Regulators Look at Credit-Rating Companies

On the heels of the sub-prime lending mess, the Securities and Exchange Commission (SEC) and state attorneys general in New York and Ohio have begun to look into the manner in which big credit-rating companies are paid and whether they are independent enough from Wall Street firms issuing bonds. 
 
The SEC and NY State General Attorney Andrew Cuomo and Ohio State General Attorney Marc Dann are reviewing how the ratings firms evaluated subprime-mortgage-backed securities that grew into a trillion-dollar market. Rating firms include: McGraw-Hill Cos.' Standard & Poor's; the Moody's Investors Service unit of Moody's Corp., whose stock has soared in recent years; and Fitch Ratings, a unit of Fimalac SA of Paris. 
 
Bankers in Wall Street produced profits in recent years by bundling mortgages into securities and selling them to investors. Ratings firms played an important role because they issued investment-grade ratings to many of those securities, making it easier for Wall Street firms to sell the bonds. 
 
Hundreds of those securities have since been downgraded by the ratings companies. And although this is a but a small portion of all the securities graded by the ratings firms, the reversal contributed to a rout in credit markets last month and has sparked criticism of the ratings firms. 
 
Critics point out that ratings firms' financial fortunes are closely tied to the volume of securities deals -- and that higher ratings often spur deals on by making securities easier to sell. In recent years, mortgage-backed securities have become a major profit driver at Moody's. 
 
From 2003 to 2006, the growth in the mortgage market helped Moody's stock price triple, while its profit climbed 27% a year on average. Moody CEO Raymond McDaniel, received a compensation package of $8.2 million last year, about double his pay package in 2005 and triple what his predecessor made in 2000. S&P, as a unit of a larger public company, isn't required to release compensation figures. 
 
This type of financial information is likely to be scrutinized by the various state and federal regulators. While ratings firms generally disclose the amount they collect to rate different kinds of bonds, the SEC wants to see whether clients that sell more deals -- and thus generate more revenue for ratings firms, tend to get better ratings. While there is no evidence so far of this kind of preferential treatment, regulators are interested in examining the question given the lucrative nature of the mortgage market, one person familiar with the matter said. 
 
We're going in to look at the conflicts of interest, both in how they are paid and in their standards for rating," said Erik Sirri, director of the SEC's division of market regulation, after testifying on Capitol Hill on Wednesday. 
 
In New York State, Attorney General Andrew Cuomo has subpoenaed documents from S&P and Fitch as part of a broader probe into the mortgage market. In Ohio, Attorney General Marc Dann is looking into the ways that rating firms interacted with Wall Street underwriters. "The more we look at it, the more we realize that these firms are important," said Mr. Dann. 
 
Ratings firms, which say they did nothing improper, contend they remained independent evaluators of the securities even as their ratings business grew with the exploding mortgage-backed security market. 
 
Additionally, European and Asian countries, as reported recently in the “Daily Newsflash” have also called for a transparency and are seeking an oversight role of American markets, banks and rating agencies.