SEC urged to end the 'issuer pay' bond ratings model once tied to the financial crisis

Key Points
  • The "issuer pay" model allows bond issuers to pay credit agencies for ratings.
  • The practice came under fire during the financial crisis over high ratings given to risky mortgages that ultimately collapsed.

A bond market arrangement tied closely to the financial crisis that has nonetheless persisted should be halted, according to testimony this week before federal regulators.

The "issuer pay" business model allows for bond issuers to pay the firms that provide ratings. During the financial crisis, ratings from the three major agencies — Moody's, S&P and Fitch — came under scrutiny for assigning top grades to risky mortgages that ultimately collapsed.

In a hearing Monday before the Securities and Exchange Commission, experts testified that it's time to scrap the practice one and for all.

"The issuer-pay model that we have is fundamentally broken," Jeffrey Manns, law professor at George Washington University, told the commission, according to a Wall Street Journal report.

An SEC committee has been convened to look at broader bond market issues. Monday's hearing was for a subcommittee looking specifically at the credit ratings industry. An executive chairing the subcommittee told the Journal that no recommendations have been made yet for changes.

Issuer pay has been criticized because of the potential for conflicts of interest where agencies could feel pressured to give good ratings for the companies paying them. An S&P official earlier this year defended the model, saying it is
"existential" for the agencies and that conflicts of interest need to be "managed, remedied and disclosed," according to the Journal.

CNBC has reached out to Moody's, S&P and Fitch for comment.

Read the full Journal story here.