For 30 years, the Securities and Exchange Commission has required securities dealers to evaluate investment risk using ratings from only a handful of providers, designated as “nationally recognized statistical rating organizations” (NRSROs). Unintentionally, the SEC in effect established a government-accredited oligopoly with enormous barriers to entry.
That exclusive club — Moody’s Investors Service, Standard & Poor’s, Fitch Ratings, and seven substantially smaller firms — has, of course, been vilified for its role in the subprime debacle. Might expanded competition prevent such a collective failure from happening again? Last month, the SEC held a roundtable discussion to explore that issue, and a variety of players, from academics to trade lobbyists to the NRSROs themselves, weighed in.
Among the proposals to make the raters more accountable, and their business more transparent, were these: require all firms, even those whose business relies on subscription fees, to publicize their ratings so the public can track their accuracy over time; create an independent review board to oversee the agencies (similar to the Public Company Accounting Oversight Board’s role over auditing firms); require issuers to rotate rating agencies every three years; and eliminate the NRSRO reference from regulations that govern the types of investments that banks, insurance companies, and other regulated entities can make.
Much of the discussion centered around the Big Three agencies’ conflicts of interest and whether it’s possible to overcome a business model relying on fees from securities issuers that seek the highest possible ratings (and that may shop around among firms to get them). “The issuer-pay model…is broken,” said Damon Silvers, associate general counsel for the AFL-CIO and deputy chair of the Congressional Oversight Panel that oversees the Treasury Department’s Troubled Asset Relief Program. Sean Egan, managing director of Egan-Jones Ratings, pressed the SEC to require all NRSROs to adopt his business model, which relies on subscriber fees, an argument he has made for many years.
Not surprisingly, Egan’s pitch didn’t wash with the larger firms, whose leaders tried to convince the SEC that all the options for running a ratings business have conflicts of interest. And, in fact, Moody’s relied on investor fees for 50 years, until the 1970s, when technology made it easy for subscribers to reproduce the firm’s work and they became increasingly reluctant to pay.