Standard & Poor's
July 28, 2003
Securities and Exchange Commission
Dear Mr. Katz:
This letter is submitted by Standard & Poor's Ratings Services ("S&P Ratings Services"), a part of Standard & Poor's, a division of The McGraw-Hill Companies, Inc., in response to the Securities Act Release No. 33-8236 (the "Concept Release").
The Concept Release raises significant questions covering the full spectrum of issues relating to the role of credit rating agencies in the U.S. capital markets. In particular, the Concept Release explores two fundamental questions: (1) should the Securities and Exchange Commission (the "Commission") continue to designate "nationally recognized statistical rating organizations" ("NRSROs") for regulatory purposes and, if so, what should the criteria for designation be; and (2) what level of oversight should the Commission apply to NRSROs? The Commission's response to these issues, and to the specific questions set forth in the Concept Release, could have a profound impact on the efficiency and cost effectiveness of the U.S. debt markets. S&P Ratings Services welcomes the opportunity to share its views on these important issues.
S&P Ratings Services believes that over the last century credit ratings have served the U.S. securities markets extremely well, providing an effective, independent and objective tool in the market's evaluation and assessment of credit risk. S&P Ratings Services believes that the availability of credit ratings that are credible and, as demonstrated by their performance, reliable is a principal factor in the U.S. debt markets' depth, breadth, efficiency and cost effectiveness. Moreover, the widespread acceptance of the NRSRO regulatory framework by market participants and its adoption in other federal and state regulations and legislation evidences the success of the NRSRO designation. Key to preserving the valuable role of credit rating agencies in the U.S. capital markets is the continuation of a regulatory framework that recognizes the market as the best judge of the credibility and reliability of a credit rating agency's rating opinions. There is no demonstrated abuse or market failure that warrants abandoning the regulatory approach that has served investors' and the market's interests so well for so many years. Nor is there any demonstrated investor or market interest to be served by the withdrawal of the use of NRSRO credit rating opinions from the Commission's regulations.
Given the established, pervasive and well-understood regulatory and legislative use of credit ratings, S&P Ratings Services believes that the wholesale withdrawal of the NRSRO concept could be costly to market participants which are subject to such regulations and disruptive to the market, with no apparent benefit to investors or the market.
S&P Ratings Services does believe that the Commission can, and should, increase the transparency of the NRSRO designation process, reduce regulatory barriers to entry and ensure that the capital markets remain the ultimate arbiter of the ratings process. As to the NRSRO designation, S&P Ratings Services believes that NRSRO designation should be based solely on the credit rating agency's being widely accepted as an issuer of credible and reliable rating opinions by predominant users of securities ratings in the United States.
As discussed in Appendix A, S&P Ratings Services believes it would enhance the transparency of the designation process for the Commission to specify the above defined criterion as the basis for NRSRO designation, provide for notice and public comment on applications for designation as an NRSRO and establish time periods to serve as a goal for action for applications for NRSRO recognition. S&P Ratings Services also believes that the Commission could, where appropriate, provide NRSRO designations to firms that limit their ratings to certain sectors of the debt markets or limited geographic areas.
At the same time, however, S&P Ratings Services strongly believes that designation criteria such as financial resources, revenue, capital, number and training of analysts, rating methodologies or processes, or performance mandates, such as diligence standards, operational, policy or rating disclosure mandates or record-keeping requirements, would not be appropriate. Such criteria cannot assure credible or reliable rating opinions and they risk erecting barriers to entry. Moreover, such criteria also could compromise the independence of a rating agency's analysis and risk setting minimum or uniform standards of credit analysis. This could erode the individual quality and independence of the rating agency's credit analysis, could stifle innovation in credit rating analytic technologies and may limit the availability of valuable credit analysis and information in the marketplace, to the detriment of the U.S. securities market. In such event, credit ratings no longer would represent the particularized opinion of the credit rating agency, based on the rating agency's independent assessments.
Finally, depending on their nature and scope, these criteria also may infringe on the NRSRO's well-established rights under the First Amendment of the U.S. Constitution.
Market Participants' Use of Credit Ratings
Since beginning its credit rating activities in 1916, S&P Ratings Services has issued rating opinions on more than two million securities issues, corporate and governmental and public finance issuers and structured financings. S&P Ratings Services began its ratings activities with the issuance of credit ratings on corporate and governmental debt issues. Responding to market developments and needs, S&P Ratings Services also assesses the credit quality of, and assigns credit ratings to, financial guarantees, bank loans, private placements, mortgage- and asset-backed securities, and the ability of insurance companies to pay claims.
Today, S&P Ratings Services has credit rating opinions outstanding on approximately 150,000 securities issues of obligors in more than 100 countries. S&P Ratings Services issues credit rating opinions and monitors developments pertaining to these securities and obligors from operations in 19 countries around the world. With a U.S. staff of approximately 1,250, S&P Ratings Services issues rating opinions on more than 99.2% of the debt obligations and preferred stock issues publicly traded in the United States.
S&P Ratings Services' credit ratings have achieved worldwide market recognition and acceptance - not only with issuers and investors, but also with bankers, financial intermediaries and securities traders - as efficient tools for differentiating credit quality. Underlying the credibility and reliability (as demonstrated by the performance of the credit rating opinions) of S&P Ratings Services' rating opinions is the market's recognition of the independence, integrity, objectivity and quality of S&P Ratings Services' credit ratings, rating process and reputation, as evidenced by its excellent track record.
On a daily basis, S&P Ratings Services issues between 500 and 1,000 rating actions around the globe. These rating actions include initial ratings, rating changes, CreditWatch listings (which are used to signal to investors that further analysis is being performed and that a rating might be changed as a result of a specific event), Outlook changes (which represent S&P Ratings Services' opinion as to the future direction of the rating, covering a six-month to two-year time horizon) and rating affirmations. As these rating actions are S&P Ratings Services' opinions, it is to be expected that there will be credit rating opinions that differ from those of S&P Ratings Services. It is through this daily process that S&P Ratings Services' credit rating opinions are subject to constant market scrutiny. S&P Ratings Services' focus is on furnishing rating opinions that will prove to be as credible and relevant as possible without regard to whether others agree or disagree with its opinions on creditworthiness.
It is this market recognition that led the Commission to recognize S&P Ratings Services as one of the first NRSROs in 1975 and to use its credit ratings as a method of determining capital charges for registered brokers and dealers under the Commission's Net Capital Rule. The NRSRO designation was not one sought by S&P Ratings Services. Rather, it was an expressed recognition by the Commission for purposes of its regulations of S&P Ratings Services' credit ratings as a widely accepted measure, recognized by the market as an independent, objective and credible "opinion, as of a specific date, of the creditworthiness of a particular company, security, or obligation" (as noted by the Commission in defining a "credit rating" in its Report on the Role and Function of Credit Rating Agencies in the Operation of the Securities Markets, January 2003 ("SEC Rating Agency Report") at 5).
Absence of Market Failure or Abuse
Following the corporate scandals that came to light over the past couple of years, it is certainly appropriate for the Commission to review the performance of all sectors of the securities market, including the credit rating agencies. Clearly, these corporate failures have demonstrated the consequences for all market participants when companies fail to meet their disclosure obligations, or worse - set out systematically to defraud the market. Like other participants in the marketplace, S&P Ratings Services was similarly misled by the issuers' disclosure failures.
Nonetheless, given the significant role played by credit rating agencies in the securities markets, S&P Ratings Services appreciates the importance of the Commission reviewing the conduct of credit rating agencies at this critical time for the U.S. securities markets to ensure that the integrity of the credit rating process is not influenced by conflicts of interest, abuse of confidential information or other dishonest or fraudulent conduct. S&P Ratings Services is confident that, in its review over the past year and a half, the Commission has not found any erosion in the independence, objectivity and integrity that have been the hallmarks of the U.S. credit rating industry.
Over almost a century, S&P Ratings Services' mission has remained the same - to provide high-quality, objective, rigorous analytical information to the marketplace. The track record of S&P Ratings Services' credit ratings continues to be excellent, as demonstrated by studies on rating trends and default and transition studies regularly published by S&P Ratings Services. These studies have repeatedly shown that there is a clear correlation between ratings assigned by S&P Ratings Services and the likelihood of default: the higher the rating, the lower the probability of default, and vice versa. While there will be occasions when S&P Ratings Services' ratings are scrutinized with the benefit of hindsight, including as a result of unforeseeable or simply unknowable events, S&P Ratings Services' excellent track record demonstrates why its credit ratings are effective and widely accepted as credible and reliable by the major users of credit ratings in the United States and around the world.
S&P Ratings Services continuously evaluates its practices and modifies or enhances them, as necessary, so that its credit ratings process is responsive to market needs. Recent initiatives undertaken by S&P Ratings Services include:
Testimonies and comments by investors, issuers and other participants at the Commission's public hearings on credit rating agencies in November 2002 clearly reflect the market's continuing view that S&P Ratings Services' credit rating opinions are independent, objective, credible and reliable. As noted in the SEC Rating Agency Report, most hearing participants favor the regulatory use of credit ratings issued by NRSROs as a simple, efficient benchmark of credit quality. The SEC Rating Agency Report also notes that, in general, hearing participants did not believe that reliance by credit rating agencies on issuer fees leads to significant conflicts of interest, or otherwise calls into question the overall objectivity of credit ratings. Most hearing participants were of the view that any such perceived conflict is manageable and, for the most part, has been effectively addressed by credit rating agencies.
In light of this, S&P Ratings Services believes that key to preserving the valuable role of credit rating agencies in the U.S. capital markets is the continuation of a regulatory framework that recognizes the market as the best judge of a credit rating agency's independence, integrity, objectivity, credibility, reliability and quality.
The Concept Release
The Concept Release solicits comment on two possible and widely variant conceptual approaches to the Commission's role with respect to credit rating agencies:
Use of NRSRO Credit Ratings for Regulatory Purposes
As to the first approach, while S&P Ratings Services did not seek the NRSRO designation or encourage the Commission to use credit ratings for regulatory purposes, S&P Ratings Services believes that any effort to withdraw all regulatory uses of NRSRO credit ratings on a wholesale basis could prove to be disruptive to the U.S. securities markets. Eliminating the regulatory uses of NRSRO credit ratings in its entirety could increase costs to market participants and disrupt current efficiencies in the regulatory system that have served the market's interests so well for so many years, with no apparent benefit to investors and other market participants.
Even if the use of NRSRO credit ratings were to be eliminated only from selected regulations, alternative measures of credit risks would have to be identified. In this respect, S&P Ratings Services is not aware of financial or other market measures that could be used effectively across the spectrum of rated securities as an efficient alternative for evaluating credit risks associated with debt and other rated securities or an obligor in general.
NRSRO Designation Criteria and Process
As to the second approach, S&P Ratings Services has consistently supported a more open and transparent NRSRO designation process. S&P Ratings Services also is of the view that the financial markets benefit from the robust and healthy dialogue as to credit risks from multiple perspectives, and would envision the designation of additional NRSROs that meet the market acceptance standard. S&P Ratings Services is of the view that the designation process should specify clearly the criteria for NRSRO designation and should provide for public notice and comment with respect to any application for NRSRO designation.
