Mr. Jonathan G. Katz, Secretary
Securities and Exchange Commission
450 Fifth Street, N.W.
Washington, D.C. 20549-0609
United States of America
Friday, 25 July 2003
Re: Rating Agencies and the Use of Credit Ratings Under the Federal Securities Laws File No. S7-12-03
Ladies and Gentlemen:
I am pleased to submit my comments regarding the concept release on Credit Rating Agencies.
To provide you with some background information on myself, I have 20 years' experience in international banking as a financial analyst, and worked for a brief period at the IBCA credit rating agency. I presently provide financial training and banking consulting services, including credit rating advisory services to bank training institutes, the financial community, international organisations, and governments. I am also the author of several books on banking and finance including "The Ratings Game", "Understanding International Bank Risk", "Syndicated Lending", "E-Finance", "Advanced IT in Finance", and "Measurement and Internal Audit".
I believe it essential to enhance the integrity and quality of the credit rating process, as well as the role and impact of credit rating agencies in the economy, in order to enable investor confidence and a proper functioning of the capital markets to be achieved, and for the worst predatory excesses, dysfunctional behaviour, performance failures, and damaging effects arising from their current activities to be eliminated.
I have several reservations as to the actual NRSRO régime, in particular: the dysfunctions arising from the NRSRO designation process; the closed monopoly state of the business; the sidelining of information from international rating agencies; the opaqueness of the rating agencies' methodologies in articulating their ratings criteria; the absence of a rigorous methodology to assess corporate, bank, and sovereign risk; the absence of professional qualifications and certification for analysts working in the business; the conflicts of interest inherent in rating agencies being paid by the entities they rate; predatory market practices such as "unsolicited ratings" and "ratings advisory services"; the legal unaccountability of the rating agencies re their various quasi official pronouncements (which are being legitimised via incorporation into legislation and regulatory regimes); and the unreliability and frequent inexplicable changes in sovereign risk ratings1 which results in highly damaging and wide ranging effects on nation states' ability to access the financial markets and optimally manage their finances to foster economic growth and full employment.
I trust the following comments assist the SEC in its deliberations on these matters.
1 Entry Criteria
The current procedures relating to the NRSRO designation process are ambiguous, deeply flawed, and have propagated numerous counterproductive phenomena - phenomena within the ratings industry, for investors, and for general economic growth, prosperity, and diversity.
These flaws are such that ideally, the NRSRO designation should be eliminated altogether, as it basically limits the choice of information available to the investor creditor community and imposes a narrow world view upon the economy - both for investors as well as issuers. It also results in numerous contradictions, inconsistencies, and conflicts of interest which shall be considered later.
We do not believe the role of the SEC is to confer NRSRO recognition but rather to ensure best practice in the industry via the implementation of professional qualifications, examinations, and competition in the industry.
We do not believe that NRSRO recognition should be conditioned on a credit rating agency documenting that it has been retained to rate securities issued by a broad group of well-capitalized firms. This merely indicates that the rating agency is able to deploy effective marketing teams rather than provide analytical reliability and credibility. Smaller agencies or foreign agencies may have equal analytical capability, but may not have the relationship networks and expensive marketing structures needed to secure business as easily as the larger agencies.
We do not believe in the effectiveness of the SEC evaluating the rating agency's developing and implementing procedures to ensure credible, reliable, and current ratings, because this becomes more an exercise for ratings agencies to strive to satisfy conditions of due diligence (which can never be all inclusive and indeed are at times mere formalities) than to produce quality information.
We believe a better solution would be to eliminate the present NRSRO régime and conflict of interest in having issuers (a captive clientele) pay for ratings, and to liberalise the market by creating the "Chartered Rating Analyst" designation.
As with any profession whose practice interfaces with the public such as accountants, airline pilots, architects, dentists, surgeons, lawyers, or investment advisors, the ability to practice the profession of rating analyst should be linked to satisfying a certification process which can incorporate various criteria such as education, degrees, professional experience, and ability to satisfy professional examiners, thus enabling the practice of the profession of rating analyst.
