Regulations of Credit Rating Agencies

Credit rating agencies (not to be confused with consumer credit bureaus) are responsible for keeping investors informed about the creditworthiness of financial instruments such as stocks and bonds and the companies that issue them. A level of trust must exist between the investor and the credit rating agency. To this end, in April 2009, the Securities and Exchange Commission (SEC) passed new rules under the Credit Rating Agency Act of 2006.

Enhanced Performance Measurement Disclosures

By law, credit rating agencies must disclose how they use certain information concerning upgrades, downgrades or defaults of certain stocks and bond companies to determine the letter grade they give the institutions issuing these instruments. According to Paul, Weiss, Rifkind, Wharton and Garrison (a law firm), credit rating agencies must disclose all information pertinent to deciding initial ratings for such assets over a one, three or 10-year period. In addition, the new rules call for more detailed disclosure of credit surveillance techniques as they apply to ongoing transactions.

Conflicts of Interest

The new rules indicate that the SEC takes conflicts of interest seriously and seeks to eliminate them. As Paul, Weiss, Rifkind, Wharton and Garrison points out, a nationally recognized statistical rating organization can no longer assign credit ratings to an organization with which it has had a previous counseling or advising relationship. Furthermore, employees of the rating company can no longer participate in fee negotiations with any issuer it has previously rated or advises. And no employee may accept gifts in excess of $25 from any clients of an issuer.

Recordkeeping Requirements

The new rules require credit rating organizations to keep accurate records of the methods they use in determining their scores. They must keep a written record of any upgrades, downgrades, withdrawals, or placements on watch for any of the above. Also, the rules state these companies must keep records of any third party complaints an analyst working for them they may receive concerning their performance as a ratings analyst in beginning, deciding, altering or withdrawal of a credit rating.

Liability Likelihood Strengthened

Credit rating companies can no longer claim that assigning credit ratings are their first amendment rights. An instrument issuer can sue a credit rating agency for issuing a lower rating against it if the issuer believes that it didn't deserve such a rating. The only way a credit rating agency can defend itself now is to prove that it believed to the best of its knowledge that the assessment was accurate. The rating agency must have records to back up its assertions.