S&P Ratings Services believes that NRSRO designation should be based solely on the market acceptance of the credibility and reliability (based on the performance of the credit rating opinions) of the credit rating agency's rating opinions, as demonstrated by the widespread use of its credit ratings by major market participants in the United States.
Withdrawal of an NRSRO designation should be based solely on the failure of an NRSRO to continue to be widely accepted as a provider of credible and reliable rating opinions by predominant users of credit ratings in the United States. The only issue for the Commission in continuing an NRSRO designation should be whether the market recognition and acceptance that was the basis for the initial designation has been lost. The market will be the most effective and immediate judge of an NRSRO's credibility and the reliability of its credit rating opinions. The Commission should take action in response to a sustained market judgment, not the Commission's anticipation of possible future degradation in the quality of a credit rating agency's ratings as a result of specific changes in its operations or methodologies.
It is critical that the criteria for NRSRO designation should continue to be based on a measure of the credibility and reliability of the credit rating agency's rating opinions, and the sole judge of such opinions should be the marketplace. Any designation criteria based on measures such as an agency's financial resources, revenue, capital, number and training of analysts, rating methodologies or processes or performance mandates such as diligence standards, operational, policy or rating disclosure mandates or record-keeping requirements will not effectively assure the credibility or reliability of an agency's credit ratings, but will erect regulatory barriers to entry to NRSRO designation and regulatory impediments to the effective operations of credit rating agencies.
More importantly, designation criteria that are based on business or operational criteria would be flawed in principle in that such an approach fails to recognize that there is no one model or methodology for producing sound credit rating opinions. Resources, methodologies, procedures, form of organization and capitalization are, and should be understood to be, simply tools to be used by credit rating agencies in the performance of their rating analyses; it is the quality of the analyses upon which the credit rating agency builds its credibility and market acceptance. Designating criteria based on measures such as performance mandates in the form of diligence standards, rating disclosure mandates, record-keeping requirements, capital and other financial resource requirements and other government controls, would:
In such event, credit ratings no longer would represent the independent opinion of a particular credit rating agency. Mandated consistency of approach among various credit rating agencies could erode the individual quality and independence of the rating agency's credit analysis and potentially could stifle innovation in credit rating analytic technologies. Additionally, as a practical matter, such substantive designation criteria could impose additional costs on credit rating agencies and, consequently, market participants, with no clear evidence that such costs would benefit investors or the market.
The Commission must take care not to prescribe, directly or indirectly, analytic operations of an NRSRO or implement an NRSRO designation process that results in homogenization of credit ratings through government-prescribed minimum or uniform standards. In sum, S&P Ratings Services believes that a designation process that includes government mandated procedures and rating methodologies could have the unintended effect of actually limiting the availability of a wide range of valuable credit analysis and information in the marketplace to the detriment of the U.S. securities market.
Moreover, any substantive government intrusion into the credit rating process and the publication of rating opinions also would raise fundamental First Amendment issues.
First Amendment Concerns
As the Commission has recognized, an S&P Ratings Services' credit rating represents its "opinion, as of a specific date, of the creditworthiness of a particular company, security or obligation." SEC Rating Agency Report at 5. Indeed, the essence of the rating process is the gathering of information about a particular issuer or security from a variety of sources, the analysis of that information, the forming of opinions about that issuer or security and the broad dissemination of those opinions to the public. These processes are highly akin to those regularly performed by professional journalists and numerous courts have recognized S&P Ratings Services' entitlement to the protections of the First Amendment along these lines. Included as Appendix B to this letter is a memorandum that details the First Amendment protections afforded to rating agencies such as S&P Ratings Services and the particular concerns raised by several of the approaches discussed in the Concept Release. A discussion of First Amendment concerns related to particular questions in the Concept Release is also included in Appendix A, which provides S&P Ratings Services' responses to such questions.
Precisely because ratings, by their nature, are opinions rather than absolute truths, the protections of the First Amendment are important to the rating process and ultimately to the market. Market participants will, and often do, disagree with S&P Ratings Services' opinions about particular issuers or securities. Rating agencies differ with each other as well. Those differing opinions are inherent in the delicate and often contentious task of assessing creditworthiness. Accordingly, in order to ensure that the market receives a rating agency's best judgment as to such creditworthiness, analysts and rating committees must be free to make ratings decisions without undue fear of retrospectively being second-guessed by government regulators. A regulatory regime that required, for example, a common set of procedures or approaches for all rating agencies and that subjected firms or individuals to rebuke and/or potential liability for failure to adhere to such procedures or approaches could well produce homogenized analysis and conformist opinions that would hardly serve the markets. Indeed, the First Amendment's protections exist precisely to foster robust debate in a "marketplace of ideas" and to avoid the "chilling" effect that attends to governmental standardization of the formation and dissemination of opinions such as those prepared and published by S&P Ratings Services.
Over the last century, credit rating agencies have served the U.S. capital markets, and, indeed, the capital markets around the world extremely well. S&P Ratings Services' and the other NRSROs' credit rating opinions are accepted worldwide, and the market's acceptance of their integrity, independence, objectivity, credibility and reliability has been critical to their valuable role in developing the market. Continuing this important role, and extending the benefits of independent, credible rating services internationally, requires great care by the Commission to assure that any legislative or regulatory initiative preserves the independence of credit rating agencies and recognizes the market as the best judge of a credit rating agency's quality, objectivity and independence.
As financial regulators around the world are now considering the appropriate regulatory framework for rating agencies in their markets, the implications of any Commission rulemaking with respect to NRSRO designation in the United States could have profound implications with respect to the development of independent, credible rating agencies internationally. Adoption of designation criteria by the Commission that suggest a substantive role for government in the business operations or rating analytic process are likely to be followed by other markets and potentially implemented in a manner that results in a governmental intrusion into the actual rating process - a result that could compromise the independence and the credibility of credit rating agencies.
There is no demonstrated abuse or market failure that warrants abandoning the regulatory approach that has served investors' and the market's interests so well for so many years. There is no demonstrated investor or market interest that warrants or justifies either a wholesale overhaul of Commission regulation and other federal and state regulations and legislation to remove the Commission from the NRSRO designation process or Commission regulation of NRSRO's credit rating processes or analytic judgments.
As previously noted, S&P Ratings Services' responses to a number of the specific questions raised in the Concept Release are set forth in Appendix A to this letter. As a number of the questions could have a significant impact on market participants and involve profound First Amendment concerns, we attached as Appendix B to this letter a memorandum which outlines the serious First Amendment issues attendant to the Commission's ongoing study of the rating agencies. S&P Ratings Services believes that a full understanding of these constitutional issues is critical to any proposed regulation by the Commission of the credit rating agencies.
S&P Ratings Services appreciates the opportunity to address the issues raised in the Concept Release and looks forward to working with the Commission as it considers the appropriate actions to take.
Chairman William H. Donaldson
A. Alternatives to the NRSRO Designation
Question 1 - Should the Commission eliminate the NRSRO designation rules?
While S&P Ratings Services did not seek to become an NRSRO in 1975, it believes that because of the pervasiveness of the NRSRO concept throughout federal and state regulation and legislation and the resulting market infrastructure and practices that have developed over the last three decades, any effort by the Commission to withdraw the use of NRSRO credit ratings on a wholesale basis could be highly disruptive to the U.S. debt markets. S&P Ratings Services does not expect any such disruption to be simply a matter of transition. The elimination of the use of NRSRO credit ratings in their entirety could potentially impair the future efficiency of the U.S. debt markets and the operations of various market participants.
Moreover, it is not clear to S&P Ratings Services what benefit the wholesale withdrawal of the regulatory uses of NRSRO credit ratings would provide to investors or to the stability, efficiency and integrity of the U.S. debt markets. Replacing the regulations and statutes that currently incorporate NRSRO credit ratings with a new regulatory regime seems, to S&P Ratings Services, to be an unnecessary response to concerns about the current NRSRO designation process.
Question 2 - What alternatives are there to NRSRO credit ratings?
S&P Ratings Services is not aware of an effective and efficient alternative financial or market measure that could be used effectively across the entire spectrum of rated securities that would be an adequate alternative to NRSRO credit ratings for general use in federal and state regulation and legislation.
Question 3 - Broker-Dealer Net Capital Rule.
No answer proposed.
Question 4 - Use of credit spreads as an alternative to NRSRO credit ratings to determine broker-dealer capital charges.
S&P Ratings Services does not believe that credit spreads would prove an efficient substitute for credit ratings primarily for the following reasons:
Question 5 - Advantages and disadvantages of requiring the SROs to set appropriate standards for broker-dealers to use in determining rating categories for net capital purposes.
No answer proposed.
Question 6 - Money-Market Funds Rule 2a-7 - advantages and disadvantages of relying solely on the subjective test.
No answer proposed.
Question 7 - Elimination of investment grade criteria from the eligibility standards for Securities Act registration statement on Form S-3.
Replacing the Form S-3 investment grade debt eligibility criteria with debt eligibility criteria that limit potential investors, minimum denominations or asset and structure experience criteria could have a substantial impact on capital raising, particularly by wholly owned subsidiaries and asset-backed issuers.
Restricting the universe of potential debt investors for these offerings could raise the cost of debt financings because the ability to use delayed shelf registration effectively depends on the ability of the offering to be registered on Form S-3, and the availability of shelf registration is a key factor in the cost effectiveness of registration for these debt issuances.
Question 8 - Are there better alternatives to NRSRO credit ratings for use in Commission rules other than those mentioned by Concept Release?
No answer proposed.
Question 9 - Should an entity other than the Commission designate NRSROs?
No answer proposed.
Question 10 - If the Commission keeps the NRSRO designation for some rules, are there specific rules that could benefit from the elimination of the use of NRSRO credit ratings?
No answer proposed.
B. Recognition Criteria
Existing Substantive Criteria
Questions 11 and 12 - Are existing NRSRO designation criteria appropriate? How should a determination be made that a criterion has been met? Is it appropriate to condition NRSRO recognition on a rating agency being widely accepted as an issuer of credible and reliable ratings by the predominant users of securities ratings in the United States?
S&P Ratings Services believes that NRSRO designation criteria should be based solely on the widespread market acceptance of a credit rating agency's rating opinions as credible and reliable (as demonstrated by the performance of the credit rating opinions) by the predominant users of securities ratings in the United States.
As suggested by the Concept Release, market acceptance of a credit rating agency may be demonstrated by:
Question 13 -
(a) Should the Commission condition NRSRO recognition on a rating agency developing and implementing procedures reasonably designed to ensure credible, reliable, and current ratings?
S&P Ratings Services has had such procedures in place for many years. These procedures are detailed in reports on rating criteria and methodologies, all of which are freely available to the public in hard copy and on S&P Ratings Services' website, and each of which has been provided to the Commission staff from time to time. S&P Ratings Services' procedures are designed to assure that a similar analysis is conducted for similarly situated issuers and that current information is used in the analysis.
