House Republicans challenge SEC approach to credit raters

Specifically, the lawmakers believe the SEC should finish implementing Section 939A of Dodd-Frank, which requires regulators to remove all references to credit ratings in existing federal regulations — the thinking being that references or reliance upon credit ratings as a matter of federal regulation gives an implicit government endorsement of the business practice. Credit raters came under significant scrutiny during the financial crisis, as many mortgage-backed products that ended up worthless had initially received top-flight ratings from the major agencies.

Once those references are removed, regulators should replace the scrubbed rules with another appropriate creditworthiness standard under the law.

{mosads}Hensarling and Garrett said the SEC has yet to fully complete that work, but announced in February it was launching a “Credit Ratings Roundtable” to discuss a report it completed as required by Dodd-Frank, analyzing credit rating practices.

Under that report, required under Section 939F of the law, the SEC analyzed the feasibility of altering credit rating practices in an effort to remove potential conflicts of interest. Currently and in the lead-up to the financial crisis, credit raters gave out ratings to issuers who paid for the evaluation. Skeptics argue that such a compensation method produces inherent conflicts of interest and encouraged raters to give out inflated ratings in an effort to avoid upsetting paying clients.

Under the Dodd-Frank provision spearheaded by Sen. Al Franken (D-Minn.), the SEC had to study a new model, in which an outside entity would assign raters to evaluate a particular financial product. The SEC completed the study in December, and announced it was convening a roundtable to discuss it in February.

But Hensarling and Garrett contend that such a discussion is premature given the still undone work scrubbing reliance on credit ratings from federal regulations. By moving ahead with the idea of assigning ratings to specific raters, the two argue that the SEC would be “cementing the dominant market position” enjoyed by the major raters and stifling competition.

The pair told the SEC to “refocus its efforts” on completing the first rule before continuing work on the second, and demanded a response by April 5 detailing the new approach.

An SEC spokesman declined to comment since the SEC had not yet responded to the letter, but reiterated the agency’s shared interest in completing Dodd-Frank implementation.

This post updated at 3:10 and 4:48pm.