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What’s a ‘Significant Error’? Standard & Poor’s Says Leave It To Us

Marian Wang
Pro Publica / News Analysis
Published: Thursday 11 August 2011
"In the controversy over the U.S. downgrade, Treasury officials accused the firm of making a miscalculation that “undermined the economic justification for S&P’s credit rating decision."
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Just days after the Treasury Department criticized Standard & Poor’s for “a $2 trillion mistake” in the math it used to justify its credit downgrade of the United States, the ratings firm sent a letter to securities regulators urging them to keep some proposed regulations as vague as possible.

One area in which S&P had specific interest in keeping things vague? A provision that would require the firm to report “significant errors.” The letter was first noticed by Reuters, though you can see the letter for yourself [PDF] on the Security and Exchange Commission’s website.

S&P “does not believe that the Commission should attempt to define the term ‘significant error,’ ” the firm wrote. Should it do so, the commission “would effectively be substituting its judgment for that of the (rating agency).” (Reuters notes that the other two of the three main ratings firms, Moody’s and Fitch, did not raise major concerns about the proposed rule on errors.)

In the controversy over the U.S. downgrade, Treasury officials accused the firm of making a miscalculation that “undermined the economic justification for S&P’s credit rating decision,” noting that after the mistake was pointed out, “S&P simply removed a prominent discussion of the economic justification from their document.”

According to the Wall Street Journal, however, S&P didn’t seem to agree on whether this mistake constituted a significant error:

S&P officials acknowledged the error Treasury pointed out but didn't believe it was so significant. It was a technical error, though it could have serious implications.

“We have found our error correction policy has proven to be effective,” the company told the SEC. That policy requires [PDF] the firm’s employees to “promptly report any material errors discovered” but essentially leaves it to the firm to define whether the error is significant enough to warrant disclosure or adjustment of ratings.

The SEC rule-making is mandated by the Dodd-Frank financial reform bill, passed by Congress last year to clean up after the financial meltdown of 2008.

In its comments on the rules, S&P sought more discretion than regulators had proposed. “The Commission should not set out such detailed requirements,” the company wrote regarding a proposal to require more reporting on firms’ internal control structures.

The rules also require ratings firms to limit the interaction between employees involved in developing ratings and employees involved in sales and marketing activities—the idea being to prevent the sort of conflicts of interest that some say aided and abetted the creation of risky mortage-backed securities.

S&P urged the SEC not to define “sales and marketing activities.”

“We think it is appropriate for individual (rating agencies) to define these activities for themselves,” the company wrote.

Meanwhile, advocates of reform expressed disappointment on key aspects of the rules regarding internal controls and conflicts of interest. In a separate letter, Americans for Financial Reform and the Consumer Federation of America urged the SEC to enact more stringent rules in those areas and to provide “extensive clarification” on other aspects of the proposed regulations that the groups felt were too vague to be meaningful.

ABOUT Marian Wang

Since graduating with honors from Northwestern University's Medill School of Journalism in 2007, she worked in Chicago as a freelance investigative reporter and blogger for The Chicago Reporter, Chi-Town Daily News, and ChicagoNow. She now lives in New York. She likes it a lot.

The other aspect that would

The other aspect that would be interesting to analyse is why the same agency, cut-off from the reality of the CDO (mortgage market) managed to maintain AAA notations on products that we rotten to the core. Now, they are trying to pass themselves off as doing due diligence and in touch. The US is far from being a risk bet especially in comparison to the crap that was inside the CDOs.

Imho, S&P's somewhat fluffy,

Imho, S&P's somewhat fluffy, insubstantial, perhaps just weasel-minded objection to Treasury’s queries about S&P’s lapse in control when it made the “2 $Trillion error” is an excellent example of a business entity getting lost in talking to itself when it is allowed to makes its own rules (“self govern”) about what constitutes “quality” in its products or services. . That is why a conscientious and universally recognized principle of quality control is to have objective (read as “free-from-conflicts-of-interest”) 3rd party source(s) render quality evaluations - hence also why ratings agencies exist in the first place. Simpler: isn’t it just common sense that given the momentous (proven last week) weight of their opinions (their product), shouldn’t the agencies themselves have outside “help” (oversight) formulating their own rules of conduct?

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