However, S&P Ratings Services strongly believes that government regulators should not set standards as to how a rating analysis is done. Conditioning NRSRO designation on the Commission's passing on the sufficiency of a credit rating agency's procedures could result in the Commission indirectly prescribing rating standards, analytic judgments and methodologies. Ratings are opinions, as of specific dates, of the creditworthiness of a particular company, security, or obligation. There is no one true ratings methodology, and no absolutely correct rating opinion.
S&P Ratings Services believes that a critical factor in the success of the credit rating industry is the independence of the rating and analytic processes not only from issuers and investors, but also from overly broad government prescriptions.
Commission review of rating procedures risks:
In sum, a requirement of systematic or uniform rating procedures is an unwise, fundamental intrusion into the rating process. There is no one right methodology or result, and there is no absolutely correct rating opinion. Each rating opinion represents an analytic judgment based on a wide range of factors, many of which are assessments of future developments. The critical issue for issuers and investors is whether the track record and quality of a credit rating agency demonstrate that its rating opinions are credible and reliable. Further, rating procedures evolve and, in the case of new types of securities or issuers, may vary. It is not at all clear how the Commission could assess the merits of an agency's rating procedures or whether such review of rating procedures would, in effect, substitute the Commission's judgment as to the appropriate ratings methodology in place of the credit rating agency's judgment.
(b) Should the Commission mandate uniform rating symbols for each NRSRO?
S&P Ratings Services believes that the mandated use of uniform rating symbols is not only unnecessary but, more importantly, might not be in investors' interests. S&P Ratings Services publishes on its website and in a broad array of publications, a full explanation of its rating symbols and what each means. Investors have easy access to clear explanations. Mandated uniformity of rating symbols could mislead investors into assuming that all NRSRO credit ratings are fungible, and involve the same analytical judgments, ratings criteria and methodologies. This would obscure the fact that a credit rating is a particularized opinion of the individual rating agency, based on such rating agency's independent assessments and methodologies.
(c) Should the Commission establish minimum due diligence requirements for rating agencies?
No. Mandated diligence requirements would represent a direct and substantial intervention by the Commission into the substance of the credit rating process and, as noted above, present a grave threat to the independence of the rating process. Mandated procedures are also likely to stifle innovation in the industry, as well as potentially reduce rating agencies' ability to provide a broad spectrum of credit rating opinions. Investors and the markets would be ill served by such developments.
S&P Ratings Services' credit ratings are based principally on public information about an issuer and additional information that may be provided by the issuer as well as other economic, financial and industry information rating analysts deem relevant and reliable. S&P Ratings Services' credit analyses necessarily embody assessments of potential future performance.
S&P Ratings Services does not perform an audit of the rated company or otherwise verify information provided by the company; nor does S&P Ratings Services audit or rate the work of the company's auditors or repeat the auditor's accounting review. S&P Ratings Services relies on the integrity and quality of the company's publicly available reports and expressly relies on the rated company to provide current and timely information. Rating agencies have neither existing resources nor the expertise to audit the disclosures or accounting of the companies whose obligations they rate. Imposition of such responsibilities could fundamentally change the nature of the credit rating business, imposing direct and indirect costs on the agencies as well as market participants, and interfering with the ability of the credit rating agencies to provide timely rating analyses for the thousands of issues and issuers participating in the debt markets.
Moreover, as noted above, imposition of such standards by the government could potentially present the hazard of investors assuming that the government is responsible for, or has approved, the substance and quality of a particular rating opinion.
Lastly, any imposition of minimum due diligence requirements (or similar involvement with S&P Ratings Services' method of establishing its ratings opinions - see Concept Release Questions 16 and 35) would raise troubling concerns under the First Amendment. Laws or regulations that require publishers to take governmentally determined steps when formulating their opinions for publication necessarily infringe on the fundamental principle that the government may not dictate to a free press how and what gets disseminated. Because for purposes of the First Amendment courts have treated S&P Ratings Services the same as "traditional" journalists, a law or regulation permitting the SEC to oversee the steps taken and diligence employed by S&P Ratings Services in forming its opinions of creditworthiness would, from a constitutional perspective, be the same as a law setting research standards for the publication of editorials by The Wall Street Journal. Such an "over the shoulder" approach would necessarily alter the content of S&P Ratings Services' publications, and produce the precise "chilling" effect that the First Amendment exists to guard against. See e.g. Miami Herald Publishing Co. v. Tornillo, 418 U.S. 241 (1974) (White, concurring) ("Any ... system that would supplant private control of the press with the heavy hand of government intrusion would make the government the censor of what the people may read and know.").
A more detailed legal analysis of the First Amendment implications of any minimum diligence or other standards is provided in Appendix B to S&P Ratings Services' Comment Letter.
Question 14 - Should NRSRO status be conditioned on contact with senior management?
No. While S&P Ratings Services has significant contact with the senior management of substantially all the issuers that its rates, it believes that it is possible to perform a high quality credit analysis relying solely on publicly available information of an issuer, where, for example, the issuers are reporting companies registered with the Commission or are subject to extensive regulatory public information requirements. S&P Ratings Services believes that investors and the marketplace are greatly benefited when debt issues of significance to the market are subject to its rating analysis, whether or not management chooses to participate in the rating process. Not only do investors benefit from the additional rating opinion, but the market also is benefited by a process that does not allow management the option of shielding itself from the analysis of any particular rating agency.
Question 15 - How should the Commission review computerized statistical models? Could the Commission designate an NRSRO that uses only statistical models and no qualitative inputs?
S&P Ratings Services believes that NRSRO designation should be based solely on widespread recognition and acceptance by the marketplace of a credit rating agency's ratings as credible and reliable (as demonstrated by the performance of the credit rating opinions).
Notwithstanding the inherent limitations in models based solely on quantitative inputs described further below, if in the future a credit rating agency that uses only computerized statistical models could meet the criteria for NRSRO designation, S&P Ratings Services believes that it would be appropriate for the Commission to designate the agency an NRSRO.
S&P Ratings Services believes, following its extensive experience in the industry, that credit ratings based on both quantitative measures and qualitative analytical judgments serve the financial markets better than credit measures derived solely from quantitative or statistical information. While credit scores have some usefulness, they are subject to the disadvantages inherent in statistically derived data, and the models upon which such data are derived. Some models may focus on fluctuations of equity value or volatility of asset value more than others, and different models may assess correlated credit risks and risks by sectors differently. Because statistical scoring models of various types exist, with different methodologies and varying results, multiple models would need to be developed and identified in order to provide coverage across the spectrum of rated securities and issuers that currently exists. Further, statistical models tend to yield volatile results with considerable false signals, reflecting market sentiment. Analytically derived credit ratings do not have such inherent limitations because credit ratings are opinions and not merely a statistic.
In sum, credit rating agencies should each independently develop analytic judgments, analytical models, ratings criteria and methodologies that they would use in the course of their businesses, and their national recognition, not Commission review, should determine whether they have served the capital markets properly.
Question 16 - Size, quality, training and qualification of credit rating agency staff.
While S&P Ratings Services is confident that its credit ratings personnel is an industry leader in quality, training, qualification and depth and would meet any reasonable standard established by the Commission, S&P Ratings Services does not support any NRSRO designation criteria that is conditioned on the attributes of a credit rating agency's staff. Such a criteria lends itself to wide interpretations and would not take into account the varying demands of different analytics, rating criteria and methodologies, or the needs of a particular rating agency. Moreover, such a criteria could prove to be a significant barrier to entry to NRSRO designation.
An imposed set of training and staffing requirements also would intrude upon S&P Ratings Services' independent editorial control and trigger significant First Amendment issues. Just as establishing minimum due diligence requirements would impermissibly involve the government in how a publisher like S&P Ratings Services comes to its published opinions (see our answer to Question 13), government-imposed training and staffing requirements would be the equivalent of the state's mandating whose opinions such a publisher can publish. As discussed at length in Appendix B to S&P Ratings Services' Comment Letter, because the First Amendment requires that bona fide publishers must be free to determine what - and whose - opinions should be disseminated without governmental interference, the imposition of training and staffing standards would be subjected to exacting constitutional scrutiny.
Question 17 - Should the Commission condition NRSRO recognition on an entity's meeting standards for a minimum number of rating analysts or a maximum average number of issues covered per analyst?
No. Such a level of scrutiny would involve the Commission too deeply into the business practices of rating agencies and could potentially create potential barriers to NRSRO designation. The appropriate levels of analyst coverage are not determinable by simple mathematical calculations. The appropriate level of coverage depends on a broad spectrum of variables, including the size and complexity of issuers covered, the experience and expertise of ratings analysts, industry concentrations and trends and the particular financial obligation in question. There can be no objective criteria as to ratings personnel staffing that could be uniformly applicable to all credit rating agencies in respect of all rated issues and issuers. Such a level of scrutiny also raises First Amendment issues, as noted in our answer to Question 16 above.
Question 18 -
(a) Is a credit rating agency's organizational structure an appropriate factor to consider when evaluating a request for NRSRO status?
S&P Ratings Services is committed to protecting the value of its ratings franchise by having in place strict policies and procedures to minimize the effects of any perceived conflicts of interest. S&P Ratings Services believes that the independence, credibility and integrity of its operations are adequately protected by its policies and procedures. S&P Ratings Services believes that the Commission could continue to consider the internal policies and procedures of NRSROs. The Commission's consideration should not, however, be used to impose, directly or indirectly, operating criteria or to interfere with the substantive rating process or the operations of a credit rating agency's business through, for example, specification of approaches to address any perceived conflicts of interest.
(b) Should the agency that seeks recognition consent to limiting its business to issuing credit ratings or could it conduct other activities, such as rating advisory services?
No. S&P Ratings Services does not believe it necessary for, or in investors' best interests to, preclude an NRSRO from being part of a larger business organization. Affiliation with a larger enterprise can offer financial strength and stability and can help support the level of investment necessary to continually enhance ratings operations, keep up with market developments and innovate. Limitation on business affiliations could result in significant barriers to entry.
Question 19 - Should the Commission consider a credit rating agency's financial resources as a factor in determining NRSRO status?
No. S&P Ratings Services believes that NRSRO designation criteria focused on capitalization and resources represent an intrusion into the business operations of a credit rating agency. NRSRO status should not be conditioned on criteria based upon objective capital or resource standards. Given the broad spectrum of rating agencies of varying sizes, using independently developed expertise, ratings criteria and methodologies, it would be very difficult to define capital or resource standards appropriate for all NRSROs. Moreover, meeting a mandated level of capital or resources will not assure the credibility or reliability of an NRSRO's rating opinions.
Other Factors to Be Considered
Question 20 - Should a credit rating agency that has coverage of a limited sector of the debt market or limited geographic area be eligible for designation as an NRSRO?
S&P Ratings Services believes that it would be appropriate for the Commission to recognize NRSROs on a limited basis, as it has done in the past, if the credit rating agency meets the fundamental criterion for designation - i.e., as noted above, widespread market recognition and acceptance of the credit rating agency as an issuer of credible and reliable ratings for the limited sector or limited geographic area by the predominant users of securities ratings in the United States.
