SEC Strengthens Credit Rating Agency Rules

The Securities and Exchange Commission voted 3-2 last month to adopt long-delayed rules to enhance the transparency and improve the integrity of credit rating agencies, those arbiters of credit quality whose willingness to assign investment grade ratings to toxic mortgage-backed securities helped to trigger the 2007 financial crisis.  Before finalizing the rules, the Commission strengthened two provisions that CFA had identified as crucial to the rule’s effectiveness.

“While the rules are far from perfect, they are significantly stronger than the original proposal in important ways,” said CFA Financial Services Counsel Micah Hauptman.  “If properly implemented and effectively enforced, the rules should help to reduce both the willingness of ratings agencies to allow marketing and sales considerations to influence the ratings process and their ability to do so.”

Since the rating agency rules were first proposed more than three years ago, CFA had been sharply critical, arguing that the proposed regulatory approach was far too weak to effectively address ratings agency abuses.  In a comment letter submitted earlier this year and in meetings with SEC commissioners and agency staff, CFA focused in on three key provisions that must be strengthened if the rule is to achieve its intended goal of reducing the harmful impact of conflicts of interest on ratings quality.

Specifically, CFA had called on the Commission to:

• adopt a broad, principles-based rule to prevent marketing-related conflicts from influencing ratings;
• set minimum standards for the control systems ratings agencies are required to adopt to ensure that they don’t circumvent their methodologies in order to inflate ratings; and
• strengthen mechanisms for holding ratings agencies accountable when they fail to apply ratings symbols consistently across asset classes.

The final rule includes the broad conflicts of interest provision advocated by CFA.  It also provides a clearer framework for how ratings agencies should develop their internal control systems, though it stops short of setting mandatory minimum standards for those systems, as CFA has urged.  “Only time will tell how effective these provisions are in reducing the impact of conflicts on ratings analysis,” said CFA Director of Investor Protection Barbara Roper.  “A lot will depend on the Commission’s willingness to use its oversight and enforcement authority to rein in abusive practices.  But the revised rules provide the Commission with important tools, lacking in the original rule proposal, to make the rating agencies more accountable.”

On the other hand, the Commission failed to strengthen provisions designed to prevent ratings agencies from using the same ratings symbols for securities that pose very different levels of risk.  In a letter to the agency last month, CFA refuted industry arguments that the Commission lacked the authority to make the necessary changes to this provision.  “This is a huge missed opportunity to hold rating agencies accountable for the ratings they issue,” Hauptman said. “The natural result of the SEC’s lack of action here is that rating agencies will continue to be able to issue ratings that are effectively meaningless. Knowing this, investors must ask themselves how they can justify relying on ratings that have no predictive value.”

Despite that caveat, CFA expressed strong appreciation both for the diligent efforts of Commissioners Aguilar and Stein to strengthen the rules and for the willingness of Chair White to move the rule forward on a 3-2 vote when opposition to those strengthening amendments emerged.

Groups Petition FCC to Block Comcast-Time Warner Merger

CFA along with two dozen allied and member groups filed a petition with the Federal Communications Commission (FCC) last month urging the agency to block Comcast from acquiring Time-Warner and the swap of additional systems with Charter Communications.

“The inevitable result of this merger will be higher prices, worse service, and less innovation,” said CFA’s Director of Research Mark Cooper press statement on the petition.

“Just four years ago the FCC and the Department of Justice (DOJ) found that Comcast has market power, as the nation’s largest buyer of professional video content and the largest provider of both multichannel video programming and broadband Internet access service. “The acquisition would increase Comcast’s market power by at least 50 percent and create a Goliath that would tower over the industry,” he added.

The petition provides evidence related to a number of reasons why the merger should be denied:

• the performance of the cable sector has gotten worse since the 2013 Comcast-NBCU merger;
• permitting Comcast to acquire Time Warner would have a devastating impact of all the markets in which Comcast plays a leading role, according to the DOJ/FTC Merger Guidelines;
• nothing in the recent past or near future has or will change the fact that cable remains the dominant technology;
• Comcast has a long history of abusing its market power that has been reaffirmed by its behavior since its acquisition of NBC; and
• Comcast remains a laggard in capital expenditures.

