Moody's Investors Service
99 Church Street
New York, New York 10007
August 26, 2002
Mr. Jonathan G. Katz
U.S. Securities and Exchange Commission
Washington, D.C. 20549-0609
Re: File No. S7-22-02, Release Nos. 33-8106, 34-46084 (Jun. 17, 2002); Proposed Rule:
Additional Form 8-K Disclosure Requirements and Acceleration of Filing Date
Dear Mr. Katz:
Moody's Investors Service ("Moody's") appreciates the opportunity to submit this comment on the above referenced rule proposal to the U.S. Securities & Exchange Commission (the "Commission"). The proposal is part of the Commission's initiative to improve the delivery of timely, high-quality information to the securities markets. This letter focuses on the additional Form 8-K disclosure requirements proposed in Item 3.01 - Rating Agency Decisions.
Moody's is the oldest credit rating agency in the world. Our roots can be traced to 1900, when John Moody and Company first published Moody's Manual of Industrial and Miscellaneous Securities. From its beginning, Moody's focused on rating debt instruments, and, as early as 1924, Moody's was rating nearly every bond in the United States bond market. Today, our credit research covers a broad range of debt totaling over $30 trillion and thousands of institutions.
As a long-time publisher of investment information, Moody's has been an advocate of rules and regulations that encourage meaningful, prompt and accurate disclosure. We firmly believe that transparency bolsters investor confidence and allows for the more efficient flow of resources in capital markets.
The Commission's proposed rule adds new triggering events for a current report on Form 8-K and shortens the Form 8-K filing deadline to two business days. Proposed Item 3.01 enumerates rating agency decisions that would trigger an issuer's Form 8-K filing obligation. It appears that the Commission believes that rating agency actions may have a material effect on registrants and that prompt disclosure of these actions would contribute to investor protection. Additionally, the Commission appears to have endeavored to lessen the issuer's disclosure burden by imposing an "information exchange" bright line test, limiting the disclosure requirement to rating actions of agencies to which the registrant has provided information.
Although it is true that current Commission rules do not require public companies to disclose ratings in registration statements or periodic reports, we note that the Commission already has rules that indirectly should obligate registrants to disclose rating agency actions. Item 10 of Regulation S-K, for example, encourages issuers to update disclosure with current information about material changes in ratings of major rating agencies. Item 303(a)(1) of Regulation S-K states that management must discuss "any known trends or any known demands, commitments, events or uncertainties that will result in or that are reasonably likely to result in" a material increase or decrease in liquidity.1 Nevertheless, we observe that such disclosure of material changes in ratings has not taken place in a systematic way. An example of the failure of registrants to disclose rating-related events that could result in a material increase or decrease in liquidity involves rating triggers.2 In a study we conducted during the Spring of 2002, we found that rating triggers could have material consequences for issuers' liquidity and financial flexibility. Yet, many of these triggers were not disclosed in the SEC filings of responding issuers.3
On balance we believe that proposed Item 3.01 could be deemed as a fitting next step within the Commission's existing regulatory framework to address this lack of disclosure.4 In this letter, however, we would like to share with you our thoughts about the proposed rule, and our concern with respect to its potential scope. For your ease of reference and consideration, we have included as Exhibit A proposed text for Item 3.01 reflecting our comments.
I. The scope of Item 3.01
While we support the Commission's interest in focusing issuers on disclosure about ratings changes, we believe that, as proposed, Item 3.01 may be overly broad, both in terms of the definition of rating agency and the nature of the rating actions that will trigger disclosure. In addition, the test which the Commission has employed to limit the disclosure trigger, the "information exchange test," could induce registrants to avoid providing information to certain credit rating agencies precisely to avoid Form 8-K disclosure and MD&A discussion. We believe that the ultimate result may be an increase in the frequency of immaterial filings that could obscure disclosure of more important information to investors and the avoidance of disclosure of unfavorable rating actions.
A. Scope of "rating agency"
As proposed, Item 3.01 would require disclosure regarding "rating changes by any entity whose primary business is the issuance of credit ratings" and "to whom the registrant provides information." On its face, this requirement is overly broad as it captures numerous types of entities that produce credit assessments. As currently drafted, the rule would result in filings with limited relevance to securities investors while imposing a potentially heavy disclosure burden on registrants. We would suggest that the Commission consider a more restrictive description of "rating agency."
For example, proposed Item 3.01 could require disclosure of assessments made by entities whose ratings are neither publicly available nor primarily relied upon for evaluating the credit risk of public debt securities. Such entities could include trade credit reporting agencies that collect information from the companies they assess and might encompass credit risk management services, which derive their assessments principally from statistical analysis of market data.