Question 21 - Should the Commission consider a provisional NRSRO status for rating agencies that comply with NRSRO recognition criteria but lack national recognition?
No. S&P Ratings Services believes it critical to the effectiveness and integrity of the NRSRO concept that the market be the judge of the credibility and reliability (based on the performance of the credit rating opinions) of a rating agency's rating opinions. As discussed in prior answers, S&P Ratings Services does not believe it feasible for the government to establish objective, operational criteria that would assure that an agency would produce credible and reliable ratings. Credibility and reliability must be established through high-quality performance of a credit rating agency's rating opinions that is recognized by the market.
Question 22 - Should the Commission develop supplemental criteria to evaluate ratings quality that would be applicable to both rating agencies performing traditional fundamental credit analysis and those primarily reliant on statistical models?
As discussed above, S&P Ratings Services believes any additional criteria to determine rating quality would unwisely insert the government into the substance of the rating process and threaten the independence, innovation and quality of the rating agency industry to the detriment of the market and investors.
Question 23 - Should the Commission consider other criteria in making the NRSRO determination, such as the existence of effective procedures reasonably designed to prevent conflicts of interest and alleged anticompetitive, abusive, and unfair practices, and improve information flow surrounding the ratings process?
See our answers to Questions 37-54 for discussion of these issues.
Question 24 - Should NRSROs follow generally accepted industry standards of diligence?
See our answer to Question 13.
Question 25 - Should recognition of NRSROs occur through Commission action, or should there be an appeal process to the Commission?
S&P Ratings Services has historically supported a more transparent NRSRO designation process. S&P Ratings Services supports the Commission modifying the process to provide for Commission involvement in the designation process, whether directly or on an appeal basis, if the Commission concludes that such modifications would enhance the market's perception of the transparency of the designation process.
Question 26 - Should the Commission publicize applications for NRSRO recognition, and seek public comment on the credibility and reliability of the applicant's ratings?
Yes. S&P Ratings Services believes that public notice and solicitation of comment would add to the transparency of the NRSRO designation process.
Question 27 - Should the Commission establish a time period to serve as a goal for action on applications for NRSRO recognition?
S&P Ratings Services believes that a published goal for action could enhance the market's perception of the NRSRO designation process. The time period should be sufficient to allow the Commission and staff to adequately review the application, and to receive and consider thoughtful public comment on the application.
C. Examination and Oversight of NRSROs
Question 28 - Should NRSRO recognition be conditioned on an NRSRO's meeting the original qualification criteria on a continuing basis? If so, should a failure to meet the original qualification criteria lead to revocation of NRSRO recognition? Should some other standard of revocation apply?
S&P Ratings Services believes that NRSRO designation should be based on the market acceptance of the credibility and reliability (as demonstrated by the performance of the credit rating opinions) of the credit rating agency's rating opinions, as demonstrated by the widespread use of its credit ratings by major market participants in the United States. Withdrawal of an NRSRO designation should be based solely on the failure of an NRSRO to continue to be widely accepted as a provider of credible and reliable rating opinions by predominant users of credit ratings in the United States.
Question 29 - What would be the appropriate frequency and intensity of the Commission's ongoing review of continuing compliance with the original criteria?
S&P Ratings Services believes it is appropriate for the Commission to assess the market's ongoing views on the credibility and reliability of an agency's credit ratings to assure that an NRSRO continues to meet the market recognition criterion upon which the initial designation was based. The market will be the most effective and immediate judge of an NRSRO's credibility and the reliability of its credit rating opinions. Any Commission assessment should be based on a sustained market judgment. It is not clear that a formalized periodic process would be necessary.
Question 30 - Should NRSRO recognition be conditioned on a rating agency's filing annual certifications with the Commission that it continues to comply with all of the NRSRO criteria?
If the Commission determines to require an annual certification, S&P Ratings Services looks forward to working with the Commission to develop an annual certification process that reflects the NRSRO designation criterion discussed in our answer to Questions 11 and 12.
Question 31 - Should the Commission solicit public comment on the performance of each NRSRO, including whether the NRSRO's ratings continue to be viewed as credible and reliable? If so, how frequently should public comment be solicited (e.g., annually)?
See our answer to Question 29.
Question 32 - Should NRSROs be subject to greater oversight; is legislation necessary?
S&P Ratings Services has serious concerns that greater level of regulation and oversight will unwisely involve the Commission in the conduct of the NRSROs' business operations, interfere with their rating methodologies and analysis, compromise their independence, impose direct and indirect costs on the agencies as well as market participants, and infringe on fundamental First Amendment rights. Credit rating agencies have served the capital markets extremely well over the last century, and independence, objectivity and integrity are the hallmark of their credit ratings. There is no evidence of abuse or suggestion of a systemic market failure that warrants substantive regulation of NRSROs or their rating processes, or that risks government mandates eroding the independence, objectivity and credibility of the rating process.
Moreover, depending on its form, this "additional oversight" would likely raise serious constitutional concerns. Courts, most notably the U.S. Supreme Court, have made clear that bona fide publishers such as S&P Ratings Services cannot be subjected to licensing or other regulatory schemes, including SEC regulatory oversight that provides for regular inspection and examination, in violation of those publishers' First Amendment rights. See e.g., Lowe v. SEC, 472 U.S. 181 (1985). This is so because such oversight would likely entail the equivalent of governmental supervision of publishers from literally within their own newsrooms. The protections of the First Amendment exist precisely to guard against the "chilling" effect that such direct governmental oversight would have on the ability of free publishers to disseminate the opinions that they, in their independent editorial judgment, deem newsworthy.
This does not mean, of course, that the Commission may not, under any circumstances, oversee the activities of S&P Ratings Services or other rating agencies through, for example, review of their records and operations. An enforcement investigation, for example, arising out of a good faith belief or credible allegation that the securities laws may have been violated could constitute sufficient grounds to justify constitutional inspection of S&P Ratings Services' records by the Commission. The present point, however, is that the principles of Lowe and other authorities make clear that "additional oversight" through random and frequent prophylactic inspections likely cannot pass constitutional muster.
A more detailed discussion of the First Amendment issues implicated by the SEC's expansion of its oversight of rating agencies is contained in Appendix B to the S&P Ratings Services' Comment Letter.
Question 33 - Should NRSRO recognition be conditioned on a rating agency's registering as an investment adviser under the Investment Advisers Act of 1940?
No. S&P Ratings Services is not in the investment advisory business and does not make recommendations or give advice. A credit rating issued by S&P Ratings Services is not a recommendation to anyone to purchase, sell or hold a particular security. Nor does it comment on the suitability of an investment for a particular investor or group of investors. No commentary or ratings opinion rendered by S&P Ratings Services is personal to the user. S&P Ratings Services' credit rating activities do not fit within the central purpose of the Advisers Act and are not investment advisory in nature under the Advisers Act. Mandatory registration under the Advisers Act is inconsistent with the Advisers Act itself.
S&P Ratings Services also falls outside of the express provisions of the Advisors Act which excludes from the definition of investment adviser "bona fide publishers" i.e., publishers of any bona fide newspaper, magazine, or business or financial publication of general and regular certification. In the Lowe case referenced above, the Supreme Court made plain that this exclusion is and must be broad enough to cover any bona fide publication of general and regular circulation that offers only impersonalized investment advice (i.e., advice not tailored to the investment needs of specific clients) such as the ratings offered by S&P Ratings Services.
Moreover, any attempt to condition NRSRO recognition on a rating agency's registration under the Advisers Act, and adherence to its requirements (including its inspection and record-keeping requirements), also would trigger constitutional problems. Because a bona fide publisher such as S&P Ratings Services cannot be required to register under the Advisers Act, conditioning NRSRO status on such registration would force rating agencies to waive certain of their First Amendment rights in order to receive a government designation for which they would otherwise qualify. The government, however, cannot evade the Constitution, and in particular the First Amendment, through withholding benefits until a party capitulates into abandoning its fundamental rights so as to secure such benefits which it would otherwise receive absent the government's imposition of the condition. Accordingly, as more fully discussed in Appendix B to S&P Ratings Services' Comment Letter, predicating NRSRO designation on Adviser Act registration could not be squared with the First Amendment.
Question 34 - Should NRSROs be subject to recordkeeping requirements, including records related to rating decisions?
While S&P Ratings Services maintains records that it believes are sufficient for its business purposes, mandated requirements that go beyond this could lead to a substantial intrusion into the business operations of a credit rating agency, resulting in additional compliance obligations which S&P Ratings Services believes would provide little, if any, benefit to the investors and the marketplace. Further, mandating recordkeeping would raise fundamental First Amendment concerns. For a more detailed discussion of the First Amendment implications of this Question, please see Appendix B to S&P Ratings Services' Comment Letter.
Question 35 - Are there minimum standards or best practices to which NRSROs should adhere? Would it be a productive use of Commission resources to develop the expertise to review issues related to quality and diligence?
S&P Ratings Services believes that the rating agency industry has served the capital markets extremely well for close to a century, and the credibility of S&P Ratings Services and the other NRSROs' ratings are accepted worldwide. There is no basis for abandoning the regulatory approach that has served investors' and the markets' interest so well. Any attempt to impose regulation on rating services would adversely affect the important capital market functions performed by rating agencies and, depending on the nature and scope of the regulation, could impinge on such agencies' rights under the First Amendment of the U.S. Constitution.
Moreover, the continued vitality of the credit rating industry to the U.S. capital markets and the extension and growth of independent, credible rating services internationally depend on the Commission's implementation of a designation process that continues to ensure the independence of rating agencies and recognizes the market as the best judge of a rating agency's independence, objectivity, credibility and quality.
As financial regulators around the world are now considering the appropriate regulatory framework for rating agencies in their markets, the implications of any Commission rulemaking with respect to NRSRO designation in the United States could have implications with respect to the continued development of independent, credible rating agencies internationally. Adoption of designation criteria by the Commission that could be viewed by other regulators as suggesting a substantive role for the government in the rating process or business operations could have the unintended effect of governmental intrusion into the actual rating process - a result that risks seriously eroding the independence and consequently the credibility of rating agencies.
For a detailed discussion of the First Amendment implications of this Question, please see Appendix B to S&P Ratings Services' Comment Letter as well as our answer to Question 13.
Question 36 - If a currently recognized NRSRO gave up its NRSRO recognition because of concerns regarding the regulatory and liability environment, what effect, if any, would that action have on the market?
Depending on the extent to which the market relies on the particular NRSRO's credit ratings, S&P Ratings Services would anticipate that an NRSRO's withdrawal from designation potentially could result in significant disruption to the affected sectors of the market. For example, the market impact may be greater if the withdrawing NRSRO provided expertise or coverage of a depth and scale that could not be quickly or easily replaced.
D. Conflicts of Interest
Question 37 - Should the Commission condition NRSRO recognition on an NRSRO's agreeing to document its procedures that address potential conflicts of interest in its business, including potential issuer and subscriber influence?
