WASHINGTON -- More securities market participants appear to oppose increased regulation of private bond rating agencies than favor it, according to participants' written comments sent to the Securities and Exchange Commission this month.
The New York Bar Association, Chemical Bank, Citibank, insurer Financial Security Assurance, and several law firms came out against new rules. They wrote that rating agencies already have a good track record and there are enough market incentive to keep it that way.
But the Investment Company Institute, lobbyists for the mutual fund industry, and Fidelity Management & Research Co., manager for the Fidelity Group, said they may favor more extensive standards for rating firms if the SEC continues to give rating agencies an increased watchdog role in its rules.
State securities regulators, which did not specifically say whether they favored or opposed broad rules for rating agencies, did warn that the SEC may be giving rating agencies too much power to "police public offerings."
The groups were responding to a request by the SEC this spring for comments on a proposal to exempt some pools of asset-backed securities from registration with the agency if they meet certain criteria. One condition would be that their securities achieve a high rating with an SEC-recognized rating agency, called a "nationally recognized statistical rating organization."
The commission, under pressure from two of its members to increase its scrutiny of such organizations, used the occasion to ask for comment on the general question of whether such groups should be required to meet broadened standards.
NRSRO standard were set up by the SEC in 1975 to help the agency determine if firms have adequate net capital. Receiving a rating from an approved rating group can mean that a firm will not have to take as many reductions, called "haircuts," when valuing the securities in their portfolios.
A firm that wants to be designated a nationally recognized statistical rating organizations sends the SEC an application discussing the firm's structure, debt rating process, procedures to prevent conflicts of interest and misuse of non-public information, and other features. If accepted, the firm gets a letter from the SEC staff pledging not to recommend commission enforcement action if the firm proceeds as a nationally recognized net-capital policeman.
SEC's Reliance at Issue
But opponents of the system, such as SEC commissioners Richard Roberts and Mary Schapiro, warn that the SEC is increasingly relying on the judgment of NRSROs in rules other than net capital, such as the agency's recent money market Standard 2a-7. That rule states that money market funds may invest, for the most part, only in securities rated in one of the two highest rating categories.
The SEC is relying more and more on rating agencies, the commissioners argue, even though it has no rule formally defining the term "nationally recognized statistical rating organization." They also complain that there are no minimum standards on the books for the organizations' operation, and that applications for NRSRO status are proliferating.
But SEC Chairman Richard Breeden and Commissioner J. Carter Beese Jr. oppose new standards, saying rating agencies already are subject to strong market disciplines and no serious abuses in the system have occurred.
"We do not believe additional regulation of rating agencies is warranted," said Chemical Bank Counsel Irshad Karim in an Aug. 3 comment letter, citing "their existing thorough review process and the market acceptance and recognition of the strength of the resulting ratings."
Stephen Dietz, associate general counsel of Citibank, wrote, "Current market practices have worked well to protect investors."
Gary Granik, with the law firm of Davis Polk & Wardwell in New York, also opposed additional regulation of rating agencies, noting that critics of the current system are not giving enough credit to the SEC staff, which has established a rigorous review process for groups seeking NRSRO status.
Woodrow Campbell Jr., with Debevoise & Plimpton in New York, writing on behalf of the firm's client New York Life Insurance Co., warned that additional regulation may lead to increased transaction costs and could have a particularly adverse effect on smaller businesses.
Discipline of the Market
Ronald Daitz, chairman of the New York Bar Association's committee on securities regulation, wrote, "The market currently presents a satisfactory discipline on NRSROs. If they were not perceived as being effective, the rated securities would not find the marketplace acceptance that they have had."
But Craig Tyle, vice president of securities for the Investment Company Institute in Washington, warned that if the SEC is going to continue to give rating agencies more and more of a role in its rules, it must begin to formally regulate the entities.
"Who will watch the watchmen?" Mr. Tyle asked. "If the role of rating agencies under the federal securities laws is to be radically changed to make them quasi-regulators, there clearly needs to be greater oversight of rating agencies by the commission."
That means "express minimum standards" for designating a rating agency as a nationally recognized statistical rating organization, and specific requirements for assigning ratings, he wrote.
Stanley Griffith, associate general counsel of Fidelity Management & Research Co., wrote that it is time for the SEC to study whether rating agencies should be regulated by the commission, although the recommendation should not be construed as a criticism of rating agencies.
He said official statements should "contain an appropriate manually signed consent of the NRSRO. Investors would be better informed concerning the meaning of, and limitations associated with, a rating. There would be more formalized accountability by ... NRSROs, and the commission would be better able to assess whether further regulation of NRSROs and/or the rating process is appropriate."
And Diane Young-Spitzer, chairperson of the investment companies committee of the North American Securities Administrators Association, warned that it is not the function of an NRSRO to police public offerings. There is no requirement, she wrote, that rating organizations should continue to monitor ratings following the initial offering period of certain securities.
"This proposal marks a major change in the area of substantive review of investment companies," she wrote. "Regulatory oversight will be transferred to a nonregulated rating agency."
Currently, there are six nationally recognized statistical rating organizations. They include Standard and Poor's Corp., Moody's Investors Service, Fitch Investors Service, Duff and Phelps, IBCA Inc., and Thomson Bankwatch Inc.
Two Canadian rating agencies, the Canadian Bond Rating Service and Dominion Bond Rating Service Ltd., have sought designation as such organizations. Similar requests are pending from four Japanese rating agencies.
Representatives of Standard and Poor's, Moody's, and Fitch said the firms did not file comments.
