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SEC Commissioner Elisse B. Walter in a March 2009 speech said that: "I believe that we need to consider alternatives to the issuer-pay model" for Nationally Registered Statistical Rating Organizations ("NRSROs").1 We could not agree more that the issuer-pay model is broken and needs to be fixed. We have proposed (in an article published earlier this year in the Journal of Structured Finance, Winter 2009-2010) that both issuers and investors should pay for ratings following the Municipal Securities Rulemaking Board (MSRB) precedent of charging fees on new issues and secondary market trades of municipal securities to finance its services for the industry.
The authors have a collective experience in assigning or using ratings of just under 1 00 years. Our experience spans both structured credit and entity-level ratings in the United States and abroad. We believe that the credit rating process for structured finance products remains plagued with conflicts of interest associated with the way the rating agencies are paid. Whether the conflicts definitively contributed to inappropriate ratings is debatable but ultimately less important now than the nagging and persistent perception that they did and still could. As a result we believe that reform of rating agency compensation models is critical to restoring confidence in rating agencies.
DODD-FRANK MANDATES STUDY OF COMPENSATION MODELS
Section 939F(b) of the Dodd-Frank financial sector reform bill passed in summer 2010 requires the SEC to carry out a study of rating agency compensation within two years of passage of the bill. Specifically, the bill requires that: "The Commission shall carry out a study of 1) the credit rating process for structured finance products and the conflicts of interest associated with the issuer-pay and the subscriber-pay models; 2) the feasibility of establishing a system in which a public or private utility or a self-regulatory organization assigns nationally recognized statistical rating organizations to determine the credit ratings of structured finance products, including (a) an assessment of potential mechanisms for determining fees for the nationally recognized statistical rating organizations; (b) appropriate methods for paying fees to the nationally recognized statistical rating organizations; (c) the extent to which the creation of such a system would be viewed as the creation of moral hazard by the Federal Government; and (d) any constitutional or other...