There have been too many cases of analysts with no qualifications in finance, accounting, or economics, or professional experience in finance or economics thriving in rating agencies. This is clearly unacceptable in organisations endowed with a regulatory function that controls access to the world's financial markets.
However, if the SEC deems it desirable to maintain the NRSRO concept, several recommendations should in any case be implemented in order to minimise the negative and counterproductive elements within the credit ratings industry and the negative and counterproductive effects arising from their activities.
- Clarify entry criteria. In the instance of the NRSRO concept being retained, we believe that a clearly articulated set of entry criteria should be formalised and made publicly available. We also believe that the approval or rejection process should occur within a designated timeframe. The current NRSRO régime has resulted in an extremely profitable2monopoly3levying fees on a captive community - a monopoly with an incomprehensible entry criteria, tremendous entry barriers4 opaque modus operandi5 performance shortcomings6 and unresponsive characteristics7
- Eliminate the duopoly. By limiting entry, the current NRSRO régime has the effect of protecting a privately owned duopoly generating monopolistic profits. A state of competition cannot be said to exist in the industry due to the threat of unsolicited ratings and spectre of rating shopping resulting in the phenomenon of multiple ratings. The end result is that the current NRSRO régime stifles competition and diversity, not only in the ratings business but in the economy at large. It results in a narrow interpretation of what constitutes acceptable economic practice. This not only has the effect of stifling diversity in the ratings sphere, and consigning to irrelevancy other perhaps more credible albeit non NRSRO analysis, it stifles diversity in what constitutes acceptable economic practice, and the ability of the markets to impose discipline. "It is a recipe for shortages, rents, distortions and stifled innovation and diversity".8Internationalise entry criteria. The current NRSRO entry criteria can be considered as fostering informational disequilibrium, since there are no non-US rating agencies with NRSRO status. Since the Bâle 2 accords have incorporated the use of credit ratings in capital adequacy calculations, regulatory dependency on ratings are assuming an international dimension. Non-US agencies however have been effectively excluded from Bâle 2. This not only propagates the dysfunctional NRSRO régime internationally; it filters the quality, quantity, and diversity of information available to investors since they are relying solely on the ability of 2½ rating agencies to rate companies, banks, and countries internationally, when local agencies may indeed have more and better experience but are effectively sidelined. Indeed present NRSRO status does not mean that these agencies have the requisite technical, legal, and analytical skills or indeed credibility to assess issuers in countries with substantially different economic and legal structures and practices such as Germany, Japan, or Russia9 Exclusive reliance on US agencies moreover can result in international information flows to investors being compromised by political factors10 Established rating agencies based in developed foreign capital markets should therefore be granted recognition for ratings in those markets, in order to enable a wider and perhaps better range of information to be available to investors.
The NRSRO concept therefore is deeply flawed. Entry criteria in the US should reside on establishing multiple providers with technical competency and proficiency standards being established via a "Chartered Rating Analyst" qualification (as in a CPA or CFA designation), rather than arcane entry criteria for firms validated via nebulous concepts such as "domestic acceptance", or "access to management.".
The market will rapidly decide which players provide credible information and which ones don't based upon the quality of the analyst and value of the analysis produced, as opposed to the rating firm. This is the ultimate sanction of discipline and would dispense with complicated manoeuvres such as behind the scenes efforts of foreign governments lobbying US authorities to intervene in the NRSRO designation process.
We believe it is effectively impossible for the SEC to monitor credit rating agencies' inner workings and methodologies since the ratings process is so inherently subjective and unstructured that evaluating rating procedures and methodologies is an effectively impossible task. The SEC moreover would need to undertake audits of credit rating files to verify the consistency and quality of analytical work. The wide range of companies being rated would necessitate tremendous investment in a diversified audit team.
We believe there are more effective mechanisms to reach this goal.
