Credit Rating Firms Under Scrutiny; Spitzer Subpoenas Moody’s

The nation’s credit rating agencies are facing increased scrutiny from federal officials and New York Attorney General Eliot Spitzer.

In recent months, the Securities and Exchange Commission and Congress have moved to make credit rating agencies more accountable to the public. More recently, Spitzer subpoenaed records from one of the biggest rating firms, Moody’s, concerning some of the its past credit ratings of reinsurers and mortgage lenders.

In its second quarter report to the SEC, Moody’s reported that it received a subpoena from Spitzer on July 13 seeking documents regarding its ratings of the financial strength and subordinated debt of reinsurance companies, including ratings that were unwanted by the reinsurer or in which the issuer did not participate in the rating process. The request is for documents dating back to January 1, 1997.

The reinsurance-related subpoena follows an earlier one from Spitzer seeking documents regarding securities offerings Moody’s rated that were backed by jumbo mortgages from prime borrowers and certain credit enhancement evaluations, during the period of June 30, 2000 through June 30, 2003. This May subpoena also seeks documents and other information regarding Moody’s credit policies and procedures since January 1, 1999.

Moody’s said that it is cooperating with Spitzer’s office.

Last November, the Washington Post raised questions about Moody’s Investors Service ratings of the financial strength of German reinsurer Hannover Re, which asked not to be rated by Moody’s. Hannover received good ratings from other agencies but downgrades from Moody’s after the reinsurer declined to pay Moody’s ratings fees. Moody’s has denied that it downgraded Hannover because of its refusal to pay Moody’s fees, according to the Washington Post.

Since the WorldCom and Enron debacles, the practices of rating agencies have caught the attention of Congress as well. The Financial Services Committee Subcommittee on Capital Markets recently held hearings on a bill that seeks to inject greater competition, transparency and accountability in the credit rating agency industry. The Credit Rating Agency Duopoly Relief Act of 2005 (H.R. 2990) was submitted by Rep. Michael G. Fitzpatrick’s (Pa.).

Fitzpatrick said “it is extremely disturbing” that the two largest agencies, Moody’s and Standard & Poor’s, rated Enron and WorldCom at investment grade just prior to their bankruptcy filings. “And these were not their only blunders,” Fitzpatrick said.

While there are more than 130 credit rating agencies, the industry is dominated by Moody’s and S&P, which together have in excess of 80 percent of the market share. Also, the SEC recognizes only five for regulatory purposes. These “nationally recognized statistical rating organizations,” or NRSROs, are A.M. Best Company, Inc.; Dominion Bond Rating Service Limited; Fitch, Inc; Moody’s Investors Service, Inc.; and the Standard & Poor’s Division of the McGraw Hill Companies, Inc.

The Financial Service Committee heard testimony that the lack of competition in the credit rating industry has lowered the quality of ratings, inflated prices, stifled innovation and allowed conflicts of interest to go unchecked. “This duopoly cannot continue to be preserved by an SEC artificial barrier to entry and anti-competitive industry practices,” Fitzpatrick stated.

Fitzpatrick’s reform bill would eliminate the SEC staff’s anti-competitive designation process and prohibit anti-competitive industry practices by mandating reporting and record keeping requirements for registered firms as well as giving inspection, examination and enforcement authority to the SEC.

Financial Services Committee Chairman Michael G. Oxley (Oh.) supports Fitzpatrick’s approach. “The bill would eliminate the SEC’s role as the gatekeeper of competition and allow new entrants to the marketplace. At the same time, Rep. Fitzpatrick envisions a more vigorous oversight role for the SEC that is badly needed. This legislation marks the starting point for debate in the committee, with the goals of more competition, greater investor protection, and better ratings.”

In March, the SEC itself proposed a rule to provide greater clarity and transparency to the process of determining whether a credit rating agency’s ratings should be relied on as NRSRO ratings.

Topics Agencies Reinsurance