09 May 2008

SEC Cox comments on CRAs and Fair Value

The SEC will consider proposed new rules to strengthen the rating agencies' accountability and transparency, and make their industry more competitive within the coming weeks, SEC chairman Christopher Cox said. Also, the apparent pro-cyclicality of fair value accounting will be reconsidered.

The SEC will consider proposed new rules to strengthen the rating agencies' accountability and transparency, and make their industry more competitive within the coming weeks, SEC chairman Christopher Cox said in a speech held on 30 April. Also, the apparent pro-cyclicality of fair value accounting will be reconsidered.

 

“We may seek to enhance competition through rules designed to ensure that every credit rating agency has access to the information underlying ratings for structured products issued by its competitors”, Cox said, adding that the Commission is also reconsidering its extensive reliance on credit ratings in its own rules.

 

Among the new rules for credit rating agencies are requirements for enhanced disclosures about ratings performance; specific prohibitions on practices that lead to conflicts of interest; requirements to disclose information about the assets underlying the mortgage-backed securities, CDOs, and other structured finance products they rate; more robust disclosure about how they determine their ratings for structured products; new disclosures regarding how the firms monitor current credit ratings on an ongoing basis; and clear disclosure to investors through a ratings symbology that would make it possible for them to readily distinguish among ratings for different types of securities, such as structured products, corporate securities, and municipal securities.

 

Turning to accounting issues, Mr Cox stated that fair value has helped solve problems that arose in the 1990s. However, it seems only imperfectly to have anticipated the problems of the 21st century, he said.

 

“The apparent pro-cyclicality of fair value accounting has gotten the attention of economists as well as accountants”, he noted. “The fact that model-based valuations in the absence of an active market can be highly variable across companies in similar circumstances means that almost every estimate of fair value requires significant judgment”, adding that a roundtable discussion on fair value being planned by the SEC's Chief Accountant may lead to policy recommendations.

 

The issues that will likely be discussed include the application of Level 3 methods, including proprietary models, to lightly traded securities as prescribed in the valuation hierarchy in the FASB Statement of Financial Accounting Standards (SFAS) No. 157, Fair Value Measurements.

 

Full speech

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