Lace Financial Corporation

November 11, 2002

Mr. Mark M. Attar
Division of Market Regulation
United States Securities and Exchange Commission
450 Fifth Street, N.W.
Washington, D.C. 20549

Re: November 21, 2002 Hearing on Credit Rating Agencies

Dear Mr. Attar:

I want to thank the SEC for inviting me to its hearing on Issues Relating to Credit Rating Agencies. I hope my comments will be helpful to the SEC concerning this issue.

Application Process for NRSRO Status

I believe the most important point I can make before the SEC Commission is that if a creditable rating company with the proper expertise applies for NRSRO status the SEC should help them through the application process. If the SEC staff feels that changes should be made in the applicants procedures or processes tell them in writing. If the company makes the necessary changes and meets SEC requirements then grant the company NRSRO status. The application process should be accomplished in an expeditious manner. LACE Financial's application for NRSRO statue was before the SEC for eight years and then denied for no clear reason.

Barrier to Entry

The SEC must realize that the greatest barrier of entry into the rating industry is the SEC itself. The SEC capital rule raises the cost of capital to broker and dealers holding non-NRSRO rated securities, resulting in Wall Street not wanting to deal with non NRSRO rating companies. Also, without NRSRO status a rating agency cannot effectively compete with existing NRSRO rating companies because companies or municipal governments have statements in their company by-laws stating that officials can only use ratings of NRSRO rating agencies. The restrictiveness of the NRSRO criteria and the ability of the Division of Market Regulation to hold up decisions and prolong the application process and deny an application with out clear reason are also barriers to entry.

Topics for Discussion at Hearings

The topic questions listed for discussion for these hearings appears to biased toward NRSRO companies and their users. For example, why are these topics and questions not asked?

  • Do you feel rating agencies ratings are creditable?

  • Are prices for securities issued and credit ratings reasonably and competively priced?

  • Do you know the date the rating was issued and the date of the financial statements used in the rating process?

  • Do you feel credit ratings issued by the rating companies truly represent the financial condition of a company?

Need for competition in the Rating Industry

Although the subject concerning competition and its effect on the pricing of ratings is not part of the proposed questions of attendees, I believe it is one of the main reasons behind the Sarbanes-Oxley Act of 2002. The fact is, that the number of NRSRO companies has recently declined from six to three. The need however; for financial soundness (credit) ratings has increased dramatically with the increase in market volume, financial intermediation and the use of derivatives over the past few years. It would appear to me that Congress is trying to tell the SEC to change its mindset. Instead of fighting small companies like ourselves- which the Division of Market Regulation of the SEC has done a superb job- the SEC should be helping qualified companies to be more effective competitors in the rating industry. It appears, that in protecting the status quo the SEC is not meeting the needs and concerns of the small investor. Many smaller companies who want to issue debt or securities cannot afford the rating costs of NRSRO rating agencies.

If the SEC decides it wants more competition in the rating industry it is not enough to grant a small company like ours NRSRO Status. The SEC should encourage small companies, which have the expertise and credibility to team up with a larger company to become a more effective competitor in the industry.

NRSRO Criteria

NRSRO rating companies have a lot of power and influence over the companies they rate and their ratings must be issued in a wise and fair manner. Creditability in the rating industry is everything. Although LACE Financial does not believe that the granting of NRSRO status has been administered properly, we do believe in the NRSRO concept. Companies should prove to the SEC that they are a creditable rating service and have a staff that has the experience and credentials to rate institutions. During the NRSRO application process the staff of the Division of Market Regulation has always been courtious and we have high regard for their lawyers. However;

    (1) It took eight years to decide on our application.

    (2) Our application was denied because the "Division" concluded that LACE did not meet the five criteria set forth above." There was no mention of what part of the criteria we did not meet.

    (3) During the eight-year process I never knew the status of our application. We received two letters during the eight years, the first acknowledging acceptance of our application in 1992 and the second in October 2000 denying our application. I was called by the SEC that our application had been denied and I had to insist that we be sent a letter telling of the denial and the reason (s) why it was denied.

    (4) Throughout the application process we felt that the staff of Division of Market Regulation, especially at the three meetings attended at the SEC, took an adversary position towards our obtaining NRSRO status. I personally do not understand how such behavior can be allowed and strongly suggest that the application process be reviewed by the SEC to expedite applications and provide more transparency.

Unsolicited Ratings and Solicited Ratings

For a rating company to use an unsolicited rating (no charge) to get a company to pay for a solicited rating is a form of extortion and the company should be charged with a criminal offense. If it is an NRSRO company, it should lose its NRSRO status.

All of LACE Financials ratings are unsolicited but a conflict of interest cannot occur because the company does not charge for its ratings. Over 18 years the company has issued over one million unsolicited financial soundness ratings and never had a threat of a lawsuit nor has a regulator received a complaint concerning our ratings.

Regulation of the credit rating industry

I am not opposed to regulation of the industry as long as is not overly burdensome, its costs are relatively small to a companies revenues, and is applied fairly among the industry. There should be some governmental entity that an investor or rated company could complain to and report serious offenses such as extortion using unsolicited ratings, etc. This entity could then refer the matter to the Justice Department and/or recommend to the Justice Department and or recommend to the SEC removing SEC status.


Barron H. Putnam, Ph.D.
President and Financial Economist


CC: Mr. Paul Adkinson, Commissioner, Securities and Exchange Commission
Mr. Roel Campos, Commissioner, Securities and Exchange Commission
Ms. Cynthia Glassman, Commissioner, Securities and Exchange Commission
Mr. Harvey Goldschmid, Commissioner, Securities and Exchange Commission
Mr. Michael Macchiaaroli, Division of Market Regulation, SEC
The Honorable Paul Sarbanes, U.S. Senator
The Honorable Barbara Mikulski, U.S. Senator
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