Inspector General Criticizes SEC Oversight of Credit Ratings Firms
The SEC's inspector general, David Kotz, released a report last Friday finding that the SEC failed to properly do its job of overseeing credit rating firms. However, based on an August 29 Wall Street Journal article ("SEC Criticized on Raters") by Sarah N. Lynch, Mr. Kotz's report apparently focused on the applications of smaller firms, not the big three agencies - Moody's, Fitch, and Standard & Poors - whose ratings are primarily relied upon by the investing public. The big three were criticized for assigning toxic mortgage securities their highest ratings after the housing price bubble began to burst in the summer of 2006 and being paid by the issuers for their ratings. (For background, see our November 3, 2008 blog called "Are Credit Rating Agencies Just a Bunch of Bull?").
Congress passed the Credit Rating Agency Reform Act, which commissioned the SEC to regulate and investigate rating companies, in the wake of the Enron fraud scandal. Congress is now considering new regulations for credit rating firms, according to an August 29 article in the Washington Post by Ian Katz and David Scheer.
As Katz and Sheer pointed out, credit rating firms must register with the SEC to obtain its designation of them as "nationally recognized." They do this in order to bolster their credibility and sales. Accordingly, the SEC has grave responsibilities to ensure that the companies and their ratings are at least competent and honest. But Katz's report found that the SEC approved applications of some firms despite suspicions and concerns about the accuracy of their representations in their applications. The SEC's incredible response is that approval without investigation was "the only legally viable option" since the SEC cannot investigate a firm before it is registered - not even when the firm is applying for registration. The Katz report further demonstrates the need for a strong bar of private attorneys to deal with the increasing complex abuses that are occurring in the capital markets.
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