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Financial Collapse Sparks Probe of Bond-Rating Agencies

Nov 20, 2008 | Parker Waichman LLP

The role bond-rating agencies played in the global financial meltdown has attracted the attention of the Senate Permanent Subcommittee on Investigations, The Wall Street Journal reports.  According to the Journal, the Subcommittee is set to begin an investigation that would focus on whether competition among bond-rating agencies led them to issue misleading  ratings in order to win business from banks.

Bond-rating agencies like Standard & Poor's and Moody's assess the credit worthiness of debt issues, such as corporate and municipal bonds.  According to The Wall Street Journal, there have been concerns that these agencies, driven by conflicts of interest, boosted mortgage investments that have since collapsed.  Such firms are paid fees by the issuers of the debt instruments they rate.

"We're going to look at the root causes of this, looking at whether the inherent conflict clouded the judgment of the agencies," Sen. Norm Coleman (R-Minn) told the Wall Street Journal. "Somebody missed something here. Was it because of the complexity or was it in the zeal to make money?"

The Senate probe would be just the latest investigation to target bond-rating agencies.  A Securities and Exchange Commission (SEC) report released in July found  "serious shortcomings" in the practices at Standard & Poor's and Moody's, as well as Fitch's Ratings.  Among the problems cited by the SEC report were a lack of disclosure of conflicts of interest, and a lack of oversight of such conflicts, the Journal said.

Just today, Reuters reported that the SEC has decided to delay action on adopting stricter rules to regulate bond-rating agencies until Dec. 3.  At that meeting , the Commission will consider a new rule  requiring credit raters to reveal more information about their ratings for complex products, including those linked to risky mortgages.  

Other proposed rules would deal with conflicts of interest at the bond-rating agencies.  For example, one rule under consideration would forbid anyone who participates in determining a credit rating from negotiating the fee that the bond issuer pays for it.

The SEC will also consider a proposal which would require rating agencies to differentiate between structured finance products and corporate bonds.  According to Reuters, that proposal is "reviled by the securitization industry".

In addition to looking into the operations of bond-rating agencies, the Senate probe will also look into the way financial derivatives known as credit-default swaps were marketed and used by banks, the Wall Street Journal said.  According to the Journal, Sen. Carl Levin (D., Mich.), who heads the investigations subcommittee, has called the swaps "one of the prime culprits responsible for this financial disaster."


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