarify policies that are contrary to the Dodd-Frank Act in that the reforms mandated by Congress in the Act remain unfulfilled. To that end, the petitioners propose that the Commission: clarify that Office of Credit Ratings annual reports will include NRSRO names; clarify that NRSROs are subject to liability under Section 11; and clarify how Regulation FD applies to NRSROs. The petitioners believe that these clarifications could be implemented immediately based on the Commission's current statutory authority.
Objectives. A primary goal of the petitioners is to put relevant academic research in front of the Commission to help ensure its approach is consistent with the Dodd-Frank mandate. According to the petition, scholars started to take a more critical view of credit ratings agencies in the late 90s. In this "regulatory license" view, the market for credit ratings was distorted by the fact that regulators and market participants relied on credit ratings when making substantive legal rules.
After the 2007-2008 financial crisis, government investigations found that credit ratings agencies were key enablers. The Dodd-Frank Act subsequently amended the securities laws to enhance the accountability and oversight of credit ratings agencies.
The petitioners lament the fact that the same dangers and market distortions that led to the financial crisis potentially remain today. The credit ratings market is once again dominated by a few major players: "Simply put, credit ratings remain enormously important but have little informational value," the petition says.
While the SEC has made efforts to remove NRSRO references from its rules, many institutions continue to rely on credit ratings. The petition focuses on three areas where there are ongoing and significant risks that can be addressed and then minimized by the Commission. Doing so would also comply with the Dodd-Frank statutory mandate.
NRSRO names. The petition first asks that the Commission clarify that Office of Credit Ratings ("OCR") annual reports will include NRSRO names. There are currently nine credit ratings agencies registered as NRSROs. Moody's and S&P dominate the market, and the rest are significantly smaller. The OCR is required to examine each NRSRO and produce an annual report of any material regulatory deficiencies. While serious deficiencies have been documented, the OCR does not identify which NRSRO was involved.
The petition accordingly proposes that the OCR describe violations more precisely. The current transparency failures conflict with the Dodd-Frank mandate that information about credit ratings be freely available and easily accessible. Naming names would help hold ratings agencies accountable and should be implemented through a stated change in policy, the petition says.
NRSRO liability. Next, the Commission should clarify that NRSROs are subject to liability under Section 11. Dodd-Frank stripped NRSROs of their insulation from liability for misstatements incorporated into offering documents. Soon thereafter, however, a no-action letter allowed credit ratings disclosure to be omitted from a prospectus, and this relief soon became permanent. The petitioners view this as flouting the obvious intent of Congress.
The petitioners argue that credit ratings agencies enjoy the profits from their ratings without the risk of liability as experts under Section 11. So, the petition proposes that the Commission make it clear that NRSROs are subject to liability under Section 11, which does not require new rules and could be accomplished through a policy statement. Alternatively, the Commission could just withdraw its 2010 no-action letter.
Regulation FD. Finally, the Dodd-Frank Act also required that the SEC revise Regulation FD to remove an exemption for entities whose primary business is credit ratings. In implementing this requirement, the Commission deleted the provision exempting NRSROs but noted potential circumstances under which NRSROs could continue to receive selective disclosures of material non-public information—that is, they could claim an exemption as "temporary insiders."
The petitioners are divided on this issue: some see the value in credit ratings agencies being able to consider additional information under Regulation FD, while others believe that issuers are flatly prohibited from disclosing inside information to NRSROs. All agree, however, that the market would benefit from the Commission clarifying its stance in a policy statement.
The petition is No. 4-799.