The European Securities and Markets Authority (ESMA), responsible for authorizing and supervising CRAs in the European Union, established legislative rules that became effective in 2013 to reduce the overreliance on credit ratings, improve the quality of ratings of the sovereign debt of EU countries, increase the accountability of CRAs, reduce conflicts of interest that arise from the CRA being paid by the credit issuer, and encourage the entrance of more players into the credit rating market. Earlier this year, the ESMA issued regulations to provide more details about implementing the 2013 legislation. A search of news databases found no record of any prosecution of violations.

In the U.S., the Securities & Exchange Commission (SEC) adopted rules in 2014 resulting from mandates in the Dodd-Frank Act of 2010. The new rules cover four topics: reports of CRAs’ internal controls over the ratings process, transparency of ratings performance of CRAs, steps to be followed when adopting or revising ratings procedures and methodologies, and a requirement that a third party be retained for the purpose of conducting due diligence related to asset-backed securities (ABS) to provide a certification containing specific information to the CRA that’s issuing the ABS rating. These rules are more than 700 pages long.

The SEC’s annual report on its examination of CRA compliance, “2014 Summary Report of Commission Staff’s Examinations of Each Nationally Recognized Statistical Rating Organization,” includes 25 findings that are considered essential. Three firms—Standard & Poor’s (S&P), Moody’s, and Fitch—are reported to have issued more than 95% of all ratings. The annual report evaluated compliance with policies and procedures, managing conflicts of interest, implementing ethics policies, internal supervisory controls, governance, compliance office, post-employment, and complaints. It didn’t consider the newly adopted rules.

Some of the findings are serious and require prompt attention by CRAs. According to a January 13 story on, the report indicated that “firms continued to compromise the objectivity of their rating process.” This included instances when CRAs failed to comply with their written policies and procedures concerning their methodologies or criteria, the timely dissemination of accurate ratings, and the development or review of certain methodologies, criteria, or models.

There also were ethical failures and conflicts of interest. All three of the large CRAs had “weaknesses concerning access to market-share and revenue information by certain personnel who participate in ratings and criteria development activities.” One of those companies also “lacked sufficient policies and procedures related to [prohibited] anticompetitive practices.” Other ethical failures included weaknesses in policies, procedures, and controls governing employee securities ownership; weaknesses in policies and procedures concerning certain conflicts of interest or their disclosure; and the insufficient separation of analytical activity from business activity.

Other findings include inadequate supervisory controls concerning the determination or review of ratings, insufficient compliance personnel, and weaknesses in compliance investigations.

The SEC’s press release “SEC’s FY 2014 Enforcement Actions Span Securities Industry and Include First-Ever Cases” contained no actions that address these CRA violations. The release says, “New investigative approaches and the innovative use of data…contributed to a very strong year for enforcement…that spanned the securities industry,” but apparently it was a weak year for CRA enforcement.

On January 21, the SEC charged S&P with fraudulent ratings misconduct, its first-ever charge against a major ratings agency. A spokesperson commented that “‘race to the bottom’ behavior by ratings firms will not be tolerated by the SEC and other regulators.” Yet the sanctions for S&P’s behavior don’t appear strict enough to deter future wrongdoing. Burying a censure sentence into each of three cease and desist orders with only a $77 million financial penalty and one-year suspension from grading certain bonds isn’t likely to change corporate culture.

On February 3, S&P announced a $1.5 billion criminal settlement with the U.S. Department of Justice, 19 states, and the District of Columbia to settle civil charges that it knowingly issued high grades on bonds containing low-quality residential mortgages. In a two-year legal battle, the government produced 290 million documents, more than in any other case in Justice Department history. “S&P falsely represented that its ratings were objective, independent, and uninfluenced by S&P’s relationships with investment banks when, in actuality, S&P’s desire for increased revenue and market share led it to favor the interests of these banks over investors,” the Justice Department said. As in the SEC civil case, however, S&P didn’t admit to breaking any laws.

Instead of limiting reliance on credit ratings and encouraging each CRA to devise its own ratings methodology, the SEC should help create an independent professional body that would set and police ethical and rating standards. As the SEC enforcement chief said, “Investors rely on credit rating agencies to play it straight when rating complex securities.”


SIDEBAR: IMA Ethics Hotline

For guidance in applying the IMA Statement of Ethical Professional Practice to your ethical dilemma, contact the IMA Ethics Helpline at (800) 245-1383 in the U.S. or Canada. In other countries, dial the AT&T USA Direct Access Number from, then the above number.