Regulation AB: Downgrading the Ratings Agencies

We know the major ratings agencies suck. We know their business model was payola. We know they sold ratings for cash, committed fraud on structured product investors. We know they hid significant modeling errors, and then hid these problems from the public and regulators.

Might their free ride be coming to an end? The SEC is tightening existing regulations that might restrain the big 3’s worst instincts.

First, a reminder of how criminally corrupt they are:

“In early 2007, according to the S.E.C., a Moody’s analyst discovered a significant flaw in one of its ratings models that inflated the grades assigned to a new type of debt called constant proportion debt obligation notes. Roughly $1 billion of these securities had been issued — carrying high Moody’s ratings — when the flaw was detected.

Rather than own up to the error, Moody’s officials fixed the model quietly, the S.E.C. said, leaving the inflated ratings intact. Because the notes were performing well in the market then, a Moody’s downgrade would have raised many questions and might have pushed Moody’s to disclose the existence of a problematic model. Recognizing the harm this would cause its reputation, Moody’s covered up the problem, the S.E.C. said.”

That is but one reason why Moody’s senior management, IMO, should be in Federal prison.

The SEC’s latest attempt to reign in the Rapings Ratings Agency is an extension of Regulation AB.

What is Regulation AB?

-Boilerplate offering statements (shelf registrations) are no longer allowed. Individual disclosures are required;

-Complex securities cannot be sold without adequate time for investor investigation;

-Requires increased disclosures and more detailed data about assets in the pool;

-The cash flow waterfall — the order of loan cash flow disbursements to investors — is required upfront, and must be made available to the public;

-CEO certification: prior to any issuer/sponsor making a shelf offering, their CEO must certify asset quality (the pool is “as advertised”). This creates a Sarbanes-Oxeley like liability.

-New disclosures MUST show prior securitized failures. Prior pool asset of originators/sponsors that were repurchased due to failure must be disclosed, with actual dollars amounts of losses/repurchases revealed;

-Independent parties must monitor the pools post-sale to see if the securities are performing as forecast;

-Most important of all, structured product registration can “no longer be based solely on the fact that its securities have received an investment-grade rating.”

In other words, the Ratings agencies are being downgraded by the SEC.


BB? AAA? Disclosure Tells Us More
NYT, September 4, 2010

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