As a starting point for narrowing the scope of "rating agency," we believe the Commission could clarify that its use in this rule should relate to "an entity whose primary business is the issuance of credit ratings made broadly available to the general public for the purpose of evaluating the credit risk of investment securities." This clarification would exclude trade credit reporting agencies whose opinions have limited relevance in the securities evaluation process, and it would exclude risk management services whose assessments may not be publicly available.
As previously noted, the Commission appears to have endeavored to lessen the registrant's disclosure burden by imposing an "information exchange" bright line test. This test would limit the disclosure requirement to rating actions of agencies to which the registrant has provided information. We can appreciate that, without such a test, the registrant would be compelled to disclose every rating action of any and all agencies whose primary business is the provision of credit ratings, including those with no track record or market standing. This would surely result in a heavy disclosure burden for issuers, on the one hand, and in a large volume of public filings with little relevance for investors, on the other hand.
We are concerned, however, that the information exchange test could have an unintended consequence. An issuer anticipating an unfavorable rating decision could avoid its disclosure requirement by ceasing to communicate with that rating agency.5 Issuers might restrict their communication to credit rating agencies that they believe will deliver more favorable rating conclusions. Such behavior, over time, would bias issuer Form 8-K filings toward favorable information. A rule that enables registrants to suppress their disclosure of unfavorable rating actions seems contrary to the Commission's ultimate goals of market transparency and investor protection.6
As a second option, the Commission could restrict the disclosure obligation to rating agencies that it has designated as "nationally recognized statistical rating organizations" or "NRSROs." However, if the Commission chooses to employ a NRSRO bright line rule as the sole condition requiring disclosure, it would presumably obligate the registrant to disclose every designated rating agency's rating actions, even if the registrant provides no information apart from publicly available financial statements to that agency. In a regulatory regime with a small number of NRSROs, the disclosure burden on the registrant would be manageable. The disclosure burden could, however, become onerous if there were a large number of NRSROs.
The Commission could elect to limit disclosure to the rating actions of NRSROs to which the registrant provides information. This limitation would reduce the burden on the registrant who would otherwise be compelled to file all existing NRSRO rating changes. However, we remain concerned that such a rule could similarly bias registrant disclosure over time to favorable rating actions, regardless of whether the rule incorporates the NRSRO designation or a generic rating agency description.
One possible approach to reducing the risk of disclosure biased to favorable rating actions would be to incorporate the materiality standard into the bright line test that the Commission will employ. Specifically, the Commission may explicitly require the issuer to file a Form 8-K if the rating agency that takes the rating action falls under the bright line test employed by the Commission, or the rating action taken by the agency has a material consequence on the registrant's liquidity, capital resources or results of operations.
In this formulation, Form 8-K disclosure would be triggered in the first instance by a rating agency action from either a NRSRO or a rating agency as defined in the rule and to whom the registrant provides information. However, rating actions of agencies to whom the registrant does not (or no longer) provide(s) information would nonetheless be captured by the disclosure requirement if such rating actions have a material impact on the registrant. The use of a materiality standard as an alternative test might offset the risk of rating shopping inherent in the proposed rule, thereby strengthening investor protection.
B. Nature of rating decisions that trigger disclosure
As proposed, Item 3.01 would require disclosure when a rating agency: changes or withdraws a credit rating; changes a credit rating outlook; changes a registrant credit watch or watchlist status;7 refuses to assign a rating; or takes any similar action. In addition, Item 3.01(a)(1) requires disclosure of rating actions affecting not only the direct indebtedness of the registrant but also of the "securities or obligations as to which the registrant is a guarantor or has a contingent financial obligation." We believe that this rule, as presently constructed, provides insufficient clarity as to the nature of rating agency actions that require disclosure.
For example, proposed Item 3.01(a)(4) requires disclosure when an agency takes "any similar action" to a change of a rating or rating outlook or watchlist status. This clause may unnecessarily add confusion to the rule. For example, Moody's publishes and makes generally available to the public credit commentary, including industry outlooks and other published research that it does not consider to be "ratings." In declining to specify "any similar actions" registrants will speculate as to which other rating agency actions should trigger a Form 8-K filing, and thus may engage in needless disclosure.
One approach to clarifying the disclosure requirement would be to provide a clear definition of the term "credit rating" for the purposes of this rule. A credit rating could be defined as "a publicly communicated opinion of a credit rating agency concerning the creditworthiness of a debt security or of an issuer of debt securities, provided that such opinion is expressed using an established and defined symbol system employing letters, numbers, alphanumeric symbols, or key words." This definition would exclude credit opinion updates and other research products that provide explanation of the credit rating but which should not give rise to Form 8-K disclosures in our opinion. We have incorporated this language in our revised instructions to the proposed rule in Exhibit A.