Because no regulatory tools exist to control the market power over customers, set top boxes and “middle mile” transport that Comcast will have if it is allowed to acquire Time Warner, “competition, consumers and the public interest can only be served by blocking this merger,” Cooper said.

FTC Urged to Strengthen Energy Labeling Rule

Consumer, efficiency and environmental groups submitted comments proposing revisions to the Energy Labeling Rule to the Federal Trade Commission’s (FTC) supplemental notice of proposed rulemaking.

Writing in response to a supplemental notice of proposed rulemaking, the groups reiterated their support for many of the proposed changes, such as requiring Lighting Facts labels on additional classes of lamps and consolidating range information for refrigerators.  But the groups also called for additional changes, including extending liability under the rule to retailers and marketplace websites, requiring labels on clothes dryers, and updating label content more frequently.

“We ultimately want to see the FTC’s EnergyGuide label be visible, as clear as possible with timely information made available by all retailers so that consumers have good information on the energy consumption of a product and can make the best informed purchasing decisions.” said CFA Special Projects Director Mel Hall-Crawford.

SEC Action Needed to End Broker-Dealer Misrepresentations

Current SEC policy allows brokers to mislead investors about the nature of the services they are offering, CFA Investor Protection Director Barbara Roper said in a statement at a recent press briefing.  She called on the Commission to fix the problem, a problem that it created, by moving forward with rulemaking that requires brokers who hold themselves out as advisers to act in their customers’ best interests.

Speaking at a press briefing sponsored by the Institute for a Fiduciary Standard, Roper noted that the SEC has permitted broker-dealers to call themselves advisers, offer services that are, or should be, advisory in nature, and market themselves as if investment advice is the primary service they have to offer.  “But brokers aren’t in fact advisers, at least not legally; they are salespeople,” Roper said.  “The standard that governs their so-called advice — the suitability standard — is a sales standard that allows them to make recommendations that put their own financial interests ahead of those of their clients.  And pervasive incentives in the broker-dealer compensation system encourage them to do just that.  That is not what people expect, and have every right to expect, when they consult a ‘financial adviser.’”

Moreover, Roper noted, an obligation to act in the best interests of their customers is precisely what distinguishes advice from a sales pitch.  “By allowing brokers to offer ‘advice’ without requiring them to act in their customers’ best interests, the SEC is permitting them to deceive investors about the nature of services they are offering,” she said.  Noting that a lack of economic data is often invoked to justify inaction to address this problem, Roper countered that, “The real question is not, where is the economic data to support the regulation.  The question is, where is the data that justifies maintaining the status quo.”  If the SEC frames the issue correctly, “rulemaking becomes easy to justify on economic grounds,” she said.

Roper concluded by urging SEC Chair Mary Jo White to move forward with rulemaking even if she must do so on a 3-2 vote.  “Rooting out misrepresentations, promoting fair competition, harnessing market forces to benefit rather than harm investors is a policy that should be able to win bipartisan support,” she said.  “But if Chair White must take a 3-2 vote to bring it about, so be it.  This is an issue of sufficient importance to the basic financial well-being of millions of investors that the Chair must be willing to take that vote.”

Consumer Alert: Insurance Companies Raising Rates without Reason

Insurance companies are changing the way they price their policies and raising rates, even for consumers have remained with the company for many years and have filed few or no claims, according to a consumer alert issued by CFA late last month. “Even if you have a perfect driving record, many insurance companies are raising rates on people just like you – people who do not shop around,” said CFA’s Director of Insurance Bob Hunter in the alert.

Adopting a practice called “Price Optimization,” many insurance companies today determine how much of a price increase a customer will tolerate by using personal consumer data and statistical models, Hunter explained.  If insurance companies determine that the diver is not likely to leave their company, they raise the driver’s premium. Factors that may make a consumer vulnerable to a price increase include staying with one insurer for many years, never calling the company with complaints or simply buying your insurance through an agent rather than online, he said.

“The first thing to do to stop being PO-ed by an insurance company is shop around,” said Hunter. “The second thing every consumer should do is call their state’s Insurance Commissioner and tell her or him that you want them to stop insurance companies from using this Price Optimization scheme to unfairly raise rates on customers.”