S&P Ratings Services maintains such documented policies and procedures and the Commission has reviewed them from time to time, including over the past year. S&P Ratings Services believes that the maintenance of such policies and procedures is important to the credibility of its credit rating business and the value of its franchise.
S&P Ratings Services believes the Commission could continue to consider the documented policies and procedures of NRSROs. The Commission's consideration should not, however, be used to impose, directly or indirectly, operating criteria or to interfere with the substantive rating process or the operations of a credit rating agency's business through, for example, specification of approaches to address any perceived conflicts of interest.
Question 38 - To what extent could concerns regarding potential conflicts of interest be addressed through the disclosure of existing and potential conflicts of interest when an NRSRO publishes ratings?
S&P Ratings Services has historically disclosed on its website and in various rating publications that it receives fees from the issuers it rates. S&P Ratings Services is in the process of enhancing such disclosures. Any disclosures must take into account the sensitivity of pricing information as well as the need to protect confidential business information.
S&P Ratings Services does not believe that it is necessary for the Commission to mandate potential conflict of interest disclosures. As the SEC Rating Agency Report noted, participants at the Commission's public hearings on rating agencies felt that any potential conflict of interest "has been effectively addressed by the credit rating agencies."
Question 39 - Should NRSROs be required to prohibit rating analysts and rating committee members from participating in the solicitation of new business and from fee negotiations? Should the Commission require strict firewalls between employees in these areas and credit analysts to address potential conflicts? Should the Commission address the credit analyst compensation structure to minimize potential conflicts of interest?
S&P Ratings Services has in place strict policies and procedures to minimize the effects of any perceived conflicts of interest, and believes that the independence, credibility and integrity of its franchise are adequately protected by its policies and procedures. S&P Ratings Services believes the Commission could continue to consider these documented internal policies and procedures of NRSROs. The Commission's consideration should not, however, be used to impose, directly or indirectly, operating criteria or to interfere with the substantive rating process or the operations of a credit rating agency's business through, for example, specification of approaches to address any perceived conflicts of interest.
S&P Ratings Services does not believe it is necessary or appropriate for the Commission to regulate analyst compensation practices. This would be a significant interference with the substantive business operations of an NRSRO and is not warranted by any demonstrated abuse.
Question 40 - Should the Commission preclude an NRSRO from offering consulting or advisory services to entities it rates, or by limiting or restricting consulting or advisory services offered by rating agencies?
No. As discussed in our answer to Question 18, S&P Ratings Services believes the independence, credibility and integrity of the credit rating process can be adequately protected by policies and procedures implemented by an NRSRO to maintain the independence and separation of its credit ratings services.
Question 41 - Should the Commission prohibit NRSRO analysts from discussing rating actions with subscribers or limit contacts between analysts and subscribers? Are existing remedies sufficient to deter inappropriate disclosures to subscribers?
S&P Ratings Services believes that existing remedies are sufficient to deter inappropriate disclosures to subscribers and that any Commission effort to restrict legitimate communications between subscribers and analysts infringes on the First Amendment rights of the NRSRO, and can undermine transparency and the flow of information to the market.
Protection of confidential information is critical to the success of S&P Ratings Services' credit ratings business. Issuers will not make such information available to S&P Ratings Services if they have any concern that S&P Ratings Services will not ensure its confidentiality. Moreover, S&P Ratings Services and its employees fully appreciate their obligation under the federal securities laws to protect the confidentiality of such information.
S&P Ratings Services also has strict policies prohibiting S&P Ratings Services' personnel from providing any analyses or views inconsistent with or beyond that which has been published by S&P Ratings Services and from providing any information concerning any pending but unpublished rating action.
Question 42 - Should NRSROs be required to have adequate financial resources to reduce dependence on individual subscribers or issuers?
S&P Ratings Services does not believe it is practically feasible to set an objective standard that would assure a credit rating agency's independence based on financial resources. As discussed in our answer to Question 19, S&P Ratings Services strongly believes that the interests of the market and investors would not be well served by the Commission setting financial criteria for becoming an NRSRO. Further, prescribing objective resource standards as designation criteria could result in barriers to entry for rating agencies to be designated as NRSROs.
Question 43 - Should NRSRO recognition be conditioned on a rating agency not deriving more than a certain percentage of its revenues from a single source to help assure that the NRSRO operates independently of economic pressures from individual customers?
No. S&P Ratings Services does not believe it is necessary or appropriate for the Commission to regulate an NRSRO's sources of revenues. This would be a significant interference with the substantive business operations of an NRSRO, and is not warranted by any demonstrated abuse.
Since 1968, S&P Ratings Services has charged issuers for its credit rating services. The practice was implemented because of the increasing costs related to credit ratings surveillance and the growing need for more ratings coverage.
The Commission's recent public hearings on rating agencies support S&P Ratings Services' view that the Commission need not be concerned about regulating rating fees directly or through the use of customer caps. As noted in the Commission's Rating Agency Report, participants in the public hearings generally "did not believe that reliance by rating agencies on issuer fees leads to significant conflicts of interest, or otherwise calls into question the overall objectivity of credit ratings."
The influence of individual issuers on S&P Ratings Services is limited as S&P Ratings Services does business with over 37,000 issuers. Most importantly, the ongoing value of S&P Ratings Services' credit rating business is wholly dependent on continued market confidence in the credibility of its credit ratings. No single issuer fee or group of fees is or would ever be important enough to risk jeopardizing the agency's reputation and future.
Question 44 - Other ways to address potential conflicts of interest.
No answer proposed.
E. Alleged Anticompetitive, Abusive and Unfair Practices
Question 45 - Should the Commission identify specific anticompetitive practices that would be prohibited to NRSROs?
No. S&P Ratings Services does not believe that there have been any demonstrated anticompetitive practices that would warrant specific Commission regulation. Existing laws provide adequate remedy for illegal, anticompetitive practices.
Question 46 - Should NRSROs be required to adopt procedures to prevent anticompetitive, abusive and unfair practices from occurring?
No. See our answer to Question 45.
Question 47 - Should NRSRO recognition specifically be conditioned on an NRSRO's agreeing to forbear from requiring issuers to purchase ancillary services as a precondition for performance of the ratings service?
S&P Ratings Services as a matter of policy does not engage in such a practice.
Question 48 - Should NRSRO designation specifically be conditioned on limitations on specified practices with respect to unsolicited fees?
No. S&P Ratings Services does not believe it is appropriate for NRSRO designation to be conditioned on limitations on specified practices with respect to unsolicited fees. S&P Ratings Services' policy is generally to rate all issuers of U.S. public corporate and financial services debt that are valued over $50 million (whether requested to do so by the issuer or not) so long as S&P Ratings Services believes that it has sufficient publicly available information upon which to make an informed opinion. As part of this process, S&P Ratings Services will notify the issuer and ask for its participation.
S&P Ratings Services believes that its practice of issuing a credit opinion on U.S. public corporate and financial service issuers of significant market interest contributes to transparency and disclosure in the U.S. capital markets. Further, as noted in our answer to Question 14, not only do investors benefit from the additional rating information, but the market also benefits from a process that does not allow management the option of shielding itself from the analysis of any particular rating agency.
Any abuse by S&P Ratings Services' ratings personnel of the unsolicited ratings process to pressure an issuer to use S&P Ratings Services' credit ratings services would be inconsistent with S&P Ratings Services' existing policies. Failure to comply with S&P Ratings Services' policies could be sufficient reason for disciplinary action, including discharge and possible legal sanctions.
F. Information Flow
Question 49 - Should the Commission address concerns about information flow from rating agencies?
S&P Ratings Services' longstanding policy has been to make its public credit ratings and the bases for such ratings generally available to the investing public without cost. Public credit ratings (99% of S&P Ratings Services' U.S. ratings) are disseminated via real time posts on S&P Ratings Services' website and through a wire feed to the news media as well as via subscription services such as Ratings Direct and Credit Wire. Subscribers do not have access to ratings or ratings actions prior to the investing public.
S&P Ratings Services places great importance on communication with the public. Following notification to the issuer, all changes to public credit ratings and all Credit Watch and Outlook listings are disseminated promptly through S&P Ratings Services' website, worldwide press releases and subscription services. S&P Ratings Services frequently publishes its rating rationale and basis for credit rating changes through media releases. All media releases are posted on S&P Ratings Services' website.
S&P Ratings Services also publishes in detail its ratings criteria and methodology. Among other things, these published manuals of criteria and methodology provide for specific credit analysis factors to ensure that salient issues are addressed in the process and to provide issuers and investors insight into the credit rating methodology and criteria.
S&P Ratings Services goes to great lengths to provide users of its ratings with information to enable them to understand how S&P Ratings Services analyzes creditworthiness, whether or not they subscribe to S&P Ratings Services' services. S&P Ratings Services regularly publishes its rating definitions, detailed reports on rating criteria and methodology, default and transition studies and studies on rating trends, all of which are freely available to the public in hard copy and on S&P Ratings Services' website.
S&P Ratings Services also regularly publishes reports and rationales that inform the market about an issuer's strengths and weaknesses, as well as key trends that could affect the issuer's creditworthiness. Around the world, S&P Ratings Services annually publishes approximately 11,000 press releases, over 1700 articles and commentary pieces on sector and industry trends, 51 editions of Credit Week (a weekly print publication on fixed income securities) and 12 Sector reports on 19 industry groups. S&P Ratings Services holds over 200 telephone conferences with investors regarding fixed income topics, sponsors investor forums and conducts hundreds of print and broadcast interviews annually.
S&P Ratings Services does not believe it necessary or appropriate for the Commission to mandate specific disclosure standards related to the credit ratings business.
Question 50 - Should NRSROs be subject to mandated disclosures of the key bases of, and assumptions underlying, their rating decisions? Who should set such standards?
As discussed in our answer to Question 49, S&P Ratings Services believes that it provides extensive transparency about its ratings, methodologies and analytics that serve the market well.
S&P Ratings Services believes mandated disclosure standards would impose compliance costs and delay in announcement of ratings and ratings actions. Depending on the extent of disclosure required, subjecting credit rating agencies to mandated disclosure standards also may risk the disclosure of confidential issuer information.
Additionally, the imposition of a set of mandatory disclosures would likely impinge impermissibly on S&P Ratings Services' rights under the First Amendment. A government mandate as to what a First Amendment protected publisher like S&P Ratings Services must say (in this case, disclosure of key bases and assumptions) carries with it the same constitutional infirmities as a government mandate as to what such a publisher must not say. Both government actions interfere directly into the editorial judgment of the publisher and create situations where publications contain the messages the government wants publicly disseminated rather than those a free press has determined to be newsworthy. Such direct governmental regulation of the content of what the public reads and hears runs counter to the core principles of the First Amendment's guaranty of a free press. For a more detailed analysis of the First Amendment difficulties of the regulations contemplated by this question, please see Appendix B to S&P Ratings Services' Comment Letter.
Question 51 - Should the Commission require periodic disclosure of performance information?
S&P Ratings Services believes that it is helpful to the market to publish its analyses as to the performance of its rating opinions.
S&P Ratings Services regularly publishes default and transition studies and studies on rating trends. These studies have been provided to the Commission staff from time to time for review and are freely available to the public in hard copy and on S&P Ratings Services' website. S&P Ratings Services' default and transition studies contain detailed information as to the bases of its default analyses, key assumptions and methodologies, all of which demonstrate to the marketplace the performance of its credit ratings and track record.
Question 52 - Should an NRSRO or issuer be required to disclose whether an issuer participated in the rating process?
S&P Ratings Services believes that it is possible to perform a high quality credit analysis relying solely on publicly available information of an issuer, where, for example, the issuers are reporting companies registered with the Commission or are subject to extensive regulatory public information requirements. S&P Ratings Services believes that its practice of issuing a credit opinion on U.S. public corporate and financial service issuers of significant market interest contributes to transparency and disclosure in the U.S. capital markets - not only do investors benefit from the additional rating information, but the market also benefits from a process that does not allow management the option of shielding itself from the analysis of any particular rating agency.
S&P Ratings Services believes that it is useful to the public to disclose whether the issuer participated in the rating process, and would be prepared to do so. S&P Ratings Services looks forward to continuing discussions with the Commission to develop an approach to making such disclosure on a voluntary basis.
Question 53 - Should the Commission continue to require NRSROs to agree to publish ratings on a widespread basis at no cost?
As discussed above, S&P Ratings Services does publish its credit ratings on a widespread basis at no cost to the marketplace and believes publication enhances the transparency and efficiency of the market.
Question 54 - Should NRSROs be required to provide public notification when they cease to rate or follow an issuer? What form of notification would be appropriate?
When S&P Ratings Services ceases to rate or follow an issuer, it revises the rating assigned to "NR" (not rated). Consistent with other public rating actions, all "NR" rating actions are publicly disseminated via real time posts on S&P Ratings Services' website and through a wire feed to the news media as well as via subscription services such as Ratings Direct and Credit Wire.
Question 55 - What improvements can the Commission make in the extent and quality of disclosure to the public and rating agencies, particularly regarding ratings triggers, conditioned elements in material financial contracts, short term credit facilities, special purpose vehicles and material future liabilities?
S&P Ratings Services' credit rating business is based on the full and fair disclosure regime mandated by the U.S. federal securities laws. The Commission's initiatives over the last year and a half to improve the quality, transparency and timeliness of public companies' disclosures, particularly in the Management's Discussion and Analysis, should significantly enhance rating agencies' ability to evaluate a company's creditworthiness. Likewise, recent accounting standard initiatives to improve the transparency of financial statements should also benefit credit analysis.
Because S&P Ratings Services' ratings analysis relies principally on the public information provided by the issuer, S&P Ratings Services is strongly in favor of any effort to enhance the quality of issuers' public disclosure, including the disclosure of ratings triggers. In this regard, S&P Ratings Services would support mandating issuer disclosure of conditioned elements in material financial contracts, including material ratings triggers.
Question 56 - Is it appropriate for the Commission to take steps to minimize the ratings "cliff" that has been represented to be particularly pronounced in the commercial paper market, and if so by what means?
No answer proposed.
JULY 28, 2003
Standard & Poor's, a division of The McGraw-Hill Companies, Inc. ("S&P"), submits this memorandum as an appendix to its comment letter to the Securities and Exchange Commission's ("SEC") recent Concept Release entitled "Rating Agencies and the Use of Credit Ratings under the Federal Securities Laws" (the "Release"). The Release addresses, among other things, "the level of oversight to apply to . . . credit rating agencies." Release at 1. The Release sets forth a number of oversight issues about which the SEC seeks public comment, including certain potential rules and regulations for credit rating agencies designated by the SEC as NRSROs. S&P submits this memorandum to highlight the serious constitutional issues that certain of these potential rules and regulations implicate. Those issues are discussed in detail in Section II, infra, and are also specifically addressed on a question-by-question basis in Appendix A to S&P's comment letter.
S&P began its credit rating activities 87 years ago and today is one of the largest credit rating agencies in the world. S&P is one of the three original "Nationally Recognized Statistical Rating Organizations," or "NRSROs." As a rating agency, S&P gathers information about debt and issuers, analyzes that information, forms opinions about the creditworthiness of the issuers, and disseminates those opinions - in the form of credit ratings and commentary - to subscribers and the general public through traditional publications, as well as non-traditional media such as the Internet.
As the SEC has recognized, S&P's credit ratings are its "opinions, as of a specific date, of the creditworthiness of a particular company, security, or obligation." See January 24, 2003 "Report on the Role and Function of Credit Rating Agencies in the Operation of the Securities Markets" (the "Report") at 5 (emphasis added). These opinions are based on public information as well as confidential information provided by issuers, along with audited financial information and qualitative analysis of issuers and their industry sectors.
In addition to its letter ratings, S&P regularly publishes reports and rationales that inform the market about an issuer's strengths and weaknesses as well as trends that could affect the issuer's creditworthiness. Around the world, S&P annually publishes approximately 11,000 press releases, over 1,700 articles and commentary pieces on sector and industry trends, 51 editions of CreditWeek (its weekly print publication on fixed income securities issues), and 12 sector reports on 19 industry groups. All of S&P's published rating actions are available to the public on its free website, along with approximately 12,000 articles of fixed income-related commentary.
S&P's credit ratings have gained respect and authority throughout the investment community because they are widely understood to be based on independent, objective and credible analysis. Indeed, independence, objectivity and credibility are the foundations of S&P's ratings business and ultimately provide that business' value to the marketplace. In order to ensure maximum objectivity, fairness and in-depth analysis, ratings are assigned by a committee, not by individuals. Moreover, no portion of an analyst's compensation is dependent on the performance of any company that analyst rates and there is no direct correlation between the amount of fees paid by any one such company to S&P and an analysts' compensation. S&P maintains editorial control over the opinions it disseminates, including the decision of when, or even if, to publish various ratings information.
As set forth below, S&P's ratings activities are journalistic in nature and are consequently afforded a high level of protection under the First Amendment. Since the SEC is, by virtue of its governmental status, subject to the limitations proposed by the First Amendment, any proposed increase in the SEC's regulatory authority must be subjected to rigorous constitutional tests.
It is well-established that members of the financial press receive the same high level of First Amendment protection extended to other publishers. Courts have recognized the common sense proposition that financial matters are of great public concern and that a free financial press is essential to the success of our market economy. In Lowe v. SEC, 472 U.S. 181, 210 (1985), the Supreme Court found that there could be "no doubt" that publications containing factual information and commentary on market conditions and trends were protected by the First Amendment. Id. at 210 n.58 ("[B]ecause we have squarely held that the expression of opinion about a commercial product such as a loudspeaker is protected by the First Amendment, it is difficult to see why the expression of an opinion about a marketable security should not also be protected.") (citation omitted). This conclusion is consistent with previous decisions establishing the far reach of the First Amendment. See e.g. Lovell v. Griffin, 303 U.S. 444, 452 (1938) ("The liberty of the press is not confined to newspapers and periodicals. . . . The press in its [historic] connotation comprehends every sort of publication which affords a vehicle of information and opinion.").1
Rating agencies such as S&P employ journalistic methods to perform press-like functions and are entitled to the protections of the First Amendment. As the SEC has recognized, an S&P rating represents S&P's "opinion, as of a specific date, of the creditworthiness of a particular company, security or obligation." Report at 5. Indeed, the essential elements of the rating processes (i.e., gathering information about a particular issuer or security from a variety of sources, analyzing that information, forming opinions about that issuer or security and the broadly disseminating of those opinions to the public) are highly akin to those regularly performed by professional journalists. Accordingly, as detailed below, courts have routinely applied the same protections to S&P and other rating agencies.
These protections are not extended lightly, and their application is important to the ratings process and ultimately to the market. Because ratings, by their nature, are opinions rather than absolute truths, market participants will, and often do, disagree with S&P's opinions about particular issuers or securities. Rating agencies differ with each other as well. Those differing opinions are inherent in the delicate and often contentious task of assessing creditworthiness. Accordingly, in order to ensure that the market receives a rating agency's best judgment as to creditworthiness, analysts and rating committees must be free to offer their best opinions without undue fear of being second-guessed. If rating agencies were subject to low thresholds for the establishment of liability, instead of the heightened "actual malice" standard that courts have applied, analysts and rating committees might very well grow excessively cautious and conservative. As discussed in Section II, infra, certain potential regulations raised in the Release may very well implicate these same concerns. The First Amendment's protections, however, exist precisely to foster robust debate in a "marketplace of ideas" and to avoid the "chilling" effect that attends to ready liability for, and governmental standardization of, the formation and dissemination of opinions such as those prepared and published by S&P. Such protections also ensure that the market gets the best and most objective opinion that a rating agency can provide.
Cases recognizing rating agencies' First Amendment protections have primarily arisen in two contexts: (1) the application of the First Amendment's (or applicable state law's) "journalist's privilege" against compelled disclosure of rating agency material where discovery is sought by a civil litigant; and (2) the application to claims brought against rating agencies of the traditional First Amendment liability standards for publishers.
A leading case with respect to the first area is Pan Am Corp. v. Delta Airlines, 161 B.R. 577 (S.D.N.Y. 1993). In Pan Am, the court quashed a subpoena seeking documents from S&P related to meetings, correspondence and other communications between S&P and an issuer, finding that "[t]he record allows no other conclusion but that S&P functions as a journalist when gathering information in connection with its ratings process and specifically that it was functioning as a journalist, viz., with the intent to use the material to disseminate information to the public, when it gathered the information sought here ...." Id. at 581-82. Discussing S&P's "editorial process," the court took "particular interest" in "(i) S&P's gathering of a wide range of information from a variety of sources - including the issuer on both a confidential and nonconfidential basis - for the purpose and with the intent of publishing a rating, (ii) analysis of that information, (iii) internal consultation in formulation of a rating, and (iv) publication of the rating with accompanying analysis and commentary." Id. at 581.
Similarly, in the case of In re Scott Paper, 145 F.R.D. 366 (E.D. Penn. 1992), the court quashed a subpoena seeking S&P's internal operating procedures and deliberations, finding that S&P is entitled to full First Amendment protection because:
Id. at 370.
Both courts in Pan Am and Scott Paper explicitly held that it was wholly irrelevant for First Amendment purposes that S&P receives compensation for its ratings directly from issuers it rates as long as it maintains editorial control over its publications. See Pan Am, 161 B.R. at 584 n.6; Scott Paper, 145 F.R.D. at 369. This is consistent with the long-honored principle of First Amendment jurisprudence that publishers fully maintain their First Amendment protections notwithstanding that they are paid for their work. In New York Times v. Sullivan, 376 U.S. 254 (1964), for instance, the Supreme Court held that The New York Times was protected by the First Amendment when it published an "editorial advertisement." The Court concluded that it was irrelevant that the newspaper received compensation from the organization sponsoring the advertisement. See id. at 266 ("That the Times was paid for publishing the advertisement is as immaterial in this connection as is the fact that newspapers and books are sold."). Like the New York Times when it published the editorial advertisement at issue in Sullivan, rating agencies maintain their full First Amendment protections regardless of whether they receive compensation from the issuers they rate because they retain editorial control over the content and dissemination of their publications.