- Constitute an Examination Board. Rather than be obliged to perpetually monitor the agencies, with their commercial agenda, we believe it would be more effective for the SEC to set up an examination body comprised for example, of SEC officials, economists from academia with a non commercial agenda, major investor groupings such as those representing pension funds or mutual funds, major creditors such as large US and International banks, as well as the board of professional organisations such as the CFA and GARP. The role of this board would be to assist in defining an examination and certification process for rating analysts, as is in place for any other licensed profession such as heating engineers, surgeons, airline pilots, architects, or investment advisors.
- Create a Chartered Rating Analyst Designation. The Chartered Rating Analyst certification procedure would eliminate the typical rating agency career path, which relies on social connections, mentoring, favouritism, political infighting, and internal promotions11because it would empower the competent certified analyst rather than the adept social climber and political infighter who does not assume responsibility for his actions12 We therefore believe that as in law firms, the Commission should define the criteria for the certification process establishing competency, and require all analysts as well as managers supervising those analysts and members of rating committees to pass the certification process. The analytical work would then be the fruit of an analyst, not a business organisation. Being certified analysts, they would become professionally responsible for the effects of their pronouncements. Ultimate discipline of the analyst would rely on revocation of the certification, thereby placing individual analysts directly in the line of behaving professionally and ethically, or suffering the consequences of decertification.
Given the quasi legal nature of the rating agencies' role and pronouncements, it is indeed astonishing that there are no set of professional qualifications or accountability in place for the analysts of the rating agencies whose pronouncements are used to rationalise investment decisions13and ensure adherence to capital adequacy requirements.
3 Methodological Issues
We do not believe having the rating agencies satisfy a due diligence exercise is meaningful because this shifts the focus of the rating agency from producing accurate investment analysis information to satisfying bureaucratic requirements in order to maintain their market dominance. Moreover, there are several problems with monitoring methodologies that have several weaknesses:
- Default Correlation Rates are not as accurate as one might believe. The rating agencies' arguments about the validity of ratings arising from the establishment of default correlations over time are misleading14 It is impossible to compare ratings (and defaults) arrived at in the 1960s with those of 2003 and claim continuity due to changes in economic data, volatility arising from real time IT systems and currency flows, analytical techniques changing over time, and high analyst turnover11. Analysis and defaults are therefore discrete and unrelated events (since like is not measured with like), and each event in the ratings agencies' time continuum (the rating as well as the default) is unique.
- Implementing guidelines does not ensure homogeneity of information. Codifying a methodology implies that the quality of research and analysis of a rating would be uniform from company to company, industry to industry, and country to country (despite the fact that these ratings may not benefit from the same level of information and analytical exactitude as another14). This would provide misleading information to investors. Simply requiring minimum levels of information cannot address the issue of heterogeneous rating quality since overseas ratings cannot be subject to such oversight and the rating quality therefore cannot ensure homogeneity.
- Heterogeneous information obviates the effectiveness of a uniform methodology. The heterogeneity of information inputted into the analytical process as well as the heterogeneity of information disclosure from one country to the next means that it is effectively impossible to reconcile the definition of a methodology with its proper execution. The underlying quality of the rating will inevitably be heterogeneous, with a commensurate adverse impact on the consistency of rating scales.
- Computer Modelling is not an all inclusive analytical technique. Regarding the matter of requiring the use of computer models and evaluating the structure of the computer models - we believe that this would place the SEC in an impossible situation of micromanagement of another matter whose evaluation criteria have yet to be defined. Granting recognition to a credit rating agency that solely uses a computerized statistical model and no other qualitative inputs would also be erroneous because a proper risk assessment is not merely a statistical analysis of financial data. Moreover, we have seen the effects that corrupted accounting information can have on financial analysis. There is a need to access non quantifiable factors such as public confidence in banks, manufacturing quality with corporates, and other operational issues which may result in lost markets or product liability lawsuits. Such subjective elements cannot be incorporated into a computerised statistical model. Moreover, certain international rating agencies have claimed to use such models when in reality they did not exist, and have not demonstrated a willingness to get to grips with accounting fundamentals.15Access to Management is not a sine qua non. Regarding access to management as part of the ratings process, we do not believe this is necessarily an indication of quality ratings since the press is replete with reports of companies lying and manipulating accounting data in audited statements in an effort to present themselves in a favourable light. We have every reason to believe that this modus operandi would equally apply in rating agencies' interviews with management. Moreover, the rating agencies have acknowledged that they primarily rely on publicly available information for their rating process, thus admitting that access to management is not crucial in financial analysis16 position also further underscored by Moody's arguments that the quality of solicited ratings was equal to unsolicited ratings and that there was no need to distinguish between the two despite that the former relies on management interviews and the latter does not.
