June 25, 2003
Jonathan G. Katz
Secretary, The Securities and Exchange Commission
450 Fifth Street, NW
Washington D.C. 20549
I am a writing to express my concerns on the role of credit rating agencies in the operation of the securities markets. To provide you with some background information on myself, I am an assistant professor at the Sloan School of Business at the Massachusetts Institute of Technology. Much of my research has focused on the use of accounting information in financial contracts. I also must inform you that the views expressed in this letter are my own; they are not the views of the Institute.
As you deliberate on the various issues relating to credit rating agencies, including whether credit ratings should continue to be used for regulatory purposes under the Federal securities laws, I would like to raise my concerns with the conflicts of interests faced by the nationally recognized statistical rating organizations (NRSRO). All of the NRSRO's are paid substantial fees from the firms that they rate. There is not a single NRSRO that discloses the amount of fee income that they derive from engaging in these activities. This would seem to be in violation of article 17b of the 1933 Securities Act.
When congress formed the SEC in 1933, they recognized that investors should be aware of the potential conflicts of interests of those that promote securities. They required that promoters disclose the financial relationships that they have with their clients. In the late 1990's the SEC actively prosecuted Internet companies that failed to disclose their relationships with firms whose securities were promoted on their websites. It would seem that credit rating agencies are somehow exempt from this requirement. Given the heightened concerns regarding independence issues of financial professionals, I believe that you all should consider requiring the NRSRO's disclose the amounts of fee revenue that are generated from rating their clients.
Thank you for the opportunity to express my point of view