The SEC on June 11 held an open meeting to consider a package of new rules intended to foster competition among credit rating agencies and improve public disclosures concerning rating methodologies and procedures, but some legal experts believe the rules will do little to improve an industry that has seen its reputation badly tarnished by the subprime mortgage crisis.

"They're fairly modest and marginal," Columbia University Law School professor John Coffee told SNL in a recent interview, referring to the proposed rules. "The SEC essentially felt that they don't have to take any significant steps." Coffee added, "We're not going to have either housing finance or securitized finance get on its feet again, or have rating agencies be made more credible without some stronger interventions."

Rating agencies have recently come under fire from lawmakers, academics and industry players alike over ratings associated with structured finance products tied to subprime mortgages. Despite receiving high ratings, mortgage-related securities have suffered sharp declines in value as the housing crisis has deepened. Since all three major rating agencies — Standard & Poor's Ratings Services, Moody's Investors Service and Fitch Ratings — are paid by the very companies they rate, a host of industry observers have argued that conflicts of interest pushed credit raters to overrate securities.

"All of the rules that we are considering are born of the subprime mortgage crisis," SEC Chairman Christopher Cox said at the meeting, noting that some conflicts of interest, including the rating agency payment structure, are "hardwired" into the business models of credit raters.

Chief executives of major rating agencies have defended their companies' products as an opinion service protected by the First Amendment, unlike the services of other industry watchdogs.

"We continue to produce exactly what we've always produced, which is an opinion about the future," Moody's Corp. Chairman, President and CEO Raymond McDaniel Jr. said during a Jan. 9 investor conference. "And for anyone in litigation to try and recharacterize an opinion about the future as a guarantee about [the] future is, I think, going to be a very, very difficult upward battle."

Fitch Ratings President and CEO Stephen Joynt made similar comments during an April 22 Senate hearing and issued a statement June 11 addressing the SEC's proposed new rules, emphasizing that investors are responsible for their own decisions on the value of securities.

"Investors and other market participants should make their own independent judgments of credit risk," Joynt said. "Fitch believes that credit ratings — and the roles they play in the SEC's rules — are an important part of that risk framework."

The SEC has resisted calls from lawmakers of both political parties to impose penalties on rating agencies that make consistently inaccurate ratings or put a ban on the pay-for-ratings fee model, because the regulator's legal authority does not include the power to evaluate the substance of credit ratings or the procedures and methodologies employed by ratings agencies. Instead, most of the rules proposed at the June 11 meeting focused on enhancing transparency of the ratings process to give investors better tools to evaluate ratings.

Several new rating agencies have been approved by the SEC in recent months, expanding the playing field for credit raters and giving government approval to rating agencies that are funded by subscribers who pay for access to rating information rather than being funded by the companies they rate.

"The fundamental purpose of the rules that we are proposing today is to buttress this new level of competition with greater transparency and accountability," Cox said at the hearing.

One rule would require any rating agency recognized by the SEC to retain records of all its rating actions and to keep those records open to public scrutiny in an "interactive data" format. The rule would allow investors to view ratings from different rating agencies on the same securities and make obvious any discrepancies between ratings provided by credit raters that are funded in different ways.

But the SEC did not suggest making any changes to Regulation FD, a rule that allows companies seeking ratings to provide different information concerning the securities to different rating agencies. Under the current regulatory framework, a rating agency paid to rate a product could receive more privileged access to information, undermining the ability of other rating agencies to accurately gauge the quality of a security. Coffee has previously suggested reforming Regulation FD to ensure that when investors compare ratings offered by different rating agencies, they are not comparing apples and oranges.

Under the new rules proposed at the meeting, SEC-recognized rating agencies, known as Nationally Recognized Statistical Rating Organizations, would be required to provide information on upgrades and downgrades on products they rate over periods of one year, three years and 10 years. Rating agencies would also have to provide default statistics relative to their initial rating on the security and disclose information on defaults that occur after the rating agency withdraws its ratings on a security. NRSROs would further be required to say whether they verified information companies provided on the quality of the assets underlying a security and what role an assessment of the asset quality provided by a company seeking a rating plays in the NRSRO's rating evaluation.

The regulator did not require that rating agencies actually verify data provided by investment banks, however.

"The leading problem with the credit rating agencies is that they are unlike any other gatekeeper in that they assume the facts that they are given and do not verify them," Coffee said. "You don't just hand your financial statements to an accountant and say 'Here they are.' You have them take inventory with you and check everything."

Coffee said New York Attorney General Andrew Cuomo outdid the SEC in devising a settlement with the three major rating agencies that would require rating agencies to obtain due diligence data on loan pools before issuing a rating, allowing the due diligence information to serve as a check on other information provided by investment banks.

The SEC also proposed requiring rating agencies to provide more detailed information on the rating surveillance process used to determine upgrades and downgrades, including whether different models or criteria are used in surveillance than in assigning initial ratings. NRSROs would have to include reports every time they publish ratings on structured finance securities that describe the methodology used to determine ratings and explain why any actual ratings differ from a rating that would be implied by an NRSRO's quantitative models. The model and methodology disclosures would force NRSROs to differentiate ratings on structured finance securities from ratings on corporate bonds.

But failing to require that the data going into models is accurate undermines the value of enhancing disclosures about methodology, according to Coffee.

"The problem with all quantitative models is: garbage in, garbage out," Coffee told SNL. "You have to get some verification of the numbers that go into the formula."

The SEC did propose to forbid rating agencies from providing consulting services to companies whose products they rate. The ban would effectively prohibit rating agencies from improperly helping investment banks structure securities to achieve higher ratings. Coffee argued that the proposal would not make a substantive difference in the credit rating industry.

"The structured finance crisis and the subprime mortgage meltdown were not caused by investment bankers taking out the credit rating analysts to a big dinner and plying them with liquor," Coffee said. Instead, Coffee claimed, rating agencies offered more favorable ratings to investment banks in an effort to increase their presence in the structured finance market.

"Investment banks learned that if this rating agency really wants to increase market share, it will be more favorable than the rest," Coffee told SNL. "You can talk to all three, but go get your rating from Moody's, for example."

Joynt offered a more positive assessment of the proposed rules.

"A number of the proposals discussed today are positive steps forward," Joynt said, reserving particular praise for the rule requiring additional disclosure of information on assets underlying structured finance securities.

The new proposed SEC rules are now subject to a public comment period that extends through Aug. 1.