- Rating Agencies do not focus sufficiently on the IT and software issues in banks. It is generally recognised in the financial services industry that due to capitalisation ratio constraints and mature economies, that balance sheet growth typically occurs by either moving i77nto higher risk lending, or increasing creditworthy lending (by taking business from other banks). One main element of competitive advantage, that of attracting retail deposits, increasingly arises from the IT and software systems in place, which enables real time reporting for optimal risk management and asset liability management purposes, and customer centric databases enabling effective customer relationship management and product development policies to be defined, implemented and monitored. For example, the CEO of global custodian State Street acknowledged that the bank was more in the "information business" than "lending business". Such operations necessitate tying together disparate information sources and databases. Seamless straight through processing of electronic data for efficient management information systems is essential for the effective day to day risk management of a bank's ongoing operations, and clear view of future operations. Nowhere in the rating agency risk analysis literature is any focus attributed to the role of IT systems, assessing IT investment patterns, assessing software procurement procedures to support the bank's business strategy, and the constitution of effective customer centric relational database systems enabling the optimal marketing of retail banking products in an effort to secure stable retail deposits (rather than rely on confidence sensitive interbank deposits as witnessed in the Continental Illinois débacle). IT policy is revelatory about a bank's vision of itself and its future marketing strategy. This lack of IT focus by rating agencies not only provides incomplete analysis, but is also indicative of the traditionalist mind set arising from operating in a protected oligopoly, with no competition to stimulate innovative thinking, oblivious to the impact of new technologies on established business models.
Managing the unmanageable would therefore seem to be more difficult than managing quality via the certification of analysts, ensuring they have the necessary analytical skills to examine heterogeneous information and put their reputation on the line via cogent and reasoned argumentation. Chartered Rating Analysts would therefore have a vested interest in producing quality and credible research in order to avoid decertification. The markets would accordingly take this into account, reach their own judgments regarding the quality of information, and purchase the best information, or indeed, undertake their own analysis if so required.
Eliminating NRSRO and the captive fee income system not only eliminates conflicts of interest, it means that the credit rating agencies will need to compete for business on commercial criteria - normal since they benefit from freedom of the press by arguing that they are members of the "media". They will consequently need to ensure that the proper tools and methodologies are in place in order to attract the requisite business on a commercial basis by selling information deemed to be of value17
4 Information Monitoring and Control Structures
In view of investors' the Commission's, and regulatory environment's increasing reliance upon NRSROs, if the concept is to be retained, the Commission's continuing oversight over NRSROs should be enhanced. Credit rating agencies need to be made to communicate more transparently the inner workings of the ratings process, and have this rating process closely monitored by the SEC in order for issuers and investors to understand the process and the nature and quality of the information being provided, and the for the adverse effects the ambiguous rationales behind ratings have on companies, banks, sovereigns, and investors be minimised.
We believe the SEC efforts to monitor the ratings industry would be significantly strengthened by implementing three proactive control mechanisms - mechanisms to manage ahead of the curve rather than a permanent game of "catch-up";
- Chartered Rating Analyst - the disciplinary mechanism would be decertification of the analyst by the SEC. This would provide a substantial incentive for professional work removed from the political and business pressures of the agency since validation and decertification would be external to the rating agency. Certification would moreover empower the individual analyst to perform professionally with the motivating factor of decertification, rather than survive via behaviour designed to ingratiate oneself politically in a qualification - free environment. Consequently, we believe it highly inappropriate for rating analysts to be certified by individual rating agencies as it would be tantamount to having the CPA accountants certified by the banks or corporations they work for. The track record of rating agencies managing the analyst function to date moreover is not convincing.
