For Immediate Release - March 07, 2011

AG Coakley Urges SEC to Enforce Regulations on Credit Agencies as Directed by Dodd-Frank Financial Reform Law

SEC had issued "no-action" letter stating that it will not enforce regulations designed to protect investors and prevent next economic crisis

BOSTON - Today, Attorney General Martha Coakley's Office urged the U.S. Securities and Exchange Commission ("SEC") to enforce legal requirements against credit rating agencies, established under the landmark Dodd-Frank financial reform law, to better protect investors and avert another lending crisis.

The letter pdf format of 2011_03_07_sec_letter_attachment1.PDF
file size 1MB is part of a continuing effort by AG Coakley to urge federal regulators and Congress to take action to protect consumers, investors, and the marketplace, all as part of her office's overall actions responding to the subprime mortgage collapse.

"Investment banks drove the increase in subprime lending and lax mortgage standards that contributed so dramatically to our economic collapse - this occurred on the watch of credit rating agencies," AG Coakley said. "The Dodd-Frank financial reform law rightly addressed that issue by holding credit rating agencies to the same standards as accountants and lawyers. That is why the SEC's decision not to enforce these important regulations is so disappointing. We are calling on the SEC to enforce these regulations as a way to protect investors and help prevent a future lending crisis."

Leading up to the market meltdown of 2008, Wall Street's drive for profits from securitizing loans dramatically increased the volume of subprime lending, loosened mortgage lending standards and contributed to the foreclosure crisis ongoing today. This process occurred on the watch of the rating agencies: Many securitization tranches were highly rated by rating agencies when first sold to investors, but later became worthless. Echoing widespread concerns about the competitiveness, competence and impartiality of the rating agencies, last year's Dodd-Frank Wall Street Reform and Consumer Protection Act ("Dodd-Frank") rescinded the agencies' exemption from what is known as "expert liability" under the Securities Act of 1933. Going forward, rating agencies, like accountants and lawyers, are required to sign any securities prospectus that includes information they have prepared. By signing, the rating agencies will accept liability to investors if they fail to meet a duty of due care.

When Dodd-Frank went into effect on July 22, 2010, asset-backed issuers were required for the first time not only to disclose ratings in prospectuses, but also to obtain rating agency consents to expert liability. The rating agencies refused to consent, and the securitization markets froze for one day. The SEC responded with a so-called "no-action" letter, first for six months, then extended indefinitely, indicating that the SEC staff would not recommend enforcement action under Regulation AB (the regulation governing the creation and sale of the securitized subprime mortgage notes) to the extent it requires asset-backed issuers to disclose ratings in prospectuses. The markets have treated this non-enforcement as though it changed SEC regulations, and major issuers are selling asset-backed securities without the required ratings disclosure or rating agency consents. As a result, investors may be unprotected from potential failures on the part of rating agencies.

In her letter, AG Coakley urges the SEC to enforce Regulation AB in its entirety and in a manner consistent with Dodd-Frank. AG Coakley argues that the SEC should let the market set rating agency pricing reflecting the duty of competence, in particular since calculating risk of loss is the rating agencies' business. Other central concerns of the letter include:

  • The SEC has defeated the intent of Congress to better protect investors against rating agency misconduct.
  • The SEC has created market confusion by allowing the widespread view that the requirements of Regulation AB have changed, when in fact the SEC has simply announced that it does not intend to initiate cases on this issue at this time.
  • The SEC may be creating the potential for significant unintended consequences, including future liability of issuers and underwriters for failure to comply with applicable regulations.

AG Coakley had previously testified to the SEC last August as it attempted to revamp Regulation AB. Regulation AB is the SEC regulation that governs the offering process and disclosure requirements for asset-backed securities. The regulation also governs the behavior of investment banks and others when they "securitize" home mortgages and other consumer debt. Securitization is the process of grouping mortgages or other debt into a pool of assets, then issuing investment notes based on the income generated by those loans. On January 20, 2011, the SEC adopted many of AG Coakley's recommendations for Regulation AB in an initial rulemaking, with further rulemakings expected to follow.

AG Coakley has been conducting an industry-wide review of Wall Street's role in the subprime loan crisis in Massachusetts, reviewing allegations that investment banks knowingly funded and facilitated the making of defective unfair loans to Massachusetts consumers. The investment banks then allegedly put many of the defective loans into securitizations, which they sold to investors.

Coakley has been a national leader in her efforts to hold Wall Street accountable and protect investors and homeowners. In response to the economic crisis, Coakley's office has recovered more than $440 million back for taxpayers in Massachusetts, helping to keep more than 15,000 people in their homes. As part of those efforts, Coakley reached a landmark settlement with Goldman Sachs regarding its role in the securitization process in Massachusetts, under which Goldman Sachs was required to pay $60 million to reimburse affected homeowners and the Commonwealth. In June 2010, the Attorney General completed her investigation of Morgan Stanley's role in the Massachusetts subprime market. In settling with the Commonwealth, Morgan Stanley agreed to pay $102 million, including $58 million in relief to homeowners and nearly $20 million for Massachusetts taxpayers.

The submission of the Attorney General's letter to the SEC, like her securitization investigations and her testimony on Regulation AB, is being handled by the staff of Attorney General Coakley's Insurance and Financial Services Division.