What’s changed in the credit ratings business?

Feb 3, 2015
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What’s changed in the credit ratings business?

Feb 3, 2015
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Quick refresher: When mortgage-backed securities and derivatives suddenly collapsed into a black hole of toxic assets in 2008, people immediately asked why credit ratings agencies had listed them as good investments.

And then people sued the credit agencies.

Standard and Poor’s, one of country’s top ratings agencies, just settled $1.38 billion in lawsuits with 19 states and the District of Columbia, the Department of Justice and the California Public Employee Retirement System. Last month, the agency paid $86 million to settle charges with the Securities and Exchanges Commission and several State Attorneys General. And now, it’s Moody’s turn to be probed by the Department of Justice.

Has anything changed since 2008 in how credit ratings agencies do business?

“The whole industry and certainly Standard and Poor’s has been transformed over recent years,” says Adam Schuman, chief legal officer of S&P Ratings Services. The SEC has expanded regulatory oversight, with an entire department focused just on ratings agencies. 

Standard and Poor’s says it now has a governance board that includes SEC-certified independent board members to oversee how the firm manages conflict of interest risk, and that S&P conducts investigations into the quality of its ratings and compliance by its employees. Schuman also says those employees are evaluated for their adherence to company rules designed to protect the quality of ratings. 

But critics are still strident, arguing that no matter how conflicts are managed, the incentives to inflate ratings still exist. “The fundamental conflict of interest that has led to this litigation and massive settlements still exists,” says Daniel Drosman, an attorney with Robbins Geller Rudman & Dowd who has successfully sued ratings agencies. “You have ratings agencies being paid by the institutions whose bonds they are grading.”

Bill Harrington, an independent researcher and former Moody’s employee, goes further. He says the problems don’t stop with ratings agencies but extend among the many other parties to any complex financial instrument. “It’s the credit rating agencies, the bank underwriters and the counsel looking at a deal’s merits, and the auditors … none of them gets paid unless the deal closes with a triple-A rating.”

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