- Frequent Sporadic and Random audits of Issuer Ratings. Since the SEC is relying on the rating agencies to perform a gatekeeper role, it is incumbent upon the SEC to insure this process is competent and effective. In the first instance, the SEC could establish rating guidelines in concert with the board of interested parties. The SEC could then use the guidelines to perform frequent sporadic and random audits of various issuer ratings without advance warning. This could consist of examining the underlying supporting documentation which was submitted to the credit rating committee for deliberation along with the committee minutes and analyst interviews. Spontaneous random checks would enable a clear comparison between the guidelines and articulated policies against the actual procedures, enabling the investor creditor community to better understand the underlying fundamentals to the ratings process.
- Constitute a public comment and review process on a periodic basis (such as every two years) regarding the NRSROs' performance. Such a process could be modelled on the Federal Communications Commission's broadcast license renewal process, under which licensees must periodically reapply and the FCC solicits public comment on the licensees' performance.
5 Anticompetitive, Predatory, and Abusive Practices
The industry to date has unfortunately exhibited several anticompetitive, predatory and abusive practices. We identify our key areas of concern:
- Issuers paying for ratings. This is a logical effect of the NRSRO régime limiting competition and protecting an oligopoly, and has resulted in artificially strengthening and enhancing the profitability of credit rating agencies to a level not witnessed by commercial enterprises18and2. The rating agencies indeed benefit from a captive market, and are sharing a market rather than engaging in competition3. This SEC sanctioned oligopoly is resulting not only in unwarranted levels of profits and an anticompetitive situation19 it is also resulting in an artificially imposed impediment on corporations to pay for ratings, and multiple ratings in order to avoid the spectre of unsolicited ratings, which can have highly damaging effects20
- The predatory practice of unsolicited ratings. This predatory practice in the current "pay for a rating" régime should be prohibited since it exhibits conflicts of interest, and is results in pronouncements that can be abusive19 and have damaging and counterproductive effects21 Under a Chartered Rating Analyst system, where professional accountability exists and subscribers pay for the information, this conflict of interest would not exist since there would be no commercial link between, the rating agency and the entity being rated.
- Granting Licenses or Providing Information? If credit rating agencies exist to disseminate information and benefit from freedom of the press, they should earn their income as does the press: from selling information to subscribers, not issuers. Indeed, we are not aware of any entities of the press levying fees on news making entities and then distributing this news via free media products except for, perhaps, the vanity press. We believe that there is a substantial conflict of interest in the mere fact that all NRSRO's are paid substantial fees from the firms that they rate rather from selling research, and that at the same time they claim free speech protection as members of the "media". It is clear however that the bulk of revenues come from levying rating fees rather than selling information, indicating that the media claim is a case of the tail wagging the dog.
6 Other consulting services and subsidiaries
We are concerned that the rating agencies' protected and anticompetitive oligopoly situation under NRSRO status enables them to further profit by selling consulting services. We believe that there is an implicit conflict of interest between rating issuers and marketing consulting services (such as rating advisory services) and ancillary services (such as training services) to issuers, since issuers may feel pressured to pay for these services in an effort to impact positively the ratings process.
This is highly inappropriate. The unspoken implication is if fee income is forthcoming, better work will be the result. Indeed, the conflicts of interest are similar to those in the unsolicited ratings matter. If the current NRSRO régime continues in its present form, rating agencies should be prohibited from selling consulting and ancillary services to issuers, either directly or via subsidiaries.
Elimination of the NRSRO concept of course, with multiple players, would reduce the relevancy of such "consulting services" and place them in proper perspective since there would be several diverse players rather than two similar players sharing a captive market, and no "value added link" between the ratings process and provision of ancillary services would exist or be seen to exist.