Another example of the lack of clarity relates to the issuer's requirement to file a Form 8-K each time it is notified of a rating change for a security to which the issuer has provided some form of conditional support. We question whether this proposed rule is intended to apply to guarantees and other forms of support for affiliate indebtedness or whether it is intended to cover third party credit support arrangements as well. If the Commission's intent is to cover third party credit support arrangements, the rule would impose an onerous burden on registrants such as banks, financial guarantors and insurance companies that have numerous conditional credit support arrangements, the majority of which - on an individual basis - may be immaterial to their overall operations.
In addition, we question whether the language "contingent financial obligation" was intended to cover structured financings issued by special purpose vehicles that are sponsored by registrants. We note that Item 3.01 provides no explicit guidance as to the inclusion of structured financings in the disclosure requirement. Given the importance of structured financings to the capital resources and liquidity of registrants, we feel that the Commission should provide explicit guidance on this point. If the Commission intends for Item 3.01 to include structured financing sponsored by the registrant, we would appreciate the opportunity to provide a comment letter directed specifically to Item 3.01 and structured finance.
Finally, we are unclear as to the scope of Item 3.01(a)(2) that requires a filing when a rating agency refuses to provide a rating to an issuer. If the Commission's intent is to limit disclosure to a rating agency's refusal to provide a rating on a corporate debt security, we would note that such instances are virtually non-existent. In our experience, when a first-time corporate issuer requests a rating, it is prepared to provide the rating agency information that is both necessary and relevant to the rating process. Moody's will review all publicly available information and will obtain additional information from the issuer and other sources to assign what we believe to be the appropriate credit opinion. The issuer may be dissatisfied with the rating outcome and may elect to go to the public or private market without our rating. In this situation, however, it is the issuer's refusal to accept the rating, not the rating agency's refusal to provide the rating, which accounts for the absence of our rating on the debt instrument. Thus, as presently drafted, Item 3.01(a)(2) seems unnecessary.
C. The triggering event - rating agency notification
The proposed Item 3.01(b) requires disclosure if a "registrant is notified by, or receives any communication from, any rating agency...to the effect that the organization has decided to..." take one of the enumerated rating actions. In addition, the registrant is required to file as an exhibit to the report on Form 8-K the rating decision notice sent to it by the rating agency. We are concerned that this requirement, as drafted, could confuse registrants and could lead to incomplete or inaccurate filings. As an alternative to rating agency "notification," we suggest that the Commission revise the rule such that the triggering event is the publication of a press release by the rating agency that communicates the rating action subject to disclosure.
One possible source of confusion under this proposed rule involves situations when an issuer poses a "what-if" scenario and asks for the rating consequence were such a scenario to be put into effect.8 Moody's will consider the information and arrive at a definitive rating conclusion that is conditional upon the transaction being implemented. Arguably, our response to such a situation could be interpreted as a rating conclusion and the communication of that conclusion could trigger a disclosure requirement under Item 3.01(b) as presently drafted. However, until that hypothetical situation is in fact put into action, it will not be factored into our public rating. Consequently, a rating conclusion communicated for a hypothetical situation should not be subject to a disclosure requirement unless and until that hypothetical situation materializes and the rating agency publishes the rating action in a press release.
In another example, the proposed requirement to file the rating agency notification could result in inaccurate filings. Such a situation could arise because the initial "notice" of a rating action is typically communicated to the issuer in draft form. When a rating decision is taken by Moody's, the issuer is contacted and informed of Moody's imminent intent to publish that rating decision. As part of the process, Moody's provides the issuer with a copy of the draft press release announcing the rating decision. The issuer then has a brief opportunity to review the draft press release and ensure that it does not contain any inaccurate or non-public information. Assuming no material facts are brought to Moody's attention that would require further deliberations, Moody's makes final corrections and modifications to the press release and disseminates it to the press. Public dissemination typically occurs within one or two hours after notifying the issuer.9
It is plausible that an issuer required to file the written "notice" from the rating agency could feel compelled to file the draft press release, which may contain inaccurate or non-public information. If this rule were to be adopted, rating agencies may respond by discontinuing their practice of sending the draft press release to issuers in an effort to avoid disclosure of an unfinished work product. As an alternative, the Commission should consider clarifying the rule to require issuers to file the actual press release, once published by the rating agency. We reflect this suggestion in our revision to the rule in Exhibit A.
D. Substance of the disclosure
Although we see proposed Item 3.01 as potentially benefiting the investing public, we believe that the substance of the disclosure should emphasize management's analysis of the effect of the rating change on the issuer and not on specific aspects of the rating decision itself. We believe this information would be useful to financial analysts and investors and is consistent with the registrant's overall disclosure requirements. Our proposed revisions shift the focus in this regard.
E. Other drafting points
We have suggested changes for drafting clarity and grammatical purposes.
