New Finra Stance on Bond Ratings May Boost Demand For Mutual Fund Credit Analysts

Just as other authorities are proposing changes that reduce the need for credit rating firms and their analysts, Finra tightened mutual fund disclosure rules in a way likely to steer more work toward the rating firms.

The self-regulatory agency ordered firms that state a weighted average bond rating for funds they sell to use a "nationally recognized statistical rating organization" to determine the average rating of securities in the fund - rather than advertising an average credit quality they computed themselves. Fund companies that lack a third-party assessment of a fund's credit quality must remove fund rating information from Web sites and shareholder communications and must refer to bonds carrying self-determined ratings as "unrated securities." Investment News reports:

Specifically, Finra said in the letter that the practice of using a weighted-average bond rating that has not been assessed by a nationally recognized statistical rating organization is misleading when used in shareholder communications because it gives the impression that the fund's overall credit quality has been independently determined.

"We learned that these weighted-average bond ratings are calculated by the funds themselves and not by the third-party independent credit ratings agencies," said Finra spokesman Herb Perone. "Each firm does them differently and it appears to investors to be apples to apples, but it's not."

Finra's move grows out of a recent case against Morgan Keegan, which is accused of improperly pricing its bond mutual funds and violating regulations on sales practices and due diligence. Morgan Keegan denies the charges brought by state and federal regulators last week involving the Regions Morgan Keegan Select bond funds. Those fund invested in risky mortgage-backed securities and lost most of their value in 2007 and 2008.

The agency's tougher stance means many fund companies, particularly smaller ones, "are going to need a third party to do the analysis of the information they use," mutual fund consultant Geoff Bobroff told Investment News. "It might be more expensive, and it might complicate life a bit, but it adds credibility, or at least consistency."