7 Legal accountability
The Commission has relieved NRSROs from the accountability that would otherwise apply under the federal securities laws: it has exempted NRSROs from expert liability under Section 11 of the Securities Act if their ratings appear in a prospectus for a public offering of a security registered under that Act.
As a result, issuers do not have to obtain consents from NRSROs before publishing their ratings and NRSROs are exempt from Section 11 liability if their ratings are included in a registration statement.
The exemption of NRSROs from the normal liability provisions of Section 11 of the Securities Act means that NRSROs are not held to a negligence standard of care. The rating agencies also maintain that they are members of the "media" that are providing their "opinions," and thus claim that they can only be liable if their conduct can be said to have been "reckless."22 As a result, the exemption from expert liability lessens the incentives of NRSROs to issue reliable securities ratings. This detached behaviour is further underscored by the fact that rating analysts do not feel a need to delve into the quality of accounting statements15 and do not feel accountable for events arising from their actions12.
In light of the reliance that investors and the Commission place upon the NRSROs, we believe that the Commission should consider rescinding the NRSROs' exemption from expert liability.
* * *
|1|| See Graciela Kaminsky and Sergio Schmukler; Rating Agencies and Financial Markets, in "Ratings, Rating Agencies, and the Global Financial System", Edited by Richard M Levich, NYU Stern, p 234; "for example during 1990-2000, Brazil received 10 rating changes, Indonesia 13, South Korea 18, Russia 18, and Thailand 10. Moody's changed their ratings 48 times, S&P 75 times, and the smaller Fitch 47 times". These ratings concern long term sovereign debt but seem to be managed on a short term basis.
|2|| Senate Committee on Governmental Affairs Report on Credit Rating Agencies, p 105; "The NRSRO designation has had a significant beneficial effect on the profitability of credit rating agencies." Also, For example, Moody's has operating margins of nearly 50 percent, more than triple those of other financial services firms, and Moody's financial ratios are more than double those of other firms. Moody's market capitalization is more than 10 percent of Goldman Sachs's, even though Moody's assets are only 0.1 percent of Goldman's. Annual rating industry revenues in aggregate are in the range of a billion dollars. From Moody's Corp. 10Q Statements.
|3|| Andrew Fight: " The Ratings Game" pg. 8-11; "The duopoly does not foster competition since there is a tendency for issuers to obtain multiple ratings - eg: ratings from both Moody's and S&P. Accordingly, a competitive situation cannot be said to exist since the choice is not to "get a rating from one or the other" but "let's get rated by both in order to satisfy our creditors' needs". The duopoly is hence sharing a monopoly and has no risk of losing market share to their competitor (each other)....... Issuers are often accused of "rating shopping" if they go to agencies other than Moody's or Standard & Poor's to obtain a recognised rating. The purpose of rating shopping is to get the best possible rating from a rating agency. This suggests that the rating agencies are by no means rivals trying to squeeze each other out of the market. They in fact make clear that the agencies complement each other. If an issuer is already being rated by an agency, rating by another agency helps to make him happier with the first rating. Further ratings thus remove doubts, not only from the investor's perspective".
|4|| Lawrence J White, The Credit Rating Industry: An Industrial Organisation Analysis, in "Ratings, Rating Agencies, and the Global Financial System", Edited by Richard M Levich, NYU Stern. "p46, "Regulation, then, is currently limiting entry ............."
|5|| Frank Partnoy University of San Diego School of Law, Law and Economics Research Paper No. 20 The Paradox of Credit Ratings, Chapter IV: "The agencies never describe their terms or analysis precisely or say, for example, that a particular rating has a particular probability of default, and they stress that the ratings are qualitative and judgmental. This secretive, qualitative process is not the type of process one would expect if the agencies had survived based on their ability to accumulate reputational capital."