Moody's strongly endorses initiatives by the Commission that promote meaningful and effective disclosure by issuers. We believe that with the revisions recommended above, Item 3.01 would serve this purpose. If you have any questions regarding this letter, please feel free to contact me. Thank you for providing us this opportunity to comment on the proposals.
Very truly yours,
/s/ Raymond McDaniel
Moody's Investors Service
|1|| See also Regulation S-K, Item 303(a)(2), (the rule requires an issuer's management to describe "any known material trends, favorable or unfavorable" in the issuer's capital resources.).
|2|| Rating triggers are third party agreements that govern the pricing, availability or conditions of credit. These contractual provisions can sometimes have multiple effects with escalating severity as companies' ratings are further downgraded.
|3|| Our study found that nearly 86% of responding companies whose debt Moody's rated at the Ba1 rating category, or higher, reported that they had rating triggers, but only 22.5% disclosed such triggers in their SEC filings.
|4|| We note the asymmetry of proposed Item 3.01 as contrasted with Item 10 of Regulation S-K, which makes the disclosure of both original and changed ratings, purely voluntary. The adoption of Item 3.01 would likely require the Commission to revisit its position with respect to the voluntary disclosure of ratings in Item 10 of Regulation S-K.
|5|| The Commission has also asked whether a contractual obligation between an issuer and a rating agency should be a prerequisite for a filing requirement under Item 3.01. We do not believe that such a test would be appropriate, principally because some contractual relationships can be easily terminated to eliminate a disclosure obligation.
|6|| The Commission could mitigate this risk to some degree by imposing a look-back rule. Such a rule would trigger the disclosure requirement if a rating decision were published by an agency to which the issuer had provided information during a stated time period (for example, 12 months) before the publication of that decision. However, we remain concerned that a look-back rule may simply delay the issuer's ability to avoid the disclosure requirement.
|7|| Moody's terminology for what the Commission refers to as "credit watch" in Item 3.01(a)(3) is "watchlist." We ask that if the term "credit watch" is used in this rule, that the Commission would also consider incorporating our terminology.
|8|| An issuer, as an example, may wonder what the impact of a share-buy back program may be on its rating. It could therefore, ask its Moody's analyst to consider the rating consequence. But as the issuer has not yet bought any shares back, that conversation is simply a hypothetical discussion and as a matter of course cannot be factored into the issuer's public rating.
|9|| If the issuer informs Moody's that there is new material information available, Moody's will temporarily refrain from releasing the rating decision and assess the materiality of the new information. Such "appeals" are rare and only occur when questions of fact are outstanding or in dispute.|
Item 3.01. Rating Agency Decisions.
(a) Furnish the information required by paragraph (b) of this Item 3.01 if:
(1) [Alternative 1: any rating agency, to whom the registrant provides information (other than its annual report or reports filed with the Commission), publishes a press release announcing a change in credit rating for the registrant or any preferred security or any class of debt security or other indebtedness of the registrant (including securities or obligations as to which the registrant is a guarantor or has a contingent financial obligation);]
(1) [Alternative 2: any nationally recognized statistical rating organization, to whom the registrant provides information (other than its annual report or reports filed with the Commission), publishes a press release announcing a change in credit rating for the registrant or any preferred security or any class of debt security or other indebtedness of the registrant (including securities or obligations as to which the registrant is a guarantor or has a contingent financial obligation);]
(2) any [rating agency] [nationally recognized statistical rating organization] publishes a press release announcing a change in credit rating for the registrant or any preferred security or any class of debt security or other indebtedness of the registrant (including securities or obligations as to which the registrant is a guarantor or has a contingent financial obligation), and such change is reasonably likely to have a material impact on the registrant, its financial condition or results of operation.
(b) If [rating agency][nationally recognized statistical rating organization] publishes a press release announcing a change in credit rating as described in paragraph (a) of this Item 3.01, the registrant shall describe the effect that such change is reasonably likely to have on the registrant, its financial condition and its results of operation. Such description shall also include the date of the announcement, the name of the rating agency and the nature of the change in credit rating.
[1. Alternative 1: For purposes of Item 3.01, the term "rating agency" means an entity whose primary business is the issuance of credit ratings made broadly available to the general public for the purpose of evaluating the credit risk of investment securities.]
2. For purposes of Item 3.01, a "credit rating" means a publicly communicated opinion of a credit rating agency concerning the creditworthiness of a debt security or of an issuer of debt securities, provided that such opinion is expressed using an established and defined symbol system employing letters, numbers, alphanumeric symbols, or key words.
3. For purposes of Item 3.01, the term "contingent financial obligation" has the same meaning as in the definition included in Instruction 4 to Item 2.03 of this Form.
4. No disclosure need be made under this Item 3.01 unless the rating agency publishes a press release announcing a change in credit rating.