U.S. PIRG Consumer Blog: SEC finds credit rating agency "shortcomings " and "significant weaknesses"

We rely on independent third parties to issue unbiased judgments in the marketplace. Credit reports for individual consumers are provided by credit bureaus. Credit ratings for debt and other instruments issued by financial firms are provided by third party credit rating agencies-- the big three are Standard and Poor's, Fitch's and Moody's and until enactment of a 2006 law, had little if any significant oversight. Based on a new SEC report, some of the problems that led to the mortgage meltdown can be attributed to that lack of oversight of these three companies. From the Summary Report of Issues Identified in the Commission Staff’s Examinations of Select Credit Rating Agencies (news release and full report in pdf) released yesterday:

findings from extensive 10-month examinations of three major credit rating agencies that uncovered significant weaknesses in ratings practices and the need for remedial action by the firms to provide meaningful ratings and the necessary levels of disclosure to investors...

The report is based on a review of millions of emails and associated deal-book files on a variety of ratings issued by the companies. It offers stunning evidence of sloppy modeling, intense pressure to maintain business relationships and inadequate controls against conflicts of interest.

Each of the NRSROs examined uses the "issuer pays" model, in which the arranger or other entity that issues the security is also seeking the rating, and pays the rating agency for the rating. The conflict of interest inherent in this model is that rating agencies have an interest in generating business from the firms that seek the rating, which could conflict with providing ratings of integrity.

I can only say what Juvenal said, back in Rome in the day: Quis custodiet ipsos custodes? Who will guard the guardians themselves? Seems as if small investors were caught in the lurch.