|6|| See for example, Japan Centre for International Finance; Characteristics And Appraisal Of Major Rating Companies 1999 Focusing On Ratings In Japan And Asia, p57 "...only downgraded sovereign ratings when it was obvious the crisis was spreading".
|7|| International Monetary Fund 1999 Annual Report, Chapter 3, pg 26; "Several Directors noted that key international credit rating agencies had failed to foresee the Asian crisis and then aggravated it when they subsequently moved to sharply lower the credit ratings of countries."
|8|| Lawrence J White, The Credit Rating Industry: An Industrial Organisation Analysis, in "Ratings, Rating Agencies, and the Global Financial System", Edited by Richard M Levich, NYU Stern. p42
|9|| St Petersburg Times (Russia) 25 August 2000; The St Petersburg Times picked up on the fact that the rating agencies were "behind the curve" in Russia, noting that "Moody's is taking steps to reassess Russia's credit rating in light of recent developments". The article noted that Moody's planned to "review" Russia's ratings as well as those of Russian Eurobonds, OFZ bonds, and MinFin bonds, and quoted a market strategist at Lehman Brothers as saying that "the agencies have been behind the curve in Russia for about half a year" and that "if we look at the market, we can see that foreign investors' interest in Russia was already picking up in the third or fourth quarter of 1999".
|10|| BBC News Article of 3 June 2002: http://news.bbc.co.uk/2/hi/business/2023568.stm Iran dropped by US rating agency: "International rating agency Moody's has withdrawn its sovereign credit ratings for Iran after pressure from the US Government. President George W Bush has claimed Iran is part of an "axis of evil" and has continued to impose economic sanctions."
|11|| Frank Partnoy, Paradox of Credit Ratings, University of San Diego Law School Research Paper No20, pp11-12"; Rating agency analysts track the credit quality of up to 35 companies each, and are paid significantly less than similarly placed professionals on Wall Street. Both S&P and Moody's have high levels of staff turnover, modest salary levels and limited upward mobility; moreover, investment banks poach the best rating agency employees. These factors limit the ability of rating agencies to generate valuable information".
|12|| Senate Committee on Governmental Affairs' Report on Credit Rating Agencies, p 122: "based on the testimony of the credit analysts at the March 20 hearing and the remarks of the analysts in interviews with Committee staff, Committee staff concluded that the credit analysts do not view themselves as accountable for their actions".
|13|| BBC News Online 1 Feb 2002, Who knew what? "Most city analysts don't think much of rating agencies is the truth of the matter - they use rating agencies as an insurance device," one seasoned market watcher said. "If things go sour, the pension fund administrator can say we checked with the rating agency and they gave it a clean bill of health, in other words it is not our fault"
|14|| Andrew Fight: "The Ratings Game" p 244; "The ratings agencies' arguments defending the accuracy of their ratings, based on accumulated historical data of ratings and default rates, are not as quantitative as one might believe. The argument is based on the premise that there is continuity in their research. For this argument to be scientifically consistent and applicable over the entire time frame in question, this would mean that the analytical tools used to analyse economic risks today are exactly the same as those used 30, 40, or 50 years ago, and that today's economy is not more complex or volatile or technologically more sophisticated than it was in the past. Since this is obviously not the case, it means there is no substance to the rating agencies' argument that the strength and accuracy of their ratings are based on the consistency of historical correlation data between ratings and default rates over the time frame of ratings activity because you cannot compare today with the 1950s or 1960s. Each fundamentally different period was analysed using essentially different yardsticks".
|15|| Financial Oversight of Enron: The SEC and Private-Sector Watchdogs Report of the Staff to the Senate Committee on Governmental Affairs; 8 October 2002; "When asked by Committee staff whether they considered as a qualitative factor in their analysis whether the company was engaging in aggressive accounting, the agencies indicated that they rely on the auditors' work. This was consistent with their testimony at the hearing. In the Committee staff interviews, the credit rating analysts resisted staff's suggestion that a company's accounting methods should be part of their analysis, because even when financial statements comply with Generally Accepted Accounting Principles (GAAP), they nevertheless may not present all the information an investor would want to know, or all the information a credit rater would want to know. This is troubling, because the fact that a company may be using the flexibility of GAAP to hide problems should be a consideration, particularly if the credit raters take a long-term view."
