Should credit ratings be used by fiduciaries when making investment decisions for retirement plans?
As a result of confusion and manipulation by certain credit rating agencies during the financial crisis of 2008 (AAA-rated subprime mortgages), the Dodd-Frank Wall Street Reform Act blocked the use of credit ratings for exemptions from prohibited transactions.
Now the Department of Labor announced it will reopen the comment period on proposed amendments to six class exemptions from prohibited transaction rules related to Dodd-Frank’s credit rating prohibition.
“Proposed in 2013, the amendments comply with Section 939A of the Dodd-Frank Wall Street Reform and Consumer Protection Act, which requires the department to remove any references to, or requirements of reliance, on credit ratings from its class exemptions and for the department to substitute standards of creditworthiness it determines to be appropriate,” the announcement read.
While the department’s Employee Benefits Security Administration (EBSA) received three comments in 2013 generally supportive of the department’s approach, it did not finalize the amendments. In the years since, other regulators have finalized changes to the treatment of credit ratings under their regulatory authorization.
“Given the passage of time, the Department of Labor wants to ensure all interested parties have an opportunity to provide comments or new information to consider as we finalize the proposal,” Acting Assistant DOL Secretary for EBSA Ali Khawar said in a statement. “As such, we are reopening the comment period and soliciting comments on all aspects of the 2013 proposal.”
Fred Reish responds
One of the root causes of the “Great Recession” was the credit ratings of tranches of securitized mortgages on residential property and other indebtedness, noted ERISA attorney Fred Reish with legal giant Faegre Drinker. Some of the risky tranches were rated as if they were relatively safe investments.
“Once the market imploded, much of the security for those tranches because worthless,” Reish explained. “As a result, the Dodd-Frank Act forbade the use of credit ratings for exemptions from the prohibited transaction.”
Calling the Dodd-Frank legislation “overreaching,” Reish added that now, the DOL must implement the restrictions on credit ratings, regardless of the type.
“That is unfortunate,” he concluded. “In some areas, I believe that credit ratings should be at least a part of the process used by plan fiduciaries in making decisions.