Subject: File No. DF Title IX - Credit Rating Agencies
From: Jason A Voss, CFA
Affiliation: Content Director, Fixed Income, CFA Institute

October 31, 2011

The comments submitted are my own views and do not necessarily reflect the views of CFA Institute.

Background:

The greater information and insight about the credit quality of a financial instrument is possessed by the issuer, not the buyer. Credit ratings agencies were established to aid investors in information discovery. Yet, the burden of discovery should not fall exclusively on the purview of the buyer. Instead, the majority of the burden of discovery should be on the part of the seller given their unique perspective as an insider and their unrivaled access to information about their own creditworthiness.

Proposal:

Establishment of a self-regulatory organization (SRO) sponsored by issuers and investors of financial instruments. The costs of establishing and maintaining the SRO would be borne by both investment issuers and investment issue buyers as a small percentage of a transaction's nominal amount. A proposed title for the SRO is: National Risk Assessment Bureau (NRAB). This overcomes several noteworthy hurdles. 1) A limited budget on the part of the Securities Exchange Commission and the resultant lack of analysts to monitor the efficacy of investment issue disclosures. 2) Complaints by industry of too much burdensome regulation by "out of touch" regulators. 3) Over reliance on credit ratings issued by NRSROs on the part of investors, regulators and others. In the end, what matters is whether or not an investment issuer delivers on its promises. 4) The funding for the NRAB puts the financial burden where it properly should reside: on those that benefit from the presence of the market for the investment issues that is, on both the issuer and investor.

The NRAB would rely upon investment issuer self-reporting about the risk of an investment issue. Provisions of the Private Securities Litigation Reform Act could be used to provide a framework for this self-reporting. This properly places the burden of discovery with the entity with the most insight into the creditworthiness of an investment issue: the issuer itself.

SEC rules would require the disclosure of significant changes in the credit worthiness of a financial issue or issuer on the part of the issuer itself. This would be similar to the disclosure required in an 8-K.

Disclosures by the NRAB would be required to be made public and available on an easily searcheable, well-indexed NRAB website so that investors and prospective investors would be able to track any changes in the credit worthiness of an investment issue. A technical requirement would be a search function, as well as the ability for investors to subscribe to e-mail alerts about changes in the credit worthiness of investment issues they are interested in or own.

A track record as to the accuracy of, and timeliness of, an issuer's credit worthiness disclosures would be required to be maintained. This would help ensure that prospective investors, and investors, would be able to not only assess the credit worthiness of an individual investment, but of the issuer itself.

To ensure compliance with the self-reporting conditions of the NRAB incentives would be put in place. For example, in the event of a too aggressive risk assessment (one where the risk assessment understated the realized risks) financial penalties would be assessed. The financial penalty would be placed into escrow and would be used to pay back buyers of the investment issue in the event of default. Effectively, this payment would work like a margin call. If the investment issue does not default, the monies would be refunded to the issuer. In the event of default of a financial issue, punitive measures would be called for, such as suspension of the ability of an issuer to issue further investments. In the event of fraud, criminal penalties would be used to punish issuers.

Investment issuers would be required to pay for either, a) an annual audit, or b) default insurance. An annual audit would only be permitted for issuers whose history of risk assessments of the creditworthiness of their issues was consistently accurate for example, greater than or equal to 70% accuracy. The default insurance option would be for issuers whose accuracy in risk assessments of the creditworthiness of their issues was below a threshold amount for example, below 70% accuracy. Default insurance would effectively be similar to the mortgage insurance that is required by banks when underwriting a mortgage for private individuals.

Jason A. Voss, CFA