|16|| BBC News Online 1 Feb 2002, Who knew what?; The low value-added approach of opinions emitted by analysts with no set of qualifications is confirmed by the following quote from a Moody's employee: "Largely, the financial information on which we base our ratings is publicly filed information...We also have meetings with the issuers, who may choose to share issues with us, it is up to them, they will choose their level of disclosure"
|17|| Centre for the Study of Financial Innovation Round Table 26 March 2003, London. Representatives from the rating agencies admitted at the 26 March 2003 CSFI conference in London that although they are privately owned companies, they could not survive on commercial basis (live off income derived from selling their analytical research).
|18|| Frank Partnoy University of San Diego School of Law, Law and Economics Research Paper No. 20; The Paradox of Credit Ratings, Chapter IV: "Beginning in the mid-1970s, the credit rating industry began to become more influential and more profitable. The changes were dramatic. In 1980, there were 30 professionals working in the S&P Industrials group (even by 1986, there still were only 40); today, S&P and Moody's employ thousands of professionals In 1975, only 600 new bond issues were rated, increasing the number of outstanding rated corporate bonds to 5,500; today, S&P Moody's rate 20,000 public and private issuers in the US, $5 trillion of securities in aggregate. Perhaps the most important change in the credit rating agencies' approach since the mid-1970s has been their means of generating revenue. Today, issuers - not investors - pay fees to the rating agencies. Ninety-five percent of the agencies' annual revenue is from issuer fees, typically 2 to 3 basis points of a bond's face amount. Fees are higher for complex or structured deals..."
|19|| The Department of Justice has investigated the possibility of anti-competitive practices in the bond rating industry, including the use of unsolicited ratings. See, e.g., Suzanne Woolley, et al., Now Its Moody's Turn for a Review, Business Week, April 8, 1996, at 116; Moody's also has been sued privately on similar grounds. In October 1995, Jefferson County School District, a local authority in Colorado, filed a lawsuit accusing Moody's of "fraud, malice, and willful and wanton conduct" for publishing a "punishment" rating on the district's bonds, because the district did not hire the agency to rate it.
|20|| See Ibrahim Warde, Rating Agencies: The New Superpowers? (visited Nov. 30, 1998); http://www.idrel.com.lb/idrel/shufimafi/archives/docs/iwarde1.htm. "Issuers typically invite a rating agency to rate their debt, although Moody's has rated debt uninvited. For example, in September 1996, Moody's announced it was preparing to issue an unsolicited rating of Egyptian government debt. Egypt immediately hired Goldman, Sachs to help it comply with certain requirements and ultimately received a very low rating of Ba2, behind Israel, Tunisia, and Bahrain, although ahead of Jordan. The Egyptian minister of state for economic affairs said, "[a]lthough it is better than no rating, it does not reflect the true strength or potential of the Egyptian economy. I am looking forward to soon having another rating from a different agency to put this right." Id.
|21|| Financial Times - 09-Sep-1999 re IMF Report on Capital Markets; ' "In some cases, the decisions made by the agencies, including the rapid downgrading of the sovereign ratings of South Korea and Thailand, had accelerated the dramatic outflow of capital from these countries. This had made a bad situation worse." "Rather than being an important independent stabilising force, the major credit rating agencies did behave very differently from the vast majority of participants," it said. "While the ratings assigned prior to the crisis were too high, it is arguable that the agencies overreacted and in some cases went to the other extreme."..... The report also criticised the agencies for devoting too few resources to sovereign risk assessment, pointing out that in some cases there was only one permanent analyst cover as many as seven countries'.
|22|| See, e.g., First Equity Corporation of Florida v. Standard & Poor's Corporation, 869 F.2d 175 (2d Cir. 1989).