In response to your request for comments regarding Rating Agencies and the use of Credit Ratings under the Federal Securities Laws, I would like to offer some observations based on a number of years dealing with the credit rating agencies as an issuer.
As general background to my comments, I am the chief financial officer of a large mid cap company listed on the NYSE which is a regular issuer in both the private and public debt markets. My company maintains long standing relationships with Moody's, Fitch and Standard and Poor's. I am also a member of Standard and Poor's corporate advisory board.
My comments on your outline of issues and questions are as follows:
A. Alternatives to the NRSRO Designation
B. Recognition Criteria
Question 11 - No comment
Question 12 - Yes it is appropriate to condition NRSRO recognition on an agency being widely accepted by both issuers and investors. Issuers spend a great deal of time developing the knowledge base of the agencies with regard to the issuer. It is critical that the agency analyzing credit understand both the industry and the individual circumstances of the company in depth. Most issuers have limited resources to dedicate to this process, which if they are spread too thinly will cause a loss of quality in the analysis. Issuers will tend to focus on agencies with the greatest level of acceptance by investors anyway since they wish to maximize their potential investor base.
Question 13 - Yes minimum standards for NRSRO recognition should be developed. This would be an excellent starting point for quality control in the industry. These requirements should be developed by the industry with Commission oversight. Uniform ratings symbols would be helpful to reduce risk of market confusion if many more NRSRO's are recognized.
Question 14 - Accurate and useful credit analysis is impossible without regular contact with the senior management of issuers. This should definitely be a criterion for NRSRO status.
Question 15 - Computerized statistical models certainly have their place in credit analysis, but this is just one tool in the process. Analysis of past performance of the models and stress testing is important, but a model is only as good as its inputs. An agency that relies solely on a model with no other qualitative inputs is not doing an in depth credit analysis and should not qualify as an NRSRO.
Question 16 - Staff quality and training is critical to the credit analysis process. Minimum standards are appropriate. These should be developed by the industry with Commission oversight. The industry should track and report compliance.
Question 17 - Decisions on the number of analysts and number of issuers covered per analyst are best left to the agencies. Issuers have a strong incentive to monitor the quality of credit analysis performed on their credit and will be quick to point out inaccuracies or lack of diligence to an agency's management. Agencies have an equally strong incentive to maintain the quality of analysis due to constant scrutiny from both issuers and investors.
Question 18 - An appropriate credit evaluation process should be a requirement for NRSRO status. Different organizational structures can still produce a good credit evaluation process, so it is the process that should be evaluated not the organizational structure. Other activities in addition to issuing credit ratings may be appropriate, but should be evaluated for potential conflicts of interest. Specifically, rating advisory services are an integral part of the credit process. Issuers must be able to evaluate the potential ratings consequences when devising business plans and strategies. To do so blindly would inject more volatility into the process to the detriment of both issuers and investors.
Question 19 - Financial resources should be sufficient to ensure a robust credit process. Continuity of the rating agency is also important. It would be extremely prejudicial to investors if securities they purchased ceased to be rated because the agencies that rated them are no longer around.
Question 20 - NRSRO designation for certain specialized market segments, industries or geographies may be appropriate. A cautious approach is warranted however. The possibility of hundreds of competing credit rating agencies is not an appealing one. This is likely to lead to investor confusion and a devaluing of the entire process. Issuers would be unable to work with so many agencies to ensure the quality of the credit analysis process.
Question 21 - No. National recognition should be an NRSRO requirement.
Question 22 - No comment.
Question 23 - Yes.
Question 24 - Yes. Minimum diligence standards are appropriate. The industry should develop these standards with Commission supervision.
Question 25 - No comment.
Question 26 - No comment.
Question 27 - No comment.
C. Examination and Oversight of NRSRO's
Question 28 - Yes. NRSRO's should be required to meet minimum criteria on an ongoing basis. Failure to meet the criteria should lead to a remediation process which, if not successful, leads to revocation.
Question 29 - Annual if in compliance. Quarterly if not in compliance.
Question 30 - Yes.
Question 31 - A public complaint process should exist for continuous comment on performance.
Question 32 - Additional regulatory oversight is not necessary with the current industry structure. The agencies are extremely diligent and produce good quality analysis in general. If there is rapid expansion in the number of NRSRO's then additional forms of quality control are likely to be necessary.
Question 33 - No comment.
Question 34 - No comment.
Question 35 - Minimum standards should be established by the industry with Commission oversight and incorporated into the conditions for NRSRO recognition.
Question 36 - Losing a currently recognized NRSRO would be extremely prejudicial to the market.
D. Conflicts of Interest
Question 37 - Well established and periodically reviewed procedures for conflict of interest avoidance should be part of the requirements for NRSRO recognition.
Question 38 - Most concerns regarding conflicts can be addressed by disclosure when ratings are published.
Question 39 - As best practice, employees involved in ratings should not solicit new business or be involved in fee discussions.
Question 40 - Ratings advisory services are a crucial part of the ratings process. Issuers must be able to evaluate the potential ratings consequences when devising business plans and strategies. To do so blindly would inject more volatility into the process to the detriment of both issuers and investors. Certain other consulting services might create conflicts. These should be evaluated on a case by case basis.
Question 41 - From an issuers perspective contact between analysts and subscribers is a double edged sword fraught with potential problems. On the one hand, issuers want investors to understand the credit and value the perspective the agencies can provide. On the other hand there are several problems. The most prominent is reg. FD. Public issuers take great pains to control disclosure of information in order to comply with FD. Contacts with credit analysts necessarily involve information not publicly available in order to provide the fullest credit picture. Analysts in discussions with subscribers may inadvertently provide non-public knowledge. Since the issuer is not a party to communications between the analyst and the subscriber, the issuer will not know that such disclosure has taken place.
Question 42 - Yes, but adequate financial resources are most important to ensure business continuity and the ability to invest in quality control. The limits proposed as an example seem far too small for this purpose.
Question 43 - With current NRSRO's this limit seems redundant given the size of the organizations. If many smaller NRSRO's are recognized this may become applicable, however then the concern addressed in question 42 becomes relevant.
Question 44 - Disclosure would seem the best method.
E. Alleged Anticompetitive, Abusive and Unfair Practices
Question 45 - Issues that might fall under this category are addressed by establishing appropriate procedures against conflict of interest.
Question 46 - See question 45.
Question 47 - See question 45.
Question 48 - See question 45.
F. Information Flow
Question 49 - The primary concern regarding information flow should be to ensure that no confidential information is released inadvertently. If this condition is met then more disclosure is desirable. The agencies already make a great effort to meet investor needs and provide more information on the basis for ratings decisions. If there are ways to improve this they are likely to be receptive.
Question 50 - See question 49.
Question 51 - No comment.
Question 52 - This would be useful disclosure. The quality of the credit analysis is likely to be better if the issuer participates in the process.
Question 53 - Most issuers would be delighted to have someone else assume the cost of ratings fees. However the investor fee for service model has been tried in the past and does not provide sufficient revenue to cover the cost of a comprehensive ratings service. It is also in an issuer's interest to ensure the widest possible investor base for its securities. Therefore, as long as issuers are paying for the service, ratings should be freely available and widely disseminated.
Question 54 - A public notification by press release would be appropriate.
Question 55 - All these issues are currently investigated by the agencies as part of the normal credit process and are already reflected in the credit rating. Direct contact between credit analysts and senior management of the issuer is important in order to fully cover these questions.
Question 56 - No comment.