Indeed, such independent editorial control is essential to the value provided by rating agencies like S&P to the marketplace. Investors turn to credit ratings for an independent and objective assessment of the risks attendant to debt instruments. Without such independence and objectivity, the unique and long-recognized value of credit ratings would disappear. Accordingly, maintenance of independent editorial control over the content and nature of their publications is not only dispositive in establishing the First Amendment protections applicable to rating agencies, but it is also woven into the very fabric of their work.
The Second Circuit's recent decision about the applicability of the New York Shield Law in the In Re Fitch matter, 2003 WL 21185690 (2d Cir. 2003), does not alter this analysis with respect to S&P. That ruling held that the Shield Law did not apply to Fitch's work on a series of structured finance transactions. Although the Court rejected Fitch's claims that it acted as a "professional journalist" under the Shield Law, it was careful to limit the reach of its opinion and cited, with approval, the previously cited Pan Am and Scott Paper decisions that did extend First Amendment protection to S&P. Indeed, the Second Circuit found the analysis in Pan Am and Scott Paper "compelling," but nevertheless held that, "subtle differences in the facts of this case mandate a different outcome." In particular, the Court pointed to two factors that distinguished the Fitch case from Pan Am and Scott Paper.
First, the Court found that "[u]nlike a business newspaper or magazine, which would cover any transactions deemed newsworthy, Fitch only `covers' its own clients" and that such a practice "weighs against treating Fitch like a journalist." In re Fitch, Inc., 2003 WL 21185690, at *5. The Court observed that "the district court in Pan Am based its holding that S&P was a journalist in part upon the fact that S&P rated virtually all public debt financing and preferred stock issues whether they were done by S&P clients or not." Id.
Second, the Court found that "Fitch played an active role in helping PaineWebber decide how to structure the transaction." Id. at 6. While it did not find Fitch's involvement with PaineWebber to be improper, the Court found that there was "a level of involvement with the client's transactions that is not typical of the relationship between a journalist and the activities upon which the journalist reports" and that such evidence "counsels strongly against finding that Fitch may assert the privilege for this information." Id. Due to a protective order in place in the litigation, the Court used only general terms when discussing the evidence demonstrating Fitch's level of involvement with PaineWebber.
These important distinctions render the Fitch ruling largely inapposite to the issue of protections available to rating agencies such as S&P in their preparation and ultimate publication of opinions about creditworthiness when such preparation and publication are done in accordance with their traditional practices of independence and editorial control.
The First Amendment protections afforded to S&P and other rating agencies also arise in the context of liability standards applicable to civil lawsuits. For example, in County of Orange v. McGraw Hill, 245 B.R. 151 (C.D. Cal. 1999), the plaintiff, Orange County, sued S&P for breach of contract and professional negligence, arising out of purportedly inaccurate ratings of the county's debt. The County claimed that as a result of relying on S&P's ratings, it incurred large debts and was forced to declare bankruptcy. The District Court granted S&P's motion for summary judgment in part, holding that the claims were subject to the actual malice standard. Id. at 154-55 ("To accommodate the `breathing-space' the First Amendment requires, a publisher will not incur liability for a false statement unless the statement was made with `actual malice,' i.e., `with knowledge that the statement was false or with reckless disregard for whether or not it was true.'") (citing Hustler Magazine v. Falwell, 485 U.S. 46, 56 (1988)).
Similarly, in First Equity Corp. of Florida v. Standard & Poor's Corp., 690 F. Supp. 256 (S.D.N.Y. 1988), aff'd on other grounds, 869 F.2d 175 (2d Cir. 1989), the court granted summary judgment for S&P in a case brought by disgruntled investors who claimed to have relied to their detriment on S&P's description of certain convertible bonds. While First Equity did not involve S&P's ratings, the court still applied traditional First Amendment analysis and found that to prevail, plaintiffs would be required to show that S&P published a false description of the bonds with actual malice. Id. at 258-59. The court found that the plaintiff failed to put forth "sufficient evidence to permit the conclusion that the defendant in fact entertained serious doubts as to the truth of his publication." Id. at 259 (citing St. Amant v. Thompson, 390 U.S. 727, 731 (1968). Likewise, in Jefferson County School District, 175 F. 3d at 856, the court affirmed dismissal of a claim for defamation brought by an issuer against Moody's, finding that the plaintiff did not allege a specific false statement in the agency's publication. The court held that the phrases used in the agency's publication (i.e., "negative outlook" and "ongoing financial pressures") constituted "protected expression[s] of opinion." Id.; see also id. at 855 ("Like the statement of a product's value, a statement regarding the creditworthiness of a bond issuer could well depend on a myriad of factors, many of them not provably true or false.").
As the court recognized in Jefferson County, one reason that rating agencies deserve a high level of constitutional protection is that their ratings are expressions of opinion. See id. at 856; Milkovich v. Lorain Journal Co., 497 U.S. 1, 20 (1990) ("[A] statement of opinion relating to matters of public concern which does not contain a provably false factual connotation will receive full constitutional protection."); see also Biospherics, Inc. v. Forbes, Inc., 151 F. 3d 180, 185-86 (4th Cir. 1998) (published statements that investors "would sour" on a company were protected by the First Amendment); National Life Insurance Co. v. Phillips Publishing, Inc., 793 F. Supp. 627, 648 (D. Md. 1992) (holding that Profitable Investing, a financial newsletter, was entitled to the actual malice standard in defamation suit by insurance company).
The overwhelming weight of judicial authority recognizes, then, that financial publishers, including rating agencies, enjoy strong constitutional protections. These protections arise from the fundamental First Amendment tenet - bolstered by the common sense principle - that because financial matters are of critical importance to our market economy, those who report, comment and opine on such matters must be free to do so without undue concern of any governmental body looking over their shoulders. Moreover, these protections place firm and definite limits on any attempt by either the SEC or Congress to regulate S&P's formation and publication of credit opinions, including, as detailed below, several of the specific potential rules and regulations contemplated by the Release.
Several of the potential rules and regulations identified in the Release - i.e., regular examinations and inspections, diligence and training standards, and certain disclosure obligations - raise particularly serious constitutional concerns. Whether these potential rules and regulations extend and apply existing regulations as against rating agencies or involve special legislative authority sought from Congress, governmental interference with the formulation and dissemination of credit ratings would necessarily invoke the most searching constitutional scrutiny.
As a threshold matter, it is axiomatic that the First Amendment, which bars "Congress" from making any laws "abridging the freedom of the press," cannot be overcome by a congressional act. See Tucker v. Texas, 326 U.S. 517, 520 (1946) ("Certainly neither Congress nor Federal agencies acting pursuant to congressional authorization may abridge the freedom of press and religion safeguarded by the First Amendment."); see also Dickerson v. United States, 530 U.S. 428, 437 (2000) ("Congress may not legislatively supersede our decisions interpreting and applying the Constitution."); City of Boerne v. Flores, 521 U.S. 507, 535-536 (1997) (holding that once the Supreme Court has defined the substantive limits of a Constitutional provision, the Legislature may not redefine those limits by simply passing a new statute). Congress thus exercises its authority subject to the limitations contained in the Constitution, and any legislation augmenting government oversight of rating agencies would face the same constitutional hurdles as regulations emanating directly from the SEC.
A. Increased SEC Oversight, Including Regular
The Release discusses subjecting NRSROs to increased oversight, including "regular Commission inspections and examinations to determine compliance with the appropriate regulatory regime for NRSROs." Release at 10. Any such regulation of rating agencies would be the equivalent of the SEC's supervision of bona fide publishers (like The Wall Street Journal) from literally within their own editorial rooms. Indeed, the goal of such a regime could be nothing other than providing the SEC with greater insight and influence into the inner-workings of rating agencies' information gathering and analytical process. As such, and for the reasons articulated below, such a regime would likely run afoul of fundamental First Amendment principles.
That a regular inspection regime (including the recordkeeping requirements referenced in Question 34 of the Release) already exists in the Investment Advisers Act of 1940 ("IAA") - which makes it unlawful for unregistered investment advisers to make use of the mails or any means of interstate commerce in connection with their business as an investment adviser (15 U.S.C. 80b-3(a)) - does not provide a basis for imposing such requirements on NRSROs. The IAA, which also gives the SEC powers of censure, denial, or suspension of registration, 15 U.S.C. §80b-3(e), requires, inter alia, periodic disclosure of business information to the SEC and permits periodic inspection of a broad array of internal documents as the SEC deems necessary or appropriate in the public interest or for the protection of investors. 15 U.S.C. §80b-4. As applied to those like S&P who engage in protected First Amendment activities (as opposed to those who are investment advisers), such intrusions implicate significant constitutional concerns.
More to the point, regulatory requirements along the lines of those contained in the IAA as applied to rating agencies would produce the precise "chilling" effect that the First Amendment and the protections afforded publishers there under guard against. This is particularly true with respect to regular inspection requirements. Indeed, it is hard to imagine a more chilling measure than the specter of regular "over the shoulder" review by government regulators. In Lowe, the Court unanimously rejected the position of the SEC that a publisher of newsletters of general circulation containing factual information and commentary on market conditions and trends could be deemed an "investment advisor" under the IAA and thus subject to Commission regulation and inspection. The majority opinion of Justice Stevens, for himself and four other members of the Court (Justice Powell not having participated), sidestepped the constitutional question by interpreting the statute's "publisher's exemption" broadly. At the same time, the majority made plain that its opinion was rooted in the strength of the First Amendment argument presented by the publisher, and firmly concluded that the appellant's publication was indeed protected by the First Amendment:
Lowe 472 U.S. at 210. (emphasis added)
The concurring opinion of Justice White in Lowe (joined by Chief Justice Burger and Justice Rehnquist) expressed those constitutional concerns even more sharply, concluding that the statute could not be read as narrowly as the majority opinion had and that, as properly read, the law violated the First Amendment as applied to the appellant. In the view of the concurring Justices, the case involved "a collision between the power of the government to license and regulate those who would pursue a profession or vocation and the rights of freedom of speech of the press guaranteed by the First Amendment." Id. at 228 (White concurring). The concurring justices made plain their rejection of the proposition that the government could enact a licensing scheme directly affecting speech. Id. at 229 (White concurring) ("[T]he principle that the government may restrict entry into professions and vocations through licensing schemes has never been extended to encompass the licensing of speech per se or of the press.") (emphasis in original) (citing Thomas v. Collins, 323 U.S. 516 (1945); Lovell v. Griffin, 303 U.S. 444 (1938); Schneider v. State, 308 U.S. 147 (1939); Near v. Minnesota ex rel. Olson, 283 U.S. 697 (1931); Cantwell v. Connecticut, 310 U.S. 296 (1940); Schaumburg v. Citizens for a Better Environment, 444 U.S. 620 (1980); Jamison v. Texas, 318 U.S. 413 (1943)).
Relying heavily on Justice White's concurrence in Lowe, the court in Taucher v. Born, 53 F. Supp.2d 464 (D.D.C. 1999), held that a publisher of books, newsletters, websites, instruction manuals and computer software containing analysis, advice and buy/sell recommendations could not be required to register under the Commodity Exchange Act ("CEA") - a statute with language nearly identical to the IAA - because the materials were entitled to full First Amendment protection. Id. at 479; see also 7 U.S.C. § 6m(1). The court held that "[b]ecause the plaintiffs do not profit from their customers' gains or losses in the market and because the plaintiffs do not exercise judgment on behalf of their customers, . . . their publications fall within the definition of protected speech." Taucher, 53 F. Supp.2d at 479. Because the CEA contains a narrower "publishers' exclusion" than that contained in the IAA, the Taucher court faced head-on the constitutional question avoided in Lowe. Guided by Justice White's concurrence in Lowe, the court determined that the CEA's registration requirement was an unconstitutional attempt to regulate speech:
Id. at 482; see also Commodity Futures Trading Commission v. Vartuli, 228 F.3d 94, 112 (2d Cir. 2000) (applying Lowe in holding that an injunction preventing defendant from distributing commodities trading software unless it registered under CEA violated the First Amendment). Accordingly, any regime aimed at providing the SEC with "additional oversight," including the ability to conduct regular inspections, would likely violate the First Amendment.
Lastly, any requirement that rating agencies comply with the recordkeeping and inspection requirements of the IAA or any other regulatory scheme as a precondition to receiving NRSRO status, as suggested in Question 33 of the Release, would run afoul of well-established constitutional principles. Any law or regulation requiring S&P to waive its right to be free of recordkeeping requirements, inspections, or any other First Amendment rights in exchange for a benefit like NRSRO status would be a paradigmatic example of an unconstitutional condition, and would be met with exacting judicial scrutiny. Under the doctrine of unconstitutional conditions, the government may not deny a "benefit" to a person (even if the person is not entitled to that benefit) because the person refused to forfeit or waive a constitutionally protected interest. The doctrine has been applied in a wide range of circumstances. See generally Rodney A. Smolla, Smolla and Nimmer on Freedom of Speech, §7:8 (October 2001). For instance, the Supreme Court has held that teachers may not be made to relinquish First Amendment rights that "they would otherwise enjoy as citizens to comment on matters of public interest in connection with the operation of the public schools in which they work...." Pickering v. Board of Education, 391 U.S. 563, 568 (1968). Similarly, the Court has held that a state Board of Regents may not fail to renew even a non-tenured teacher in retaliation for the teacher's exercise of free speech. Perry v. Sindermann, 408 U.S. 593 (1972). More recently, in Board of County Commissioners v. Umbehr, 518 U.S. 668, 680-81 (1996), the Supreme Court held that certain contractors were protected from termination of at-will government contracts in retaliation for their exercise of free speech. Id. at 674 (holding that "`constitutional violations may arise from the deterrent, or `chilling,' effect of governmental [efforts] that fall short of a direct prohibition against the exercise of First Amendment rights....'") (citations omitted).
It is of no consequence in this regard that S&P and other rating agencies are not constitutionally entitled to NRSRO status. In Umbehr, the Court held that "our modern `unconstitutional conditions' doctrine holds that the government `may not deny a benefit to a person on a basis that infringes his constitutionally protected ... freedom of speech' even if he has no entitlement to that benefit." Id. (citations omitted).
The above discussion does not mean, of course, that the SEC may not, under any circumstances, oversee the activities of S&P or other rating agencies through review of their records and operations. An enforcement investigation, for instance, arising out of a good faith belief or credible allegation that the securities laws may have been violated could constitute sufficient grounds to justify constitutional inspection of S&P's records by the SEC. The present point, however, is that the principles of Lowe and other authorities make clear that "additional oversight" through a regime of random and frequent prophylactic inspections cannot pass constitutional muster.
B. General Standards Of Diligence For Ratings
In multiple places, the Release discusses the possibility of creating "minimum due diligence standards" for NRSROs. Release at Question 13. See also Release at Questions 24 & 35. The Release also seeks comment on whether the SEC should adopt "minimum standards for the training and qualifications, of . . . credit analysts." Release at Question 16.
An attempt to impose minimum standards of diligence (or otherwise interfere with S&P's method of establishing ratings) would likely constitute impermissible governmental interference in the "newsroom" and would squarely implicate fundamental First Amendment concerns. Indeed, any rule or regulation that required rating agencies to take particular steps (by particular individuals) when formulating their rating opinions would likely violate the venerable principle that the government may not regulate the inner-workings of publishers who are protected by the wide reach of the First Amendment. See e.g. Miami Herald Publishing Co. v. Tornillo, 418 U.S. 241 (1974) (White, concurring) ("Any ... system that would supplant private control of the press with the heavy hand of government intrusion would make the government the censor of what the people may read and know."); Pittsburgh Press Co. v. Human Relations Commission, 413 U.S. 376, 391 (1973) ("[W]e reaffirm unequivocally the protection afforded to editorial judgment and to the free expression of views on these and other issues, however controversial."); Smith v. People of the State of California, 361 U.S. 147, 158-59 (1959) (Black concurring) ("I do not believe that any federal agencies, including Congress and this Court, have power or authority to subordinate speech and press to what they think are `more important interests.'").
As set forth in Section I, for purposes of the First Amendment, courts treat S&P and other rating agencies the same as "traditional" journalists. Accordingly, rating agencies enjoy no less protection from governmental intrusion than other journalists. Therefore, a law or regulation permitting the SEC to oversee the "diligence" with which S&P determines its opinions of creditworthiness would suffer the same fate as a law setting research standards for the publication of editorials by The Wall Street Journal. Likewise, legislative or regulatory standards for the "training" of analysts would be a governmental intrusion wholly intolerable under the First Amendment. If enacted, these regulations would prescribe, with exacting detail, the very manner by which rating agencies form their published opinions. With this authority, Congress or the SEC would find itself inside the editorial rooms of bona fide publishers, possessing the authority to define qualified journalists and to affect the content of widely disseminated opinions. The First Amendment exists to protect the public from just such governmental intrusion. See Turner Broadcasting System, Inc. v. Federal Communications Commission, 512 U.S. 622, 641 (1994) ("At the heart of the First Amendment lies the principle that each person should decide for himself or herself the ideas and beliefs deserving of expression, consideration, and adherence.").
C. Any Requirement That Ratings And Commentary
The Release also seeks comment on whether NRSRO status should be conditioned on a "rating agency disclosing the key basis of, and assumptions underlying its rating decisions." (Release at Question 50.)
A rule or regulation dictating the particular content of an NRSRO's publications would likely be at odds with settled First Amendment law. See Riley v. National Federation of the Blind of North Carolina, 487 U.S. 781, 795, 798 (1988) ("Mandating speech that a speaker would not otherwise make necessarily alters the content of the speech" and subjects the law to "exacting First Amendment scrutiny"). As a member of the press, S&P cannot be required to cede control over the content of its publications to government regulators. Just as it would be unthinkable for the government to require The Wall Street Journal to include particular facts that its editors would otherwise not include, Congress and the SEC may not dictate the content of S&P's published opinions about creditworthiness. See Turner Broadcasting System, Inc., 512 U.S. at 641 ("Government action that ... requires the utterance of a particular message favored by the Government, contravenes this essential right."); Pacific Gas & Electric Co. v. Public Utilities Comm. of Cal., 475 U.S. 1, 11 (1986) ("Just as the State is not free to `tell a newspaper in advance what it can print and what it cannot,' ... the State is not free either to restrict appellant's speech to certain topics or views or to force appellant to respond to views that others may hold.") (citations omitted); Passaic Daily News v. National Labor Relations Board, 736 F. 2d 1543, 1558 (D.C. Cir. 1984) ("To enforce the Board's order [mandating that a newspaper publish an author's editorials] would require this court to recognize, for the first time, that government regulation of the material to go into a newspaper `can be exercised consistent with the First Amendment guarantees of a free press as they have evolved to this time.' We decline to do so.") (citations omitted).
The Supreme Court, in Tornillo, 418 U.S. at 260, explicitly recognized that the government may not compel publishers to disseminate particular speech. The Court struck down a Florida law requiring newspapers to afford political candidates a right of reply to editorials attacking their character, holding that a law compelling speech is an "intrusion into the function of editors," and "operates as a command in the same sense as a statute or regulation" prohibiting speech. Id. at 256, 258. See also id. at 261 (White, concurring) (finding that the statute ran "afoul of the elementary First Amendment proposition that government may not force a newspaper to print copy which, in its journalistic discretion, it chooses to leave on the newsroom floor"). Thus, the same principles that preclude Congress and the SEC from prohibiting rating agencies from publishing certain information also foreclose their ability to require NRSROs to make disclosures about the analytical bases of their credit opinions or any other matter.
The Court in Tornillo made plain that governmentally compelled speech is impermissible even where the publisher faces "no additional costs to comply" and "would not be forced to forgo publication of news or opinion." Id. at 258. The Court held that the "choice of material to go into a newspaper, and the decisions made as to limitations on the size and content of the paper ... constitute the exercise of editorial control" and that it "has yet to be demonstrated how governmental regulation of this crucial process can be exercised consistent with First Amendment guarantees of a free press." Id.
Moreover, in Tornillo, the Court held that it would be "intensely skeptical" of any government compelled speech, "[r]egardless of how beneficent-sounding the purposes of controlling the press might be . . . ." Id. at 259. In this regard, the Court was clear that the government may not compel speech, even where - as the SEC contemplates here - the legislation would be designed to increase the flow of information and benefit the public at large. See id. at 256 ("A responsible press is an undoubtedly desirable goal, but press responsibility is not mandated by the Constitution and like many other virtues it cannot be legislated."). Thus, the purposes of the disclosure contemplated in Section F of the Release - no matter how laudable - would be scarcely relevant in a First Amendment analysis.
Accordingly, the Supreme Court has invalidated laws compelling speech in other contexts where the regulation is seemingly designed to benefit the public. In Riley, for instance, the Court struck down a law requiring professional fundraisers to disclose to their donors the percentage of charitable contributions that they have collected and actually turned over to charitable organizations. 487 U.S. at 798. The law was designed to inform donors about how their contributions were spent and to "dispel the alleged misperception" that a high proportion of the money actually benefits charity. Id. at 798. Holding that the law was an impermissible content-based regulation of speech, the Court applied "exacting First Amendment scrutiny" and found it to be unconstitutional. Id. at 795, 797. See also Pacific Gas and Electric Co. v. Public Utilities Commission of California, 475 U.S. 1, 20-21 (1985) (vacating commission's order requiring utility to place a third party's newsletter in its billing envelopes, finding that it impermissibly burdened the utility's First Amendment rights). These well-settled authorities make plain that any attempt by Congress or the SEC to compel NRSROs to make the disclosures contemplated in the Release about their analytical bases and assumptions would be subject to the most exacting